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US downgrade: an opportunity in a disaster

business Updated: Aug 14, 2011 22:02 IST
Highlight Story

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