The Bond King: How One Man Made a Market, Built an Empire, and Lost It All

by Mary Childs

Until this point, the U.S. mortgage market had long been halfway socialist (though we’d never call it that). The government had always sort of promised it would step in and “guarantee” mortgages;

“Creative destruction”—letting things fail, for the health

of the ecosystem—now seems too destructive. What they still call capitalism has become a fun sandbox where someone always comes running if you get hurt.

The frame of this book is necessarily influenced by who would speak to me;

low interest rates reduced monthly payments, which allowed home buyers to buy bigger, fancier, more expensive homes, at the same monthly installment. Prices rose and rose. To feed the market, lenders created interest-only and other delayed- or hidden-payment loans, which only bought borrowers time as they stacked up more and more debt. Eventually, they would owe too much; the only way out was to find another buyer for an even higher price. Someday that trick would

stop working, and borrowers would stop paying. The market was “slowing under its own weight,” Pimco’s report said. The number of homes actually selling was falling; the number of homes for sale was increasing.

the world was in a state of “stable disequilibrium,” good times about to turn bad.

Being a bond investor was about seeking safety, calculable certainty. Optimism was for stock investors, people who had zero claim on the assets, who bought a story about growth, potential, and the future and hoped to ride it to the moon. Their upside was hypothetically infinite, but their investment could go to zero. They bet on faith in corporate management, instead of the black-and-white promises of bond documents, the covenants that limited the borrower’s ability to make dumb choices.

too much calm, too much stability, sows the seeds of instability. When

Sometimes in finance, he knew, you need to grind your view into everyone else’s consciousness, get people on board, force the market to turn. That

In real life, Gross was exacting, uncompromising, unwilling to back down.

avoid finance’s self-reinforcing thought bubble; out

Intentionally isolated, he said, “a quiet oasis of serenity.”

No moment wasted, no dollar left unsqueezed.

The legend went that his wife, Sue, kept a spare bedroom in their sprawling Laguna Beach compound for her to sleep in when Total Return wasn’t doing well (this rumor wasn’t true).

“The market can stay irrational longer than you can remain solvent.” Turning out to be right doesn’t do much good if you run out of money first.

“on the thesis that an unresponsive mule is not really unresponsive, just in need of additional whacks on the head with a two-by-four.”

“Reality is a delicate fabric,”

“Even in the face of hard facts, people resort to self-deception in order to protect treasured illusions.”

“To persist. To persevere. To land on my feet, keep on running, and never stop.”

The economy was suffering not from a run on the banks, as others were suggesting. No, this was a run on the shadow banking system, on that veiled, interconnected web of unregulated institutions and corporate shells, he said, “the whole alphabet soup of levered-up non-bank investment conduits, vehicles, and structures.”

A player can track how many “face” cards or high-number cards have hit the table versus low-number cards, simply by counting—plus one for every high card, minus one for every low card, depending on the system.

Thorp’s system mandated playing as long as possible, so the player got the “true odds” and not a random slice that might contain a losing streak.

“Vegas taught me that I could beat the system with a combination of hard work, ideas that no one has thought of yet, and the ability to tolerate a constant routine that to many people seems monotonous. But to me, it’s the most exciting thing in the world!”

The war room’s whiteboard hosted a “lesson plan,” the multipoint process of “What Happens During Delevering.” One, people abruptly demand to be paid

more to take risk; spreads widen. Two, people panic-sell until they raise enough cash to feel calm again. Three, raising money now depends on the arrival of clean, new balance sheets, heroes showing up. Without that, prices will keep falling.

“Strategic mediocrity,

never to be number one in a given year, but also never to blow up. Simply staying in the game long enough meant you won.

I was her son who was going to do very, very well, but not so well, it seemed, that I couldn’t ‘do better than that.’”

he was a “private placement loan officer,” evaluating to whom to lend money. (He would evaluate a nice young man named Sam Walton in Arkansas, and Warren Buffett’s Berkshire Hathaway.)

As CEO, this was Mohamed El-Erian’s mandate: find where Pimco could expand. He planned to bring the diversified-portfolio approach he’d overseen at Harvard Management Company to Pimco, by spreading money across products with different types of risks, the sum of which should have a lower overall risk profile than if all the investment eggs were in one basket. Pimco was definitionally heavy in the bond basket, which had just experienced an unprecedented run-up.

Even with all the excitement of 2008, by the end of that year, he could see the outcome of every conversation, knew the conclusion of every meeting before sitting down, could soothe every Gross eruption. People in his position always stayed on too long, and he could feel he was at risk.

he called “constructive paranoia,” feeling your competitor’s hot breath on your neck. Constant, suspicious vigilance was how you remained in the lead.

“Mohamed operated behind the scenes, usually in unilateral conversations, where he would conspire to bring others into supporting his view that other people in the organization should not be given the responsibility they currently are, or compensation, or role. He was a champion underminer of people, in a stealth fashion.”

he expected intensity; everyone should be operating at their most exceptional.

his brain’s muscle memory reverted to that instinctive mistrust.

The moment was now; stocks were a fire sale now. Why was this at all difficult? It was easy to sell equities to people, he said; people fucking love equities. They gobble them up. It’s like pepperoni pizza. Everybody eats pepperoni pizza.

For El-Erian, silence was expedient.

In Pimco’s blame-seeking framework, Gross now owned the risk; it was his problem. Should it fail, unwritten Pimco code dictated that the blame would revert to Gross—which meant the

blame would evaporate. El-Erian would stay clean.

they had it solved: “Pimco: It’s How We Think.” This new tagline shifted the focus from the products Pimco sold to its process, its thought leadership, its differentiated vision.

“The revolving door between Treasury and the giant investment funds and banks just never stops spinning,”

“If you’re in a marriage,” he answered, “each person has his or her own concept of what the argument is about. That’s because they perceive reality differently, and not always because one is right and the other is wrong. The policy prescriptions I’ve proposed were a realistic attempt to assist the markets. In my eyes, they had nothing to do with bailing out our positions.”

Yes, these opinions supported Pimco’s book, Benner wrote. “But that doesn’t make the views wrong,”

what Gross called “structural alpha”—alpha meaning outperformance (whatever can be squeezed out of a market beyond the market’s own rally, what every fund manager seeks), structural meaning replicable, persistent. Structural alpha trades were supposed to generate 0.5 percent, 1 percent in performance a year.

Structural trades, he wrote, a

portfolio’s “genetic makeup,” were one of two things that make a money manager successful over the course of a career. The other part was the “secular outlook,” or the three- to five-year forecast. Setting that forecast, he said, “forces one to think long-term, and to avoid the destructive bile arising from the emotional whipsaws of fear and greed” that compel a trader “to do exactly the wrong thing”—just as he had witnessed in his fellow gamblers

An inverted curve is a strong recession indicator, and it freaks people out every time. But as the crisis burned off, Pimco could see that things would revert to normal.

Downgrades normally push bond prices lower, as investors jump ship. Often investors are constrained by ratings—they have promised clients they will hold a proportion of bonds rated this or that and must trade around those promises. But at the moment of the U.S. downgrade, a few external factors were warping this normal chemistry.

Mortgages in the United States are not a product of a free market; it’s a little sandbox where the government supervises play, promising money if any mortgage investor gets hurt. That promise is why homeowners in the United