[FoRK] wall street over

Eugen Leitl eugen at leitl.org
Fri Nov 14 03:06:06 PST 2008


The End

by Michael Lewis Nov 11 2008

The era that defined Wall Street is finally, officially over. Michael Lewis,
who chronicled its excess in Liar’s Poker, returns to his old haunt to figure
out what went wrong.

Photoillustration by: Ji Lee

To this day, the willingness of a Wall Street investment bank to pay me
hundreds of thousands of dollars to dispense investment advice to grownups
remains a mystery to me. I was 24 years old, with no experience of, or
particular interest in, guessing which stocks and bonds would rise and which
would fall. The essential function of Wall Street is to allocate capital—to
decide who should get it and who should not. Believe me when I tell you that
I hadn’t the first clue.

I’d never taken an accounting course, never run a business, never even had
savings of my own to manage. I stumbled into a job at Salomon Brothers in
1985 and stumbled out much richer three years later, and even though I wrote
a book about the experience, the whole thing still strikes me as
preposterous—which is one of the reasons the money was so easy to walk away
from. I figured the situation was unsustainable. Sooner rather than later,
someone was going to identify me, along with a lot of people more or less
like me, as a fraud. Sooner rather than later, there would come a Great
Reckoning when Wall Street would wake up and hundreds if not thousands of
young people like me, who had no business making huge bets with other
people’s money, would be expelled from finance.

When I sat down to write my account of the experience in 1989—Liar’s Poker,
it was called—it was in the spirit of a young man who thought he was getting
out while the getting was good. I was merely scribbling down a message on my
way out and stuffing it into a bottle for those who would pass through these
parts in the far distant future.

Unless some insider got all of this down on paper, I figured, no future human
would believe that it happened.

I thought I was writing a period piece about the 1980s in America. Not for a
moment did I suspect that the financial 1980s would last two full decades
longer or that the difference in degree between Wall Street and ordinary life
would swell into a difference in kind. I expected readers of the future to be
outraged that back in 1986, the C.E.O. of Salomon Brothers, John Gutfreund,
was paid $3.1 million; I expected them to gape in horror when I reported that
one of our traders, Howie Rubin, had moved to Merrill Lynch, where he lost
$250 million; I assumed they’d be shocked to learn that a Wall Street C.E.O.
had only the vaguest idea of the risks his traders were running. What I
didn’t expect was that any future reader would look on my experience and say,
“How quaint.”

I had no great agenda, apart from telling what I took to be a remarkable
tale, but if you got a few drinks in me and then asked what effect I thought
my book would have on the world, I might have said something like, “I hope
that college students trying to figure out what to do with their lives will
read it and decide that it’s silly to phony it up and abandon their passions
to become financiers.” I hoped that some bright kid at, say, Ohio State
University who really wanted to be an oceanographer would read my book, spurn
the offer from Morgan Stanley, and set out to sea.

Somehow that message failed to come across. Six months after Liar’s Poker was
published, I was knee-deep in letters from students at Ohio State who wanted
to know if I had any other secrets to share about Wall Street. They’d read my
book as a how-to manual.

In the two decades since then, I had been waiting for the end of Wall Street.
The outrageous bonuses, the slender returns to shareholders, the never-ending
scandals, the bursting of the internet bubble, the crisis following the
collapse of Long-Term Capital Management: Over and over again, the big Wall
Street investment banks would be, in some narrow way, discredited. Yet they
just kept on growing, along with the sums of money that they doled out to
26-year-olds to perform tasks of no obvious social utility. The rebellion by
American youth against the money culture never happened. Why bother to
overturn your parents’ world when you can buy it, slice it up into tranches,
and sell off the pieces?

 At some point, I gave up waiting for the end. There was no scandal or
reversal, I assumed, that could sink the system.

Then came Meredith Whitney with news. Whitney was an obscure analyst of
financial firms for Oppenheimer Securities who, on October 31, 2007, ceased
to be obscure. On that day, she predicted that Citigroup had so mismanaged
its affairs that it would need to slash its dividend or go bust. It’s never
entirely clear on any given day what causes what in the stock market, but it
was pretty obvious that on October 31, Meredith Whitney caused the market in
financial stocks to crash. By the end of the trading day, a woman whom
basically no one had ever heard of had shaved $369 billion off the value of
financial firms in the market. Four days later, Citigroup’s C.E.O., Chuck
Prince, resigned. In January, Citigroup slashed its dividend.

>From that moment, Whitney became E.F. Hutton: When she spoke, people
listened. Her message was clear. If you want to know what these Wall Street
firms are really worth, take a hard look at the crappy assets they bought
with huge sums of ­borrowed money, and imagine what they’d fetch in a fire
sale. The vast assemblages of highly paid people inside the firms were
essentially worth nothing. For better than a year now, Whitney has responded
to the claims by bankers and brokers that they had put their problems behind
them with this write-down or that capital raise with a claim of her own:
You’re wrong. You’re still not facing up to how badly you have mismanaged
your business.

Rivals accused Whitney of being overrated; bloggers accused her of being
lucky. What she was, mainly, was right. But it’s true that she was, in part,
guessing. There was no way she could have known what was going to happen to
these Wall Street firms. The C.E.O.’s themselves didn’t know.

Now, obviously, Meredith Whitney didn’t sink Wall Street. She just expressed
most clearly and loudly a view that was, in retrospect, far more seditious to
the financial order than, say, Eliot Spitzer’s campaign against Wall Street
corruption. If mere scandal could have destroyed the big Wall Street
investment banks, they’d have vanished long ago. This woman wasn’t saying
that Wall Street bankers were corrupt. She was saying they were stupid. These
people whose job it was to allocate capital apparently didn’t even know how
to manage their own.

At some point, I could no longer contain myself: I called Whitney. This was
back in March, when Wall Street’s fate still hung in the balance. I thought,
If she’s right, then this really could be the end of Wall Street as we’ve
known it. I was curious to see if she made sense but also to know where this
young woman who was crashing the stock market with her every utterance had
come from.

It turned out that she made a great deal of sense and that she’d arrived on
Wall Street in 1993, from the Brown University history department. “I got to
New York, and I didn’t even know research existed,” she says. She’d wound up
at Oppenheimer and had the most incredible piece of luck: to be trained by a
man who helped her establish not merely a career but a worldview. His name,
she says, was Steve Eisman.

Eisman had moved on, but they kept in touch. “After I made the Citi call,”
she says, “one of the best things that happened was when Steve called and
told me how proud he was of me.”

Having never heard of Eisman, I didn’t think anything of this. But a few
months later, I called Whing for anyone who knew anything about the mortgage
business. Recalls Eisman: “I’m a junior analyst and just trying to figure out
which end is up, but I told him that as a lawyer I’d worked on a deal for the
Money Store.” He was promptly appointed the lead analyst for Ames Financial.
“What I didn’t tell him was that my job had been to proofread the ­documents
and that I hadn’t understood a word of the fucking things.”

Ames Financial belonged to a category of firms known as nonbank financial
institutions. The category didn’t include J.P. Morgan, but it did encompass
many little-known companies that one way or another were involved in the
early-1990s boom in subprime mortgage lending—the lower class of American

The second company for which Eisman was given sole responsibility was Lomas
Financial, which had just emerged from bankruptcy. “I put a sell rating on
the thing because it was a piece of shit,” Eisman says. “I didn’t know that
you weren’t supposed to put a sell rating on companies. I thought there were
three boxes—buy, hold, sell—and you could pick the one you thought you
should.” He was pressured generally to be a bit more upbeat, but upbeat
wasn’t Steve Eisman’s style. Upbeat and Eisman didn’t occupy the same planet.
A hedge fund manager who counts Eisman as a friend set out to explain him to
me but quit a minute into it. After describing how Eisman exposed various
important people as either liars or idiots, the hedge fund manager started to
laugh. “He’s sort of a prick in a way, but he’s smart and honest and

 “A lot of people don’t get Steve,” Whitney says. “But the people who get him
love him.” Eisman stuck to his sell rating on Lomas Financial, even after the
company announced that investors needn’t worry about its financial condition,
as it had hedged its market risk. “The single greatest line I ever wrote as
an analyst,” says Eisman, “was after Lomas said they were hedged.” He recited
the line from memory: “ ‘The Lomas Financial cy.

Eisman wasn’t, in short, an analyst with a sunny disposition who expected the
best of his fellow financial man and the companies he created. “You have to
understand,” Eisman says in his defense, “I did subprime first. I lived with
the worst first. These guys lied to infinity. What I learned from that
experience was that Wall Street didn’t give a shit what it sold.”

Harboring suspicions about ­people’s morals and telling investors that
companies don’t deserve their capital wasn’t, in the 1990s or at any other
time, the fast track to success on Wall Street. Eisman quit Oppenheimer in
2001 to work as an analyst at a hedge fund, but what he really wanted to do
was run money. FrontPoint Partners, another hedge fund, hired him in 2004 to
invest in financial stocks. Eisman’s brief was to evaluate Wall Street banks,
homebuilders, mortgage originators, and any company (General Electric or
General Motors, for instance) with a big financial-services division—anyone
who touched American finance. An insurance company backed him with $50
million, a paltry sum. “Basically, we tried to raise money and didn't really
do it,” Eisman says.

Instead of money, he attracted people whose worldviews were as shaded as his
own—Vincent Daniel, for instance, who became a partner and an analyst in
charge of the mortgage sector. Now 36, Daniel grew up a lower-middle-class
kid in Queens. One of his first jobs, as a junior accountant at Arthur
Andersen, was to audit Salomon Brothers’ books. “It was shocking,” he says.
“No one could explain to me what they were doing.” He left accounting in the
middle of the internet boom to become a research analyst, looking at
companies that made subprime loans. “I was the only guy I knew covering
companies that were all going to go bust,” he says. “I saw how the sausage
was made in the economy, and it was really freaky.”

Danny Moses, who became Eisman’s head trader, was another who shared his
perspective. Raised in Georgia, Moses, the son of a finance professor, iate
this, but I just want to know one thing: How are you going to screw me?”

Heh heh heh, c’mon. We’d never do that, the trader started to say, but Moses
was politely insistent: We both know that unadulterated good things like this
trade don’t just happen between little hedge funds and big Wall Street firms.
I’ll do it, but only after you explain to me how you are going to screw me.
And the salesman explained how he was going to screw him. And Moses did the

Both Daniel and Moses enjoyed, immensely, working with Steve Eisman. He put a
fine point on the absurdity they saw everywhere around them. “Steve’s fun to
take to any Wall Street meeting,” Daniel says. “Because he’ll say ‘Explain
that to me’ 30 different times. Or ‘Could you explain that more, in English?’
Because once you do that, there’s a few things you learn. For a start, you
figure out if they even know what they’re talking about. And a lot of times,
they don’t!”

At the end of 2004, Eisman, Moses, and Daniel shared a sense that unhealthy
things were going on in the U.S. housing market: Lots of firms were lending
money to people who shouldn’t have been borrowing it. They thought Alan
Greenspan’s decision after the internet bust to lower interest rates to 1
percent was a travesty that would lead to some terrible day of reckoning.
Neither of these insights was entirely original. Ivy Zelman, at the time the
housing-market analyst at Credit Suisse, had seen the bubble forming very
early on. There’s a simple measure of sanity in housing prices: the ratio of
median home price to income. Historically, it runs around 3 to 1; by late
2004, it had risen nationally to 4 to 1. “All these people were saying it was
nearly as high in some other countries,” Zelman says. “But the problem wasn’t
just that it was 4 to 1. In Los Angeles, it was 10 to 1, and in Miami, 8.5 to
1. And then you coupled that with the buyers. They weren’t real buyers. They
were speculators.” Zelman alienated clients with her pessimism, but she
couldn’t pretend everything was good. “It wasn’t that hard in hindsight to
see it,” she says. “It was very hard to know when it would stop.” Zelman
spoke occasionally with Eisman and always left these conversations feeling
better about her views and worse about the world. “You needed the occasional
assurance that you weren’t nuts,” she says. She wasn’t nuts. The world was.

By the spring of 2005, FrontPoint was fairly convinced that something was
very screwed up not merely in a handful of companies but in the financial
underpinnings of the entire U.S. mortgage market. In 2000, there had been
$130 billion in subprime mortgage lending, with $55 billion of that
repackaged as mortgage bonds. But in 2005, there was $625 billion in subprime
mortgage loans, $507 billion of which found its way into mortgage bonds.
Eisman couldn’t understand who was making all these loans or why. He had a
from-the-ground-up understanding of both the U.S. housing market and Wall
Street. But he’d spent his life in the stock market, and it was clear that
the stock market was, in this story, largely irrelevant. “What most people
don’t realize is that the fixed-income world dwarfs the equity world,” he
says. “The equity world is like a fucking zit compared with the bond market.”
He shorted companies that originated subprime loans, like New Century and
Indy Mac, and companies that built the houses bought with the loans, such as
Toll Brothers. Smart as these trades proved to be, they weren’t entirely
satisfying. These companies paid high dividends, and their shares were often
expensive to borrow; selling them short was a costly proposition.

 Enter Greg Lippman, a mortgage-bond trader at Deutsche Bank. He arrived at
FrontPoint bearing a 66-page presentation that described a better way for the
fund to put its view of both Wall Street and the U.S. housing market into
action. The smart trade, Lippman argued, was to sell short not New Century’s
stock but its bonds that were backed by the subprime loans it had made.
Eisman hadn’t known this was even possible—because until recently, it hadn’t
been. But Lippman, along with traders at other Wall Street investment banks,
had created a way to short the subprime bond market with precision.

Here’s where financial technology became suddenly, urgently relevant. The
typical mortgage bond was still structured in much the same way it had been
when I worked at Salomon Brothers. The loans went into a trust that was
designed to pay off its investors not all at once but according to their
rankings. The investors in the top tranche, rated AAA, received the first
payment from the trust and, because their investment was the least risky,
received the lowest interest rate on their money. The investors who held the
trusts’ BBB tranche got the last payments—and bore the brunt of the first
defaults. Because they were taking the most risk, they received the highest
return. Eisman wanted to bet that some subprime borrowers would default,
causing the trust to suffer losses. The way to express this view was to short
the BBB tranche. The trouble was that the BBB tranche was only a tiny slice
of the deal.

But the scarcity of truly crappy subprime-mortgage bonds no longer mattered.
The big Wall Street firms had just made it possible to short even the tiniest
and most obscure subprime-mortgage-backed bond by creating, in effect, a
market of side bets. Instead of shorting the actual BBB bond, you could now
enter into an agreement for a credit-default swap with Deutsche Bank or
Goldman Sachs. It cost money to make this side bet, but nothing like what it
cost to short the stocks, and the upside was far greater.  

The arrangement bore the same relation to actual finance as fantasy football
bears to the N.F.L. Eisman was perplexed in particular about why Wall Street
firms would be coming to him and asking him to sell short. “What Lippman did,
to his credit, was he came around several times to me and said, ‘Short this
market,’ ” Eisman says. “In my entire life, I never saw a sell-side guy come
in and say, ‘Short my market.’ ”

And short Eisman did—then he tried to get his mind around what he’d just done
so he could do it better. He’d call over to a big firm and ask for a list of
mortgage bonds from all over the country. The juiciest shorts—the bonds
ultimately backed by the mortgages most likely to default—had several
characteristics. They’d be in what Wall Street people were now calling the
sand states: Arizona, California, Florida, Nevada. The loans would have been
made by one of the more dubious mortgage lenders; Long Beach Financial,
wholly owned by Washington Mutual, was a great example. Long Beach Financial
was moving money out the door as fast as it could, few questions asked, in
loans built to self-destruct. It specialized in asking home­owners with bad
credit and no proof of income to put no money down and defer interest
payments for as long as possible. In Bakersfield, California, a Mexican
strawberry picker with an income of $14,000 and no English was lent every
penny he needed to buy a house for $720,000.

More generally, the subprime market tapped a tranche of the American public
that did not typically have anything to do with Wall Street. Lenders were
making loans to people who, based on their credit ratings, were less
creditworthy than 71 percent of the population. Eisman knew some of these
people. One day, his housekeeper, a South American woman, told him that she
was planning to buy a townhouse in Queens. “The price was absurd, and they
were giving her a low-down-payment option-ARM,” says Eisman, who talked her
into taking out a conventional fixed-rate mortgage. Next, the baby nurse he’d
hired back in 1997 to take care of his newborn twin daughters phoned him.
“She was this lovely woman from Jamaica,” he says. “One day she calls me and
says she and her sister own five townhouses in Queens. I said, ‘How did that
happen?’ ” It happened because after they bought the first one and its value
rose, the lenders came and suggested they refinance and take out $250,000,
which they used to buy another one. Then the price of that one rose too, and
they repeated the experiment. “By the time they were done,” Eisman says,
“they owned five of them, the market was falling, and they couldn’t make any
of the payments.”

 In retrospect, pretty much all of the riskiest subprime-backed bonds were
worth betting against; they would all one day be worth zero. But at the time
Eisman began to do it, in the fall of 2006, that wasn’t clear. He and his
team set out to find the smelliest pile of loans they could so that they
could make side bets against them with Goldman Sachs or Deutsche Bank. What
they were doing, oddly enough, was the analysis of subprime lending that
should have been done before the loans were made: Which poor Americans were
likely to jump which way with their finances? How much did home prices need
to fall for these loans to blow up? (It turned out they didn’t have to fall;
they m was Moody’s, the aristocrats of the rating business, 20 percent owned
by Warren Buffett. And the company’s C.E.O. was being told he was either a
fool or a crook by one Vincent Daniel, from Queens.

A full nine months earlier, Daniel and ­Moses had flown to Orlando for an
industry conference. It had a grand title—the American Securitization
Forum—but it was essentially a trade show for the ­subprime-mortgage
business: the people who originated subprime mortgages, the Wall Street firms
that packaged and sold subprime mortgages, the fund managers who invested in
nothing but subprime-mortgage-backed bonds, the agencies that rated
subprime-­mortgage bonds, the lawyers who did whatever the lawyers did.
Daniel and Moses thought they were paying a courtesy call on a cottage
industry, but the cottage had become a castle. “There were like 6,000 people
there,” Daniel says. “There were so many people being fed by this industry.
The entire fixed-income department of each brokerage firm is built on this.
Everyone there was the long side of the trade. The wrong side of the trade.
And then there was us. That’s when the picture really started to become
clearer, and we started to get more cynical, if that was possible. We went
back home and said to Steve, ‘You gotta see this.’ ”

Eisman, Daniel, and Moses then flew out to Las Vegas for an even bigger
subprime conference. By now, Eisman knew everything he needed to know about
the quality of the loans being made. He still didn’t fully understand how the
apparatus worked, but he knew that Wall Street had built a doomsday machine.
He was at once opportunistic and outraged.

Their first stop was a speech given by the C.E.O. of Option One, the mortgage
originator owned by H&R Block. When the guy got to the part of his speech
about Option One’s subprime-loan portfolio, he claimed to be expecting a
modest default rate of 5 percent. Eisman raised his hand. Moses and Daniel
sank into their chairs. “It wasn’t a Q&A,” says Moses. “The guy was giving a
speech. He seeans, would pronounce most of them AAA. These bonds could then
be sold to investors—pension funds, insurance companies—who were allowed to
invest only in highly rated securities. “I cannot fucking believe this is
allowed—I must have said that a thousand times in the past two years,” Eisman

His dinner companion in Las Vegas ran a fund of about $15 billion and managed
C.D.O.’s backed by the BBB tranche of a mortgage bond, or as Eisman puts it,
“the equivalent of three levels of dog shit lower than the original bonds.”

FrontPoint had spent a lot of time digging around in the dog shit and knew
that the default rates were already sufficient to wipe out this guy’s entire
portfolio. “God, you must be having a hard time,” Eisman told his dinner

“No,” the guy said, “I’ve sold everything out.”

After taking a fee, he passed them on to other investors. His job was to be
the C.D.O. “expert,” but he actually didn’t spend any time at all thinking
about what was in the C.D.O.’s. “He managed the C.D.O.’s,” says Eisman, “but
managed what? I was just appalled. People would pay up to have someone manage
their C.D.O.’s—as if this moron was helping you. I thought, You prick, you
don’t give a fuck about the investors in this thing.”

 Whatever rising anger Eisman felt was offset by the man’s genial
disposition. Not only did he not mind that Eisman took a dim view of his
C.D.O.’s; he saw it as a basis for friendship. “Then he said something that
blew my mind,” Eisman tells me. “He says, ‘I love guys like you who short my
market. Without you, I don’t have anything to buy.’ ”

That’s when Eisman finally got it. Here he’d been making these side bets with
Goldman Sachs and Deutsche Bank on the fate of the BBB tranche without fully
understanding why those firms were so eager to make the bets. Now he saw.
There weren’t enough Americans with shitty credit taking out loans to satisfy
investors’ appetite for the end product. The firms used Eisman’s bet to
synthesize more of them. Here, then, was the differen and fantasy football:
When a fantasy player drafts Peyton Manning, he doesn’t create a second
Peyton Manning to inflate the league’s stats. But when Eisman bought a
credit-default swap, he enabled Deutsche Bank to create another bond
identical in every respect but one to the original. The only difference was
that there was no actual homebuyer or borrower. The only assets backing the
bonds were the side bets Eisman and others made with firms like Goldman
Sachs. Eisman, in effect, was paying to Goldman the interest on a subprime
mortgage. In fact, there was no mortgage at all. “They weren’t satisfied
getting lots of unqualified borrowers to borrow money to buy a house they
couldn’t afford,” Eisman says. “They were creating them out of whole cloth.
One hundred times over! That’s why the losses are so much greater than the
loans. But that’s when I realized they needed us to keep the machine running.
I was like, This is allowed?”

This particular dinner was hosted by Deutsche Bank, whose head trader, Greg
Lippman, was the fellow who had introduced Eisman to the subprime bond
market. Eisman went and found Lippman, pointed back to his own dinner
companion, and said, “I want to short him.” Lippman thought he was joking; he
wasn’t. “Greg, I want to short his paper,” Eisman repeated. “Sight unseen.”

Eisman started out running a $60 million equity fund but was now short around
$600 million of various ­subprime-related securities. In the spring of 2007,
the market strengthened. But, says Eisman, “credit quality always gets better
in March and April. And the reason it always gets better in March and April
is that people get their tax refunds. You would think people in the
securitization world would know this. We just thought that was moronic.”

He was already short the stocks of mortgage originators and the homebuilders.
Now he took short positions in the rating agencies—“they were making 10 times
more rating C.D.O.’s than they were rating G.M. bonds, and it was all going
to end”—and, finally, the biggest Wall Street firms because of their exposure
to C.D.O.’s. He wasn’t allowed to short Morgan Stanley because it owned a
stake in his fund. But he shorted UBS, Lehman Brothers, and a few others. Not
long after that, FrontPoint had a visit from Sanford C. Bernstein’s Brad
Hintz, a prominent analyst who covered Wall Street firms. Hintz wanted to
know what Eisman was up to. “We just shorted Merrill Lynch,” Eisman told him.

“Why?” asked Hintz.

“We have a simple thesis,” Eisman explained. “There is going to be a
calamity, and whenever there is a calamity, Merrill is there.” When it came
time to bankrupt Orange County with bad advice, Merrill was there. When the
internet went bust, Merrill was there. Way back in the 1980s, when the first
bond trader was let off his leash and lost hundreds of millions of dollars,
Merrill was there to take the hit. That was Eisman’s logic—the logic of Wall
Street’s pecking order. Goldman Sachs was the big kid who ran the games in
this neighborhood. Merrill Lynch was the little fat kid assigned the least
pleasant roles, just happy to be a part of things. The game, as Eisman saw
it, was Crack the Whip. He assumed Merrill Lynch had taken its assigned place
at the end of the chain.

There was only one thing that bothered Eisman, and it continued to trouble
him as late as May 2007. “The thing we couldn’t figure out is: It’s so
obvious. Why hasn’t everyone else figured out that the machine is done?”
Eisman had long subscribed to Grant’s Interest Rate Observer, a newsletter
famous in Wall Street circles and obscure outside them. Jim Grant, its
editor, had been prophesying doom ever since the great debt cycle began, in
the mid-1980s. In late 2006, he decided to investigate these things called
C.D.O.’s. Or rather, he had asked his young assistant, Dan Gertner, a
chemical engineer with an M.B.A., to see if he could understand them. Gertner
went off with the documents that purported to explain C.D.O.’s to potential
investors and for several days sweated and groaned and heaved and suffered.
“Then he came back,” says Grant, “and said, ‘I can’t figure this thing out.’
And I said, ‘I think we have our story.’ ”

 Eisman read Grant’s piece as independent confirmation of what he knew in his
bones about the C.D.O.’s he had shorted. “When I read it, I thought, Oh my
God. This is like owning a gold mine. When I read that, I was the only guy in
the equity world who almost had an orgasm.”

On July 19, 2007, the same day that Federal Reserve Chairman Ben Bernanke
told the U.S. Senate that he anticipated as much as $100 billion in losses in
the subprime-mortgage market, FrontPoint did something unusual: It hosted its
own conference call. It had had calls with its tiny population of investors,
but this time FrontPoint opened it up. Steve Eisman had become a poorly kept
secret. Five hundred people called in to hear what he had to say, and another
500 logged on afterward to listen to a recording of it. He explained the
strange alchemy of the C.D.O. and said that he expected losses of up to $300
billion from this sliver of the market alone. To evaluate the situation, he
urged his audience to “just throw your model in the garbage can. The models
are all backward-looking.

The models don’t have any idea of what this world has become…. For the first
time in their lives, people in the asset-backed-securitization world are
actually having to think.” He explained that the rating agencies were morally
bankrupt and living in fear of becoming actually bankrupt. “The rating
agencies are scared to death,” he said. “They’re scared to death about doing
nothing because they’ll look like fools if they do nothing.”

On September 18, 2008, Danny Moses came to work as usual at 6:30 a.m. Earlier
that week, Lehman Brothers had filed for bankruptcy. The day before, the Dow
had fallen 449 points to its lowest level in four years. Overnight, European
governments announced a ban on short-selling, but that served as faint
warning for what happened next.

At the market opening in the U.S., everything—every financial asset—went into
free fall. “All hell was breaking loose in a way I had never seen in my
career,” Moses says. FrontPoint was net short the market, so this total
collapse should have given Moses pleasure. He might have been forgiven if he
stood up and cheered. After all, he’d been betting for two years that this
sort of thing could happen, and now it was, more dramatically than he had
ever imagined. Instead, he felt this terrifying shudder run through him. He
had maybe 100 trades on, and he worked hard to keep a handle on them all. “I
spent my morning trying to control all this energy and all this information,”
he says, “and I lost control. I looked at the screens. I was staring into the
abyss. The end. I felt this shooting pain in my head. I don’t get headaches.
At first, I thought I was having an aneurysm.”

Moses stood up, wobbled, then turned to Daniel and said, “I gotta leave. Get
out of here. Now.” Daniel thought about calling an ambulance but instead took
Moses out for a walk.

Outside it was gorgeous, the blue sky reaching down through the tall
buildings and warming the soul. Eisman was at a Goldman Sachs conference for
hedge fund managers, raising capital. Moses and Daniel got him on the phone,
and he left the conference and met them on the steps of St. Patrick’s
Cathedral. “We just sat there,” Moses says. “Watching the people pass.”

This was what they had been waiting for: total collapse. “The
investment-banking industry is fucked,” Eisman had told me a few weeks
earlier. “These guys are only beginning to understand how fucked they are.
It’s like being a Scholastic, prior to Newton. Newton comes along, and one
morning you wake up: ‘Holy shit, I’m wrong!’ ” Now Lehman Brothers had
vanished, Merrill had surrendered, and Goldman Sachs and Morgan Stanley were
just a week away from ceasing to be investment banks. The investment banks
were not just fucked; they were extinct.

Not so for hedge fund managers who had seen it coming. “As we sat there, we
were weirdly calm,” Moses says. “We felt insulated from the whole market
reality. It was an out-of-body experience. We just sat and watched the people
pass and talked about what might happen next. How many of these people were
going to lose their jobs. Who was going to rent these buildings after all the
Wall Street firms collapsed.” Eisman was appalled. “Look,” he said. “I’m
short. I don’t want the country to go into a depression. I just want it to
fucking deleverage.” He had tried a thousand times in a thousand ways to
explain how screwed up the business was, and no one wanted to hear it. “That
Wall Street has gone down because of this is justice,” he says. “They fucked
people. They built a castle to rip people off. Not once in all these years
have I come across a person inside a big Wall Street firm who was having a
crisis of conscience.”

Truth to tell, there wasn’t a whole lot of hand-wringing inside FrontPoint
either. The only one among them who wrestled a bit with his conscience was
Daniel. “Vinny, being from Queens, needs to see the dark side of everything,”
Eisman says. To which Daniel replies, “The way we thought about it was, ‘By
shorting this market we’re creating the liquidity to keep the market
going.’ ”

“It was like feeding the monster,” Eisman says of the market for subprime
bonds. “We fed the monster until it blew up.”

About the time they were sitting on the steps of the midtown cathedral, I sat
in a booth in a restaurant on the East Side, waiting for John Gutfreund to
arrive for lunch, and wondered, among other things, why any restaurant would
seat side by side two men without the slightest interest in touching each
otheed Too Early in Life” along with some child actors who’d gone on to
become drug addicts.) Anti-Wall Street feeling ran high—high enough for Rudy
Giuliani to float a political career on it—but the result felt more like a
witch hunt than an honest reappraisal of the financial order. The public
lynchings of Gutfreund and junk-bond king Michael Milken were excuses not to
deal with the disturbing forces underpinning their rise. Ditto the cleaning
up of Wall Street’s trading culture. The surface rippled, but down below, in
the depths, the bonus pool remained undisturbed. Wall Street firms would soon
be frowning upon profanity, firing traders for so much as glancing at a
stripper, and forcing male employees to treat women almost as equals. Lehman
Brothers circa 2008 more closely resembled a normal corporation with solid
American values than did any Wall Street firm circa 1985.

 The changes were camouflage. They helped distract outsiders from the truly
profane event: the growing misalignment of interests between the people who
trafficked in financial risk and the wider culture.

I’d not seen Gutfreund since I quit Wall Street. I’d met him, nervously, a
couple of times on the trading floor. A few months before I left, my bosses
asked me to explain to Gutfreund what at the time seemed like exotic trades
in derivatives I’d done with a European hedge fund. I tried. He claimed not
to be smart enough to understand any of it, and I assumed that was how a Wall
Street C.E.O. showed he was the boss, by rising above the details. There was
no reason for him to remember any of these encounters, and he didn’t: When my
book came out and became a public-relations nuisance to him, he told
reporters we’d never met.

Over the years, I’d heard bits and pieces about Gutfreund. I knew that after
he’d been forced to resign from Salomon Brothers he’d fallen on harder times.
I heard later that a few years ago he’d sat on a panel about Wall Street at
Columbia Business School. When his turn came to speak, he advised students to
find something morme animal need to see the world as it was, rather than as
it should be.

We spent 20 minutes or so determining that our presence at the same lunch
table was not going to cause the earth to explode. We discovered we had a
mutual acquaintance in New Orleans. We agreed that the Wall Street C.E.O. had
no real ability to keep track of the frantic innovation occurring inside his
firm. (“I didn’t understand all the product lines, and they don’t either,” he
said.) We agreed, further, that the chief of the Wall Street investment bank
had little control over his subordinates. (“They’re buttering you up and then
doing whatever the fuck they want to do.”) He thought the cause of the
financial crisis was “simple. Greed on both sides—greed of investors and the
greed of the bankers.” I thought it was more complicated. Greed on Wall
Street was a given—almost an obligation. The problem was the system of
incentives that channeled the greed.

But I didn’t argue with him. For just as you revert to being about nine years
old when you visit your parents, you revert to total subordination when you
are in the presence of your former C.E.O. John Gutfreund was still the King
of Wall Street, and I was still a geek. He spoke in declarative statements; I
spoke in questions.

But as he spoke, my eyes kept drifting to his hands. His alarmingly thick and
meaty hands. They weren’t the hands of a soft Wall Street banker but of a
boxer. I looked up. The boxer was smiling—though it was less a smile than a
placeholder expression. And he was saying, very deliberately,

I smiled back, though it wasn’t quite a smile.

“Your fucking book destroyed my career, and it made yours,” he said.

I didn’t think of it that way and said so, sort of.

“Why did you ask me to lunch?” he asked, though pleasantly. He was genuinely

You can’t really tell someone that you asked him to lunch to let him know
that you don’t think of him as evil. Nor can you tell him that you asked him
to lunch because you thought that you could trace the biggest financial
crisis in the history of the world back to a decision he had made. John
Gutfreund did violence to the Wall Street social order—and got himself dubbed
the King of Wall Street—when he turned Salomon Brothers from a private
partnership into Wall Street’s first public corporation. He ignored the
outrage of Salomon’s retired partners. (“I was disgusted by his materialism,”
William Salomon, the son of the firm’s founder, who had made Gutfreund C.E.O.
only after he’d promised never to sell the firm, had told me.) He lifted a
giant middle finger at the moral disapproval of his fellow Wall Street
C.E.O.’s. And he seized the day. He and the other partners not only made a
quick killing; they transferred the ultimate financial risk from themselves
to their shareholders. It didn’t, in the end, make a great deal of sense for
the shareholders. (A share of Salomon Brothers purchased when I arrived on
the trading floor, in 1986, at a then market price of $42, would be worth
2.26 shares of Citigroup today—market value: $27.) But it made fantastic
sense for the investment bankers.

>From that moment, though, the Wall Street firm became a black box. The
shareholders who financed the risks had no real understanding of what the
risk takers were doing, and as the risk-taking grew ever more complex, their
understanding diminished. The moment Salomon Brothers demonstrated the
potential gains to be had by the investment bank as public corporation, the
psychological foundations of Wall Street shifted from trust to blind faith.

No investment bank owned by its employees would have levered itself 35 to 1
or bought and held $50 billion in mezzanine C.D.O.’s. I doubt any partnership
would have sought to game the rating agencies or leap into bed with loan
sharks or even allow mezzanine C.D.O.’s to be sold to its customers. The
hoped-for short-term gain would not have justified the long-term hit.

No partnership, for that matter, would have hired me or anyone remotely like
me. Was there ever any correlation between the ability to get in and out of
Princeton and a talent for taking financial risk?

Now I asked Gutfreund about his biggest decision. “Yes,” he said. “They—the
heads of the other Wall Street firms—all said what an awful thing it was to
go public and how could you do such a thing. But when the temptation arose,
they all gave in to it.” He agreed that the main effect of turning a
partnership into a corporation was to transfer the financial risk to the
shareholders. “When things go wrong, it’s their problem,” he said—and
obviously not theirs alone. When a Wall Street investment bank screwed up
badly enough, its risks became the problem of the U.S. government. “It’s
laissez-faire until you get in deep shit,” he said, with a half chuckle. He
was out of the game.

It was now all someone else’s fault.

He watched me curiously as I scribbled down his words. “What’s this for?” he

I told him I thought it might be worth revisiting the world I’d described in
Liar’s Poker, now that it was finally dying. Maybe bring out a
20th-anniversary edition.

“That’s nauseating,” he said.

Hard as it was for him to enjoy my company, it was harder for me not to enjoy
his. He was still tough, as straight and blunt as a butcher. He’d helped
create a monster, but he still had in him a lot of the old Wall Street, where
people said things like “A man’s word is his bond.” On that Wall Street,
people didn’t walk out of their firms and cause trouble for their former
bosses by writing books about them. “No,” he said, “I think we can agree
about this: Your fucking book destroyed my career, and it made yours.” With
that, the former king of a former Wall Street lifted the plate that held his
appetizer and asked sweetly, “Would you like a deviled egg?”

Until that moment, I hadn’t paid much attention to what he’d been eating. Now
I saw he’d ordered the best thing in the house, this gorgeous frothy
confection of an earlier age. Who ever dreamed up the deviled egg? Who knew
that a simple egg could be made so complicated and yet so appealing? I
reached over and took one. Something for nothing. It never loses its charm. 

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