cancel2 2022
Canceled
This extract is from the book the Big Short by Michael Lewis, when will these people be brought to book?
From The Sunday Times
March 21, 2010
Liars Poker II
Two decades ago, a former bond trader wrote a darkly comic exposé of Wall Street lies and excess. Now he traces the roots of the biggest financial crisis in history back to the decision of one man – and finds the few who made billions betting on the collapse
Michael Douglas reprises, his role as the unscrupulous Gordon Gekko in Wall Street; Money Never Sleeps
Michael Lewis
The willingness of a Wall Street investment bank to pay me hundreds of thousands of dollars to dispense investment advice to grown-ups remains a mystery to me to this day. I was 24 with no experience of, or particular interest in, guessing which stocks and bonds would rise and which would fall. Believe me, 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, richer, in 1988. 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 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 or persuading other people to make those bets, would be expelled from finance.
When I sat down to write my account of the experience in a book called Liar’s Poker, I thought I was recording a period piece about the 1980s in America, when a great nation lost its financial mind. I expected readers of the future would be appalled that back in 1986 the CEO of Salomon Brothers, John Gutfreund, was paid millions as he ran the business into the ground. I expected them to gape in wonder at the story of the mortgage bond trader who had lost $250m and to be shocked that once upon a time on Wall Street the CEOs had only the vaguest idea of the complicated risks their bond traders were running.
Not for a moment did I suspect that the financial 1980s would last for two full decades longer. That a single bond trader might be paid $47m a year and feel cheated. That the mortgage bond market, invented on the Salomon Brothers trading floor, would lead to the most purely financial economic disaster in history.
In the two decades after I left I waited for the end of Wall Street as I had known it. Over and over again the financial system was discredited in some narrow way: the outrageous bonuses, the endless parade of rogue traders, the scandal that destroyed Gutfreund and finished off Salomon Brothers, the crisis following the collapse of the Long-Term Capital Management hedge fund (run by another old boss, John Meriwether), the internet bubble.
Yet the big Wall Street banks at the centre of it just kept on growing, along with the sums of money they doled out to 24-year-olds to perform tasks of no obvious social utility.
At some point I gave up waiting. There was no scandal or reversal, I assumed, sufficiently great to sink the system. Then came the events of 2008. In mid-September that year, as the investment banking system collapsed, I sat in a restaurant on Manhattan’s East Side waiting for Gutfreund to arrive for lunch.
I had not seen my old boss since I quit Wall Street. I’d met him, nervously, a couple of times on the trading floor. A few months before I’d quit, I had tried to explain to him what at the time seemed exotic trades in derivatives that I had done with a European hedge fund. He claimed not to be smart enough to understand and I assumed that was how a Wall Street CEO showed he was the boss, by rising above the details. There was no reason for him to remember and when my book became a public-relations nuisance to him he told reporters that we had never met.
I knew that after he’d been forced to resign in 1991 he had fallen on harder times. I heard that he had sat on a panel about Wall Street at the Columbia Business School. When his turn came to speak, he advised the students to find some more meaningful thing to do with their lives than go to work on Wall Street. As he began to describe his career, he had broken down and wept.
When I had emailed Gutfreund to invite him to lunch, he could not have been more polite or more gracious. That attitude persisted as he was escorted to the table, made chitchat with the owner and ordered his food. He was more deliberate in his movements but was completely recognisable. The same veneer of courtliness masked the same animal impulse to see the world as it is 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 a mutual friend. We agreed that the Wall Street CEO 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.”) We agreed, further, that the CEO of the Wall Street investment bank had shockingly little control over his subordinates. (“They’re buttering you up and then doing whatever the f*** 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 channelled the greed.
The line between gambling and investing is artificial and thin, and the outcome should be the same: for every winner there is a loser. Pretty much all the important people on both sides of the gamble that shattered Wall Street in 2008 left the table rich, however.
A few shrewd investors “shorted” the sub-prime mortgage bond market. Realising that the odds were in their favour, they gambled on the inevitable collapse of the multi-trillion-dollar bond market built on mortgages taken out by poor Americans. They reaped millions, even billions. The people on the other side —the entire financial system, essentially — failed to realise they were betting with the odds against them. The CEOs of every major Wall Street firm either ran their public corporations into bankruptcy or were saved from bankruptcy by the US government. Yet they all got rich, too.
What are the odds that people will make smart decisions about money if they don’t need to make smart decisions — if they can get rich making dumb decisions? The incentives on Wall Street were all wrong; they’re still all wrong.
But I didn’t argue with Gutfreund. Just as you revert to being about nine years old when you go home to visit your parents, you revert to total subordination when you are in the presence of your former CEO. 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 were not 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, “Your . . . f****** . . . book.”
I smiled back, though it wasn’t quite a smile.
“Why did you ask me to lunch?” he asked, though pleasantly. He was genuinely curious.
You can’t really tell someone that you asked him to lunch to let him know that you didn’t think of him as evil. Nor can you tell him you asked him to lunch because you thought you could trace the biggest financial crisis in the history of the world back to a decision he had made.
Gutfreund did violence to the Wall Street social order — and got himself dubbed the King of Wall Street — when in 1981 he turned Salomon Brothers from a private partnership into Wall Street’s first public corporation, a decision that can now be seen as the first pebble kicked off a cliff that triggered the avalanche that has engulfed Wall Street.
At the time it was more a question of decorum. Gutfreund lifted a giant middle finger in the direction of the moral disapproval of his fellow Wall Street CEOs and ignored the outrage of Salomon’s retired partners. (“I was disgusted by his materialism,” William Salomon, the son of one of the firm’s founders, who had made Gutfreund CEO only after he had promised never to sell it, told me.) Gutfreund seized the day. He and the other partners not only made a quick killing; they also transferred the ultimate financial risk from themselves to their shareholders.
The shareholders, who financed the risk-taking by bond traders, had no real understanding of what the risk-takers were doing. As the risk-taking grew ever more complex, their understanding diminished. All that was clear was that the profits to be had from smart people making complicated bets overwhelmed anything that could be had from servicing customers or allocating capital to productive enterprise. The customers became beside the point.
In the late 1980s and early 1990s Salomon Brothers had entire years — great years! — in which five proprietary traders generated more than the firm’s annual profits. Which is to say that the 10,000 or so other employees, as a group, lost money.
The moment Salomon Brothers demonstrated the potential gains to be had from turning an investment bank into a public corporation, the psychological foundations of Wall Street shifted from trust to blind faith. I doubt that any partnership would have leapt into bed with loan sharks, or even allowed mezzanine CDOs (let’s just call them a very risky sub-prime investment) to be sold to its customers.
Yet by early 2005 all the big Wall Street investment banks were deep into a game involving bonds based on sub-prime loans made by dubious mortgage lenders, who urged homeowners with bad credit and no proof of income to accept apparently cheap mortgages — no money down and low initial interest, followed by a sudden hike that they would not be able to afford.
In California a Mexican strawberry picker with an income of $14,000 and no English was lent every penny needed to buy a house for $724,000. In New York nannies and housekeepers were offered mortgages to buy expensive townhouses. Their sudden ability to obtain loans was no accident: it followed from the defects of the models used to evaluate sub-prime mortgage bonds by the two big ratings agencies, Moody’s and Standard & Poor’s.
The inner workings of these models were, officially, a secret: Moody’s and S&P claimed they were impossible to game. But everyone on Wall Street knew that the people who ran the models were ripe for exploitation. They were dismissed as brain-dead. “Guys who can’t get a job on Wall Street get a job at Moody’s,” as one Goldman Sachs trader turned hedge fund manager put it.
Wall Street bond trading desks, staffed by people making seven figures a year, set out to coax from the brain-dead guys making high five figures the highest possible ratings for the worst possible loans. Performing the task with Ivy League thoroughness and efficiency, they quickly figured out that the people at Moody’s and S&P didn’t actually evaluate the individual home loans or even so much as look at them.
The top concern of those betting that the knock-on effects of mortgage defaults would soon overwhelm Wall Street was that the powers-that-be might step in to prevent the strawberry pickers and nannies from failing. The powers-that-be never did so. Instead, in 2008 they stepped in to prevent the failure of the big Wall Street firms that had contrived to bankrupt themselves by making their dumb bets on sub-prime borrowers.
A few Wall Street CEOs were fired for their roles in the sub-prime mortgage catastrophe, but most remained in their jobs and they, of all people, became important characters operating behind closed doors, trying to figure out what to do next. With them were a handful of government officials — the same government officials who should have known a lot more about what Wall Street firms were doing, back when they were doing it.
Hank Paulson, the Treasury secretary, persuaded Congress that he needed $700 billion to buy sub-prime mortgage assets from banks. Thus was born Tarp, the Troubled Asset Relief Program. Once handed the money, Paulson abandoned his promised strategy and instead essentially began giving away billions of dollars in fantastic handouts to Citigroup, Morgan Stanley, Goldman Sachs and a few others unnaturally selected for survival.
The $13 billion that AIG, the rescued insurance giant, owed to Goldman Sachs as a result of its bet on sub-prime mortgage loans was paid off in full by the US government: 100 cents on the dollar.
Just weeks after receiving $25 billion, Citigroup returned to the Treasury to confess that — lo! — the markets still didn’t trust Citigroup to survive. In response, the Treasury granted another $20 billion from Tarp and simply guaranteed $306 billion of Citigroup’s assets. This guarantee — equal to 2% of US gross domestic product, or roughly the combined budgets of the US Departments of Agriculture, Education, Energy, Homeland Security, Housing and Urban Development and Transportation — was presented undisguised as a gift.
By then it was clear that Tarp’s $700 billion was insufficient to grapple with the troubled assets acquired over the previous few years by Wall Street bond traders. That’s when the US Federal Reserve took the unprecedented step of buying bad sub-prime mortgage bonds directly from the banks. Soon the risks and losses associated with more than a trillion dollars’ worth of bad investments had been transferred from big Wall Street firms to the US taxpayer.
The events on Wall Street in 2008 were reframed — not just by Wall Street leaders but also by the US Treasury and the Federal Reserve — as a “crisis in confidence”: an old-fashioned financial panic triggered by the failure of Lehman Brothers, the one firm allowed to go bankrupt.
But there’s a difference between an old-fashioned financial panic and what happened in 2008. In an old-fashioned panic, someone shouts, “Fire!” in a crowded theatre and members of the audience crush each other to death in the rush for the exits. On Wall Street in 2008 a crowded theatre burnt down with a lot of people still in their seats. Every big firm on Wall Street was either bankrupt or fatally intertwined with a bankrupt system.
The new regime — free money for capitalists, free markets for everyone else — plus the more or less instant rewriting of financial history vexed Steve Eisman, one of the key players who had bet against sub-prime.
The world’s most powerful and most highly paid financiers had been entirely discredited; without government intervention every single one of them would have lost his job; and yet those same financiers were now using the government to enrich themselves.
“I can understand why Goldman Sachs would want to be included in the conversation about what to do about Wall Street,” Eisman told me. “What I can’t understand is why anyone would listen to them.”
In Eisman’s view, the unwillingness of the US government to allow the bankers to fail was a symptom of a still deeply dysfunctional financial system. The problem wasn’t that the banks were, in themselves, critical to the economy. The problem, he felt certain, was that some gargantuan, unknown dollar amount of credit default swaps — essentially, bets on the banks’ inability to pay their debts — had been bought and sold on every one of them.
The failure of, say, Citigroup might be economically tolerable but it would also trigger the payoff of a massive bet of unknown dimensions from people who had sold credit default swaps on Citigroup to those who had bought them.
“There’s no limit to the risk in the market,” he said. “A bank with a market capitalisation of $1 billion might have $1 trillion-worth of credit default swaps outstanding. No one knows how many there are. And no one knows where they are.”
This was yet another consequence of turning Wall Street partnerships into public corporations: it turned them into objects of speculation. It was no longer the social and economic relevance of a bank that rendered it too big to fail, but the number of side bets that had been made upon it.
I couldn’t resist asking Gutfreund about his biggest and most fateful act: turning Salomon Brothers into a corporation. “Yes,” he said. “They — the heads of the other Wall Street firms — said what an awful thing it was to go public and how could you do such a thing. But when the temptation rose 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, but when the corporation was a Wall Street investment bank and it screwed up badly enough, its risks became the problem of the US 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 asked.
I told him that 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 though it was for him to enjoy my company, it was harder for me not to enjoy his. He was still tough, straight and blunt as a butcher. He’d helped to 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 a book about them. “No,” he said, “I think we can agree about this: your f****** book destroyed my career and it made yours.”
© Michael Lewis 2010 Extracted from The Big Short by Michael Lewis, published by Penguin at £25. Copies can be ordered for £22.50, including postage, from The Sunday Times Bookshop on 0845 271 2135 Wall Street prophet, John Arlidge reviews The Big Short, Books, Culture, pages 39-40
From The Sunday Times
March 21, 2010
Liars Poker II
Two decades ago, a former bond trader wrote a darkly comic exposé of Wall Street lies and excess. Now he traces the roots of the biggest financial crisis in history back to the decision of one man – and finds the few who made billions betting on the collapse
Michael Douglas reprises, his role as the unscrupulous Gordon Gekko in Wall Street; Money Never Sleeps
Michael Lewis
The willingness of a Wall Street investment bank to pay me hundreds of thousands of dollars to dispense investment advice to grown-ups remains a mystery to me to this day. I was 24 with no experience of, or particular interest in, guessing which stocks and bonds would rise and which would fall. Believe me, 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, richer, in 1988. 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 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 or persuading other people to make those bets, would be expelled from finance.
When I sat down to write my account of the experience in a book called Liar’s Poker, I thought I was recording a period piece about the 1980s in America, when a great nation lost its financial mind. I expected readers of the future would be appalled that back in 1986 the CEO of Salomon Brothers, John Gutfreund, was paid millions as he ran the business into the ground. I expected them to gape in wonder at the story of the mortgage bond trader who had lost $250m and to be shocked that once upon a time on Wall Street the CEOs had only the vaguest idea of the complicated risks their bond traders were running.
Not for a moment did I suspect that the financial 1980s would last for two full decades longer. That a single bond trader might be paid $47m a year and feel cheated. That the mortgage bond market, invented on the Salomon Brothers trading floor, would lead to the most purely financial economic disaster in history.
In the two decades after I left I waited for the end of Wall Street as I had known it. Over and over again the financial system was discredited in some narrow way: the outrageous bonuses, the endless parade of rogue traders, the scandal that destroyed Gutfreund and finished off Salomon Brothers, the crisis following the collapse of the Long-Term Capital Management hedge fund (run by another old boss, John Meriwether), the internet bubble.
Yet the big Wall Street banks at the centre of it just kept on growing, along with the sums of money they doled out to 24-year-olds to perform tasks of no obvious social utility.
At some point I gave up waiting. There was no scandal or reversal, I assumed, sufficiently great to sink the system. Then came the events of 2008. In mid-September that year, as the investment banking system collapsed, I sat in a restaurant on Manhattan’s East Side waiting for Gutfreund to arrive for lunch.
I had not seen my old boss since I quit Wall Street. I’d met him, nervously, a couple of times on the trading floor. A few months before I’d quit, I had tried to explain to him what at the time seemed exotic trades in derivatives that I had done with a European hedge fund. He claimed not to be smart enough to understand and I assumed that was how a Wall Street CEO showed he was the boss, by rising above the details. There was no reason for him to remember and when my book became a public-relations nuisance to him he told reporters that we had never met.
I knew that after he’d been forced to resign in 1991 he had fallen on harder times. I heard that he had sat on a panel about Wall Street at the Columbia Business School. When his turn came to speak, he advised the students to find some more meaningful thing to do with their lives than go to work on Wall Street. As he began to describe his career, he had broken down and wept.
When I had emailed Gutfreund to invite him to lunch, he could not have been more polite or more gracious. That attitude persisted as he was escorted to the table, made chitchat with the owner and ordered his food. He was more deliberate in his movements but was completely recognisable. The same veneer of courtliness masked the same animal impulse to see the world as it is 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 a mutual friend. We agreed that the Wall Street CEO 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.”) We agreed, further, that the CEO of the Wall Street investment bank had shockingly little control over his subordinates. (“They’re buttering you up and then doing whatever the f*** 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 channelled the greed.
The line between gambling and investing is artificial and thin, and the outcome should be the same: for every winner there is a loser. Pretty much all the important people on both sides of the gamble that shattered Wall Street in 2008 left the table rich, however.
A few shrewd investors “shorted” the sub-prime mortgage bond market. Realising that the odds were in their favour, they gambled on the inevitable collapse of the multi-trillion-dollar bond market built on mortgages taken out by poor Americans. They reaped millions, even billions. The people on the other side —the entire financial system, essentially — failed to realise they were betting with the odds against them. The CEOs of every major Wall Street firm either ran their public corporations into bankruptcy or were saved from bankruptcy by the US government. Yet they all got rich, too.
What are the odds that people will make smart decisions about money if they don’t need to make smart decisions — if they can get rich making dumb decisions? The incentives on Wall Street were all wrong; they’re still all wrong.
But I didn’t argue with Gutfreund. Just as you revert to being about nine years old when you go home to visit your parents, you revert to total subordination when you are in the presence of your former CEO. 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 were not 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, “Your . . . f****** . . . book.”
I smiled back, though it wasn’t quite a smile.
“Why did you ask me to lunch?” he asked, though pleasantly. He was genuinely curious.
You can’t really tell someone that you asked him to lunch to let him know that you didn’t think of him as evil. Nor can you tell him you asked him to lunch because you thought you could trace the biggest financial crisis in the history of the world back to a decision he had made.
Gutfreund did violence to the Wall Street social order — and got himself dubbed the King of Wall Street — when in 1981 he turned Salomon Brothers from a private partnership into Wall Street’s first public corporation, a decision that can now be seen as the first pebble kicked off a cliff that triggered the avalanche that has engulfed Wall Street.
At the time it was more a question of decorum. Gutfreund lifted a giant middle finger in the direction of the moral disapproval of his fellow Wall Street CEOs and ignored the outrage of Salomon’s retired partners. (“I was disgusted by his materialism,” William Salomon, the son of one of the firm’s founders, who had made Gutfreund CEO only after he had promised never to sell it, told me.) Gutfreund seized the day. He and the other partners not only made a quick killing; they also transferred the ultimate financial risk from themselves to their shareholders.
The shareholders, who financed the risk-taking by bond traders, had no real understanding of what the risk-takers were doing. As the risk-taking grew ever more complex, their understanding diminished. All that was clear was that the profits to be had from smart people making complicated bets overwhelmed anything that could be had from servicing customers or allocating capital to productive enterprise. The customers became beside the point.
In the late 1980s and early 1990s Salomon Brothers had entire years — great years! — in which five proprietary traders generated more than the firm’s annual profits. Which is to say that the 10,000 or so other employees, as a group, lost money.
The moment Salomon Brothers demonstrated the potential gains to be had from turning an investment bank into a public corporation, the psychological foundations of Wall Street shifted from trust to blind faith. I doubt that any partnership would have leapt into bed with loan sharks, or even allowed mezzanine CDOs (let’s just call them a very risky sub-prime investment) to be sold to its customers.
Yet by early 2005 all the big Wall Street investment banks were deep into a game involving bonds based on sub-prime loans made by dubious mortgage lenders, who urged homeowners with bad credit and no proof of income to accept apparently cheap mortgages — no money down and low initial interest, followed by a sudden hike that they would not be able to afford.
In California a Mexican strawberry picker with an income of $14,000 and no English was lent every penny needed to buy a house for $724,000. In New York nannies and housekeepers were offered mortgages to buy expensive townhouses. Their sudden ability to obtain loans was no accident: it followed from the defects of the models used to evaluate sub-prime mortgage bonds by the two big ratings agencies, Moody’s and Standard & Poor’s.
The inner workings of these models were, officially, a secret: Moody’s and S&P claimed they were impossible to game. But everyone on Wall Street knew that the people who ran the models were ripe for exploitation. They were dismissed as brain-dead. “Guys who can’t get a job on Wall Street get a job at Moody’s,” as one Goldman Sachs trader turned hedge fund manager put it.
Wall Street bond trading desks, staffed by people making seven figures a year, set out to coax from the brain-dead guys making high five figures the highest possible ratings for the worst possible loans. Performing the task with Ivy League thoroughness and efficiency, they quickly figured out that the people at Moody’s and S&P didn’t actually evaluate the individual home loans or even so much as look at them.
The top concern of those betting that the knock-on effects of mortgage defaults would soon overwhelm Wall Street was that the powers-that-be might step in to prevent the strawberry pickers and nannies from failing. The powers-that-be never did so. Instead, in 2008 they stepped in to prevent the failure of the big Wall Street firms that had contrived to bankrupt themselves by making their dumb bets on sub-prime borrowers.
A few Wall Street CEOs were fired for their roles in the sub-prime mortgage catastrophe, but most remained in their jobs and they, of all people, became important characters operating behind closed doors, trying to figure out what to do next. With them were a handful of government officials — the same government officials who should have known a lot more about what Wall Street firms were doing, back when they were doing it.
Hank Paulson, the Treasury secretary, persuaded Congress that he needed $700 billion to buy sub-prime mortgage assets from banks. Thus was born Tarp, the Troubled Asset Relief Program. Once handed the money, Paulson abandoned his promised strategy and instead essentially began giving away billions of dollars in fantastic handouts to Citigroup, Morgan Stanley, Goldman Sachs and a few others unnaturally selected for survival.
The $13 billion that AIG, the rescued insurance giant, owed to Goldman Sachs as a result of its bet on sub-prime mortgage loans was paid off in full by the US government: 100 cents on the dollar.
Just weeks after receiving $25 billion, Citigroup returned to the Treasury to confess that — lo! — the markets still didn’t trust Citigroup to survive. In response, the Treasury granted another $20 billion from Tarp and simply guaranteed $306 billion of Citigroup’s assets. This guarantee — equal to 2% of US gross domestic product, or roughly the combined budgets of the US Departments of Agriculture, Education, Energy, Homeland Security, Housing and Urban Development and Transportation — was presented undisguised as a gift.
By then it was clear that Tarp’s $700 billion was insufficient to grapple with the troubled assets acquired over the previous few years by Wall Street bond traders. That’s when the US Federal Reserve took the unprecedented step of buying bad sub-prime mortgage bonds directly from the banks. Soon the risks and losses associated with more than a trillion dollars’ worth of bad investments had been transferred from big Wall Street firms to the US taxpayer.
The events on Wall Street in 2008 were reframed — not just by Wall Street leaders but also by the US Treasury and the Federal Reserve — as a “crisis in confidence”: an old-fashioned financial panic triggered by the failure of Lehman Brothers, the one firm allowed to go bankrupt.
But there’s a difference between an old-fashioned financial panic and what happened in 2008. In an old-fashioned panic, someone shouts, “Fire!” in a crowded theatre and members of the audience crush each other to death in the rush for the exits. On Wall Street in 2008 a crowded theatre burnt down with a lot of people still in their seats. Every big firm on Wall Street was either bankrupt or fatally intertwined with a bankrupt system.
The new regime — free money for capitalists, free markets for everyone else — plus the more or less instant rewriting of financial history vexed Steve Eisman, one of the key players who had bet against sub-prime.
The world’s most powerful and most highly paid financiers had been entirely discredited; without government intervention every single one of them would have lost his job; and yet those same financiers were now using the government to enrich themselves.
“I can understand why Goldman Sachs would want to be included in the conversation about what to do about Wall Street,” Eisman told me. “What I can’t understand is why anyone would listen to them.”
In Eisman’s view, the unwillingness of the US government to allow the bankers to fail was a symptom of a still deeply dysfunctional financial system. The problem wasn’t that the banks were, in themselves, critical to the economy. The problem, he felt certain, was that some gargantuan, unknown dollar amount of credit default swaps — essentially, bets on the banks’ inability to pay their debts — had been bought and sold on every one of them.
The failure of, say, Citigroup might be economically tolerable but it would also trigger the payoff of a massive bet of unknown dimensions from people who had sold credit default swaps on Citigroup to those who had bought them.
“There’s no limit to the risk in the market,” he said. “A bank with a market capitalisation of $1 billion might have $1 trillion-worth of credit default swaps outstanding. No one knows how many there are. And no one knows where they are.”
This was yet another consequence of turning Wall Street partnerships into public corporations: it turned them into objects of speculation. It was no longer the social and economic relevance of a bank that rendered it too big to fail, but the number of side bets that had been made upon it.
I couldn’t resist asking Gutfreund about his biggest and most fateful act: turning Salomon Brothers into a corporation. “Yes,” he said. “They — the heads of the other Wall Street firms — said what an awful thing it was to go public and how could you do such a thing. But when the temptation rose 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, but when the corporation was a Wall Street investment bank and it screwed up badly enough, its risks became the problem of the US 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 asked.
I told him that 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 though it was for him to enjoy my company, it was harder for me not to enjoy his. He was still tough, straight and blunt as a butcher. He’d helped to 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 a book about them. “No,” he said, “I think we can agree about this: your f****** book destroyed my career and it made yours.”
© Michael Lewis 2010 Extracted from The Big Short by Michael Lewis, published by Penguin at £25. Copies can be ordered for £22.50, including postage, from The Sunday Times Bookshop on 0845 271 2135 Wall Street prophet, John Arlidge reviews The Big Short, Books, Culture, pages 39-40
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