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US downgrade: an opportunity in a disaster

business Updated: Aug 14, 2011 22:02 IST

One of the most harrowing stretches in Wall Street history began with the loss of the AAA credit rating of the United States and ended with fears of a new recession. In between, the wild swings in the financial markets captivated the nation, and the world.

Financial professionals were grasping for answers. Many were selling — and many were buying as fast as they could.

Noon Saturday, Aug. 6: Pasadena, Califonia.

Stephen Walsh, the chief investment officer of Western Asset, had been expecting the e-mail all day.

"How do you think the markets will respond on Monday?" a worried official from the US Treasury asked him.

"World investors didn't downgrade US debt; S&P did,” he told one caller. “It’s just one opinion.”

“What if you're wrong?” his wife asked him.

“That’s the great thing about Wall Street,” he replied. “We’ll know Monday morning if I’m a genius or an idiot.”

11.30 pm Sunday, Aug. 7: East 66th Street, Manhattan

It looked like a sell-off. Not a panic like the one struck in 2008, but something different. Michael Warlan, who heads equity trading for Third Avenue, a mutual fund company, smelled opportunity. He sat with a list of stocks he had been eyeing for months. Many were dropping close to the target prices that Third Avenue had been seeking. His colleagues were calling.

The consensus: it was time to buy.

Warlan started executing trades in foreign markets, pausing for a nap around 2 am, then waking at 4 am for the opening of European markets. Without stopping to sleep any more, he went to his office that morning, at the corner of Third Avenue and 41st Street, a few blocks from Grand Central Station. By close of business on Monday, he had spent $110 million to buy stocks around the world.

“It was adrenaline,” he would later say. “Pure adrenaline.”

They had worked up a list of companies that they suspected would suffer from a spooked market. Ford. HCA. Energy stocks. As the trader watched his screens, he saw that those companies' bond prices were trading 8% to 10% below their expected range.

It didn't make any sense: Ford’s finances hadn't changed over the weekend. HCA — a large hospital chain - hadn't stopped admitting patients. It was as if investors were dumping anything with a hint of risk, and, paradoxically, rushing to Treasuries, the very securities that S&P had just downgraded.

Western Asset had set aside $700 million for just such an opportunity. His trader started bidding on bonds that, seemingly, no one else wanted to touch.

A week later: looking back on the hundreds of trades he made, was he happy?

“I’m happy we had a plan in place for these very circumstances,” he said.

And the trades themselves? “Talk to me in 6 to 12 months.”

The New York Times