Lewis Faults ‘Short-Term Greedy,’ Cites Goldman
Interview by Erik Schatzker
March 15 (Bloomberg) -- Michael Lewis made a name for himself on Wall Street by writing about it. His 1989 book, “Liar’s Poker,” exposed the inner workings of Salomon Brothers, a firm then at the peak of its power, and described his improbable run as a bond salesman there.
Lewis has since written about Silicon Valley, in “The New New Thing,” baseball, in “Moneyball,” and football, in “The Blind Side.” His newest book, “The Big Short” (W.W. Norton & Co., 266 pages, $27.95), chronicles how a small handful of investors anticipated the subprime-mortgage collapse and positioned themselves to make fantastic profits.
Lewis says “The Big Short” is “the end of my story that I wrote 20 years ago” because it documents the damage wreaked by securities first developed at Salomon Brothers in the 1980s. He attributes the economic crisis of 2008 to the emergence of a “short-term greedy” culture on Wall Street, the growing complexity of financial instruments and traders’ efforts to profit at the customer’s expense.
If there’s one group to blame, Lewis says it’s the “people who designed synthetic CDOs at Goldman Sachs.”
I interviewed Lewis on March 9 in Berkeley, California. Portions of the interview will air on Bloomberg Television at 9 p.m. New York time today.
SCHATZKER: Was “The Big Short” a natural evolution from your days at Salomon Brothers and “Liar’s Poker?”
LEWIS: It was. I didn’t think one day something would happen that would bring me back to Wall Street to write what is essentially a sequel. But that’s what happened.
I really thought that. I thought in the first place that “Liar’s Poker” was describing a world that was ending, not that a world was beginning. And what it was describing, it turns out, is a period in finance that went on for another 25 years or 20 years.
And what we’re reckoning with now is an event that really has its seeds in the early ‘80s, and is not something that just happened three or four years ago. So there was that connection.
It was just, it was like the things I was describing in “Liar’s Poker” ended up having all these effects. And I felt like I really should go back and see what on earth happened. That was the first thing that pulled me in.
SCHATZKER: Did you get the feeling over time that, because the world that you thought would end hadn’t ended, maybe someday you would have to revisit it?
LEWIS: No, I just assumed it would never end. I really did assume that if the mere fact of me being paid hundreds of thousands of dollars to give financial advice did not end the financial world, then nothing would. That, that was a shocking enough event that if that didn’t stop this thing from happening, nothing would.
As I watched, I became more detached from the financial services industry as time went on after “Liar’s Poker.” Book comes out, it’s a big hit, for a number of years I’m asked to write about Wall Street one way or another.
But my connection to the place diminished with time. And I really thought I just drifted away, and I was off doing other things. Some of my writing, like “Moneyball,” was informed by the Wall Street experience, but I didn’t think there was any reason I was going to be coming back.
When the financial crisis starts to break, and the losses in the subprime mortgage market are starting to look really big in late 2007, I started to get really interested again.
And there were several layers to the interest. But I can remember the first thing that grabbed me was I was shocked that these big firms, that used to essentially be the smart money at the poker table, had become the dumb money. And I was really curious how that had happened.
I was curious. I watched them change over the years and adapt to the world in ways that enabled people to continue to get paid large sums of money. And the outrageous behavior that I described in “Liar’s Poker,” that didn’t exist. Places got much more corporate, much more sanitized, all in the service of preserving paychecks.
So the short answer to the question is I really didn’t think there was going to be something else to write that would really intrigue me in the way this has. And I really didn’t think I’d ever feel that kind of personal connection to the event again. But I felt a very personal connection to this one. I felt like this is the end of my story that I wrote 20 years ago. I’ve really got to go finish the job.
SCHATZKER: Calamity for the rest of us, serendipity for you.
LEWIS: Well, yes. I also thought one of the points of “Liar’s Poker” was it was a very bad sign for Wall Street that I was on it. Me and people like me probably don’t belong there, but we drifted in because of what’s happened in the world of finance. And when I saw some of the names of the people who were then associated with this catastrophe, there were people inside Citigroup who I’d worked with at Salomon Brothers.
I really did have the thought: If I’d hung around on Wall Street, I might have helped create this catastrophe. This is just the kind of catastrophe I would have created. And so I felt that kind of personal connection to it too. It was the logical conclusion of me being on Wall Street.
SCHATZKER: The characters in the book itself are wonderfully eccentric and certainly unusual. Does that help explain why they found this incredible trade that most everybody else missed?
LEWIS: This is one of the great mysteries of the last few years in finance. There emerges on the scene this really, really smart trade, buying credit default swaps on subprime mortgage bonds. You’re buying insurance on subprime mortgage bonds. Limited downside: You’re paying a couple of percent premium a year for a bet that, maybe it’s not sure to pay out, but the odds are better than 50-to-1 that they will. It’s a really obvious, smart bet.
And many thousands of investors could have made this bet. Not individual investors, for the most part, but a lot of institutional investors could have made this bet. In the end, only about a dozen make it in a huge way. A lot of people dabble in it, but only about a dozen make it in a huge way. I got to know most of the people who did, to do this book. I did a kind of casting search.
Most of them are outsiders, are people who are kind of on the fringe, certainly on the fringe of the credit markets. They’re not people who are bond market people. They were, for the most part, stock market people, crawfished into it because they could see that the stocks that they were trying to understand were going to be driven by this event that was going on in the subprime mortgage market.
So they had to understand the subprime mortgage market. And then the more they came to understand it, the more appalled they were about how that market worked. And the more appalled they became, the more they began to think about really how to bet against it.
So they were outsiders to the market that they were betting on. And in addition, they were, in many cases, personally curious people, not clubbable members of the group. And I think that was a key to the success. I think that the fact that they didn’t feel compelled in any way, on any level, to think like other people gave them an advantage.
SCHATZKER: But as you point out, much of what they saw could have, could have been obvious to others.
LEWIS: We’ve lived through a period of mass financial delusion. And there was a handful of people who were wandering around sane in an insane world.
One of the reasons I wrote the book is that I wanted to know why that was in very particular ways and not generally what was true about all these people. But why, if there are only a dozen of you who are right and millions who are wrong, what is it about the dozen of you that were right that enabled you to be right?
I think the answer is more than one thing. You can’t just say it’s because they’re oddballs, because there are a lot of oddballs who were wrong too. Being an oddball doesn’t enable you to get rich in the financial markets. It just happened to be a trait of many of these people.
But in the case of Michael Burry, a man who has Asperger’s Syndrome and doesn’t know it, even though he’s a former medical doctor, he’s misdiagnosed himself, but he’s diagnosing the financial markets correctly. The Asperger’s is critical to his success, because the Asperger’s did two things that helped him.
One was it made him very uncomfortable in social situations, so he avoided them entirely. So he wasn’t bombarded by the same propaganda as everybody else, because he just shut out the world.
The second was in lieu of getting his information socially, he got his information through documents, and through data. And he sought out data. He lived in a room with data. And if you were a person who didn’t listen to what anyone said and you just looked at the structure and composition of subprime mortgage bonds and read subprime mortgage bond prospectuses, you had a completely different view of the world than everybody else.
Nobody but someone with Asperger’s would read a subprime mortgage bond prospectus. And he had a feeling that he was the only one who read the things, except for the lawyers who drafted them. So I think his intense focus on data really helped.
In the case of one of my other main characters, Charlie Ledley and Jamie Mai of a tiny little firm called Cornwall Capital, they had a view that the financial markets made a systematic intellectual error. And it’s the Black Swan error. It’s underestimating the likelihood of unlikely events. That yes, an event, some catastrophe, some event is unlikely, but it’s not as unlikely as your pricing these way out of the money options.
They had spent several years scouring the world for way out of the money options to buy on currencies, commodities, stocks, bonds, everything. And it’s with their filtering everything through that prism, they’re thinking “I’m just looking for cheap options, cheap. I want to make bets on double zero on the roulette table where the odds are actually better than 32-to-1.”
So they did that without often knowing that much about the underlying things that they were betting on. They just knew that the odds were better than the markets were saying.
And they stumble into this market called the subprime mortgage market, the bond market, and they see you can buy credit default swaps for 2 percent. And that’s your downside. And they think the odds of these things going bad are much more likely than the 50 to 1 against the price of the option implies. And they start to build a position.
And then they start to learn about it. And the more they learn about it, they think this is not only more likely than the market thinks it is, it’s likely to happen, this catastrophe. And they become obsessed with it. So that’s another way you can come to it, through that.
The third person, my third character, who had a point of view that was very particular, was Steve Eisman, with FrontPoint Partners. And Eisman happened to actually know a lot about on- the-ground behavior between subprime mortgage lenders and borrowers because he had been essentially the world’s foremost expert on the subject of subprime mortgage originators back in the ‘90s. And he knew how bad the behavior had been then.
So when the market is reborn in 2002, 2003, he’s very alert to the possibility that this could end badly. In addition, and his wife actually is very interesting on this subject, they’d had a tragedy in their lives. His first son had been killed as a baby. His wife said when that happened, Steve went from being someone who was a joyous cynic to being actually a pessimist about the world.
He was always looking for something bad that actually could happen that people didn’t think was possible. So he was predisposed to...
SCHATZKER: Finding the downside.
LEWIS: Finding the downside. And so in each case, I learned something about investing from this book, because I’ve always thought of it as antiseptic event, and a purely intellectual event. And it was pretty clear to me in each case these characters had an emotional, some psychological dimension to them that enabled them to get where they are.
SCHATZKER: You note early on in the book that John Paulson made more money than anyone had ever made so quickly on Wall Street. So why not make him more a part of this story?
LEWIS: I spent time with him. And he was very friendly. I could have made him part of the story very easily.
But I had a purpose for this story. And the purpose was I wanted to explain to the reader what on earth had happened. And to do that, it helped that the characters themselves had to learn about these markets, that they didn’t understand these markets to begin with.
So the reader could learn with them. John Paulson happened to be oddly positioned inside the financial markets in that he was one of the few people who made his living shorting bonds and looking for bonds to short.
His motives were, to me, less interesting. He’s much more a purely economic animal. And so he didn’t have a great distance to travel to get to the trade.
And in addition I’m writing a story. And the story is driven by these characters. And it’s got to be true. I can’t make it up. I don’t want to exaggerate what this thing means to a character.
The people who I was interested in were the people who had laid it all on the line, where they started out thinking, “A nice little trade,” and they’d end up, essentially, that if this didn’t work out, their careers were over. And Paulson had very cleverly but, from the character, the logical point of view, less interestingly structured his financial life so that he was going to win either way.
When he went to investors and said, “Give me your money so I can short the subprime mortgage bond market,” he didn’t say this is a bet we want to make because we’re all going to get rich. He said your whole portfolio is premised on this not happening, this catastrophe not happening. Give me a tiny bit of your money and put it in this as an insurance policy. And if it works out, it will be a hedge. And if it doesn’t work out, the rest of your portfolio is fine.
So there wasn’t a lot at stake there. He made a lot of money when it worked out. But he wasn’t set up to be in a lot of trouble if it failed. And I was particularly interested in the people who were set up to be in a lot of trouble if it failed.
SCHATZKER: How on earth did you find the guys at Cornwall Capital?
LEWIS: No one’s ever heard of them. And they were very reluctant to talk to me. It was agonizing getting them to let me do what I do. I have to be in their lives. I have to live with them. And to get them to let me do that was not easy for them. And I’m eternally grateful that they did.
I wandered around the hedge fund world for a year on a casting search, finding everybody who made this trade in a big way. And I was in an office of, I can’t name him, a very well known hedge fund manager. I was rattling off the names of the people I knew who had done the trade, who had made a bunch of money.
And he said there’s one you left off. And I said who? And he said there’s this crazy guy I went to business school with who’s over there. And I think he had $100,000 in a Schwab account. Two years ago he was going on about how the subprime mortgage bond market was going to collapse, and he’d bet on it. And sure enough, he did, and he got rich. And his name’s Charlie Ledley. Go talk to him.
I went over to see Charlie. And it took about an hour before I realized that I wanted to write about him. He’s so interesting. He wasn’t a money person. He was more interested in public policy than he is in money. He worked in the Clinton campaign. He really was. His passion is education reform.
But he’s intellectual and curious. And he had landed in this job working with a friend as a small investor. And it started with $100,000 in a Schwab account. They had this theory about how financial markets made mistakes. And this mistake, this particular mistake, underestimating the likelihood of unlikely events, became the premise of their portfolio.
He’d educated himself about the subprime mortgage bond market. And he was very funny on the subject, and I thought, “He’s perfect.” He’s perfect because he can be a proxy for the reader who knows absolutely nothing, because he started out knowing absolutely nothing, and yet he figured it out.
SCHATZKER: You identify some of the people on Wall Street who figured out the subprime bubble early. Greg Lippmann from Deutsche Bank, Gene Park at AIG Financial Products. Why no central character from Goldman Sachs, because it was Goldman that created the synthetic CDO in the first place?
LEWIS: Goldman is in the book in a big way. I suppose if they would have let me speak honestly to Jonathan Egol, the trader there, or Andy Davilman, the salesman who bought credit default swaps from AIG, I might have developed them further as characters. But Goldman, the last thing they want is someone like me writing about Goldman Sachs. They’re very careful about what they’ll divulge.
But I didn’t need it. I knew what had happened. And so absent total cooperation, where you actually get to know the people in a really intimate way, there was no intermediate place I was going to go with Goldman Sachs that was going to be useful to me. I needed to know what they’d done and I needed to be able to describe it.
The people inside the Wall Street firms who were more interesting to me were the people who had first seen the opportunity. And there weren’t many. Greg Lippmann is the exception. Goldman Sachs was shrewd in finding AIG to be the turkey at the table, and shrewd in getting them to insure subprime mortgage bonds.
But Goldman Sachs was not set up when they were doing that to make money if the subprime mortgage bond market collapsed. If the subprime mortgage bond market had done what it was supposed to do and collapsed maybe a year or a year-and-a-half earlier than it did, Goldman would have been buried. They were long.
They were the dumb money, too. So they weren’t that interesting for that reason. The one guy who was really interesting as smart money inside a Wall Street firm was Greg Lippmann. Lippmann was a Deutsche Bank asset-backed trader who was at war with his own firm, because the whole rest of the firm was long in the market. And he’s saying this is going to be a disaster. And Lippmann was the proselytizer of the trade.
SCHATZKER: The evangelist.
LEWIS: He was. All the people who did the trade, almost everybody, you can trace it back one way or another to Lippmann running around trying to get people to short the subprime mortgage market. So he was really interesting. And he is a character in the book.
And then the other, broadly speaking, character on Wall Street who was interesting to me was who in a big way was the dumb money on the other side?
SCHATZKER: Howie Hubler.
LEWIS: Howie Hubler. And I looked around and I said you’re spoiled for choice, because all these firms lost a lot of money. All these firms had traders who were long and wrong. And the numbers at some of the other firms were more spectacular: Merrill Lynch lost $50 billion. Citigroup lost I don’t know how many tens of billions of dollars.
But no where else on Wall Street was there a single trader, I don’t think, making a directional bet on the subprime mortgage market who lost as much as Howie Hubler did at Morgan Stanley. He lost $9.4 billion.
I don’t think anybody’s ever done that on Wall Street. And this guy had done it. And he was basically anonymous. It was amazing to me. This is another example of the way things that used to be scandalous became innocent. When I was at Salomon Brothers, we had a Howie, Howie Rubin, who went from Salomon Brothers to Merrill Lynch and lost a few hundred million dollars and ended up on the front page of the Wall Street Journal and became radioactive for awhile. And it was only $300 million.
Howie Hubler loses almost $10 billion, and...
SCHATZKER: Nobody notices.
LEWIS: Nobody knows who he is or what he did. Morgan Stanley comes out, John Mack the CEO comes out and issues an elaborate apology of how embarrassed he is, how much money they’ve lost, and attributes it to this small group of traders. But he doesn’t explain what happened.
So there was a story to be told. And I figured if I could get that story, I was getting in a way the other side of the smart people, the other side of the bet, the thinking that was on the other side of my protagonists’ profits.
SCHATZKER: What should we make of a guy like Greg Lippmann? He effectively creates the market for shorting subprime CDOs. Does that make him a good guy or a bad guy?
LEWIS: I think it makes him a neutral guy. There’s more than one question here, it’s so complicated. The question what we should make of Greg Lippmann is a wonderful question because even the people who do the trade that he’s selling to them don’t know what to make of him. He is the cipher to them. They think he’s an unreliable narrator. And they completely mistrust the market he comes from.
The bond market is the Wild West. What goes on in the bond market would never be allowed to go on in the stock market. Investors in the bond market know that if Goldman Sachs and Deutsche Bank come to you and want to sell you something, you don’t want to buy it.
That Greg Lippmann is running around selling the single greatest trade in the history of the bond market and nobody believes him tells you something about the bond market. He can’t get the message across, because of where he comes from.
Now, he does also succeed in eventually creating the short side of the market, which in theory should be a great thing. Because in theory what it should do is subdue the market. It should make the market more rational. It’s introducing the negative information into the market that the market needs to function to price things accurately.
In practice, the activity he generates is too small in relation to the size of the market to move the market at all. And the demand side of the market is so separate; the buyers are so separate from the shorters they don’t talk. Whatever information the people who are short the market have does not inform the decisions of the people who are buying the market.
So it doesn’t have the positive effect you would like. Instead, it has a very negative effect. And the negative effect is every time he gets someone to buy a credit default swap on a subprime mortgage bond...
SCHATZKER: Somebody else has to go long.
LEWIS: Someone else has to go long. And every time he gets someone to short, he replicates the market. The market replicates not just subprime mortgage loans, but the absolute worst subprime mortgage loans, because the people who were shorting the market are selecting the absolute worst ones to short.
This is one of the bizarre things about what happened in the free markets in the United States of America in 2005, 2006, 2007. The only people who were doing serious credit analysis on the loans that were being made to subprime mortgage borrowers were the people who were doing it to short the bonds, to bet against them, not the people who were making the loans themselves.
So when the losses happened, when the market finally does, in fact, crater, the effect of Greg Lippmann -- not just Greg Lippmann, but the market he’s in the middle of -- is to increase the number of losses because they’ve replicated all these bad loans.
It isn’t so much the raw size of this market that Lippmann sits in the middle of, because that’s only a few hundred, $400 billion, whatever it is. It’s a lot of money, but it’s not as big as the $3 trillion in subprime and Alt-A loans that have been made in the previous three years.
The problem is it’s totally hidden. Nobody knows. People can tell you who owns the subprime mortgage loans. They can’t tell you who’s on the other side of the credit default swaps. No one knows which firms are on the wrong side of this bet. These are private transactions between consenting adults. And no one knows how much of it there is.
This creates uncertainty. If you want to know why the panic happened in 2008, it was because no one knew who had what losses. And the reason no one knew who had what losses is there were all these private transactions of enormous size, enormous indeterminate size, that were undisclosed.
And so the effect of Greg Lippmann in the world is very ambiguous. On the one hand, he was a voice, truth and honesty in the market. He was doing exactly what he should be doing, making the smart bet. If everyone thought like him, this whole problem never would have happened. So it’s hard to say he’s the villain, certainly not the villain.
SCHATZKER: Hard to call him a hero at the same time.
LEWIS: That’s a little hard, too. He’s an ambiguous character. If he had been outside the Wall Street firm, if he’d been in a hedge fund doing what he was doing, I think I would have a less ambiguous feeling about him. I would think he’s not part of the engine of the problem.
Deutsche Bank was part of the problem, not part of the solution. And the mystery of him, the great mystery, is he was so right, he was so smart about it, and yet he was so unpersuasive, even to the people in his firm. Deutsche Bank lost, I don’t know, $12 billion, $15 billion in the subprime mortgage market. And they had the single most persuasive salesman against that market in their shop. Why didn’t they listen?
SCHATZKER: It seems as though there is a parallel of sorts between what happened back in 2007 and 2008 and what we’re seeing happen this very moment with Greece and the EU.
LEWIS: The parallel gets even more elaborate, because Goldman Sachs appears to advise the Greek government on how to disguise its level of indebtedness. So it feels as if Wall Street went into entire countries and persuaded them to take out subprime mortgage loans, in effect, or help them, enable them, in taking out a subprime mortgage loan.
So yes, we’re living through this period where we’re reckoning with the real consequences of financial engineering, and financial engineering gone wrong. The very small-bore version of this was the financial engineering that enabled some poor schmuck in Chico, California, who had no income, to buy a $1 million house. And the big version of this is Greece.
SCHATZKER: And it may be soon to be Italy...
LEWIS: And Ireland and Iceland.
SCHATZKER: How did Wall Street become so dangerous?
LEWIS: I think the seeds of this catastrophe go back to the ’80s. The source of a lot of the problems are people’s incentives being screwed up. It’s not right, or it’s certainly not satisfying to say Wall Street’s just greed, got too greedy, and that was the problem. Wall Street’s always greedy. People who go to work on Wall Street are greedy. That’s why they go to Wall Street. They don’t go to Wall Street because they have a calling in finance. A handful of people do. But for the most part, people go there because that’s where the money is, and they want money.
You’re not going to change that. What changes are the rules that channel the greed or the system that channels the greed. And so the greed came to be channeled in very short-term ways. So people became very short-term greedy, greedy for the next quarter, greedy for the next bonus, rather than greedy for a long and lucrative career.
What caused that? Firms ceasing to be partnerships is the beginning of it. A Wall Street firm that is investing its own money, the people inside it, it’s their money that’s at stake, are going to behave very differently from people who are a public corporation who are using shareholders’ money.
No partnership would have ever allowed itself to own billions of dollars of AAA-rated CDOs backed by subprime. It just wouldn’t have happened, because they would have scrutinized it in a different way. Nobody will say that on Wall Street or say that’s true. They’ll say, “We’ve behaved just as we would as if it was our own money.” But they don’t. Nor would you expect them to. It’s amazing how powerful incentives are.
Two, the business got intellectualized in the 1980s. The proximate cause of the intellectualization was the Black-Scholes option pricing model. But just generally, it got more complicated. And so as it got more complicated, it got harder and harder for normal people to understand it, and easier and easier for smart people to persuade dumb people to do things they shouldn’t do, and easier and easier for smart traders to disguise what they were doing from their bosses because it’s so complicated.
That was absolutely necessary. One of the signature traits of this crisis is that the people on the top of the firms clearly didn’t know what their firms were doing. They were buffaloed by people underneath them. They all feel betrayed by their employees when they’re speaking privately about them. But this is why they could be: because the businesses got too complicated for the people who ran them.
Finally, and this is a really, really big one, and related to the other two: the relationship between Wall Street and its customers. The legitimate business of Wall Street is to allocate capital. The traditional businesses on Wall Street, the traditional capital allocation businesses, have gotten less and less profitable. All these new markets, this financial innovation, is a response, in part, to Wall Street’s need for profits.
Profits dried up in old-fashioned stock brokering because you can now go onto the Internet and buy a stock and pay a tiny commission rather than call your guy at Merrill Lynch and pay a fat one.
If you look at how firms make their money, especially if you’ve been inside one of them, you realize that increasingly, especially in the bond markets, where more of the profits are than in the stock markets, Wall Street has come to increasingly trade against its customers rather than on their behalf, acting not as an intermediary, but as essentially a big proprietary trading fund that is using its customers to get itself out of the positions it doesn’t want to be in, to take the stupid side of the smart trade they want to do.
There is a poisonous interface between these big firms and the customers in the bond market. And everybody now takes it for granted. It shocked me when I saw it in 1986 and 1987, but it’s now just normal. It’s thought to be normal.
The minute you’re starting to think, “The way I make money is exploiting the idiocy of my customers,” is the minute you start creating securities that are designed to explode, that you could be on the other side of.
The minute you’re thinking less like a handmaiden to productive enterprise and a useful allocator of capital, you’re becoming the jerk in the zero sum game. And they become the jerks in the zero sum game. So you back away from it all and you say, “look at what these people did.” And the shocking thing is what they did was legal. And you say how do you change the rules, what do you do here?
One of the things you obviously do is you have to destroy this notion that it’s okay to trade against your customers. Maybe what you say is you can be a firm like Schwab that has customers, but you don’t trade in anything for yourself. Or you can be a hedge fund. But you can’t be both.
Because the minute you start trading against the customers is the minute you start designing things that aren’t good for the customers. And the minute you start designing things that aren’t good for the customers, you start designing CDOs, subprime mortgage bonds. You start to misallocate capital. You’re trying to misallocate capital.
And that’s crazy. It’s insane. But it is the normal on Wall Street. And so breaking it up, changing it is going to be a violent act, because it’s become so assumed. It’s so deeply embedded as the assumption of how the business is.
SCHATZKER: Did you learn anything about Wall Street that you didn’t know before?
LEWIS: If I hadn’t learned a lot, I wouldn’t have been interested in doing it. But I learned first about investing. It was very interesting to me to see just how personal investing decisions can be, just how in the end, a lot of it comes back to who you are as a person. That you’re guided by all sorts of things that I wouldn’t have thought would have informed investment decisions. So just how human the financial markets were on the buy side was really interesting to me.
In the Wall Street firms -- I should have known it, but I didn’t know it -- I didn’t know quite how cynical they could become, just how detached from their original purpose they could get.
This surprised me, because the Salomon Brothers I left in 1989 was a fractious, violent body. Interesting place. But there was a personal attachment that people felt to the institution. People were angry with me for writing the book, because they felt I had betrayed Salomon Brothers.
On the Wall Street that I walked back into to do “The Big Short” it wouldn’t occur to anyone that you could betray your Wall Street firm, because there isn’t that relationship. The relationship doesn’t exist anymore. Everybody is a free agent. There’s no sense of loyalty to an institution or a cause greater than yourself or all that stuff.
So what I learned was just how purely financial and commercial the place had become. Essentially, it was denuded of was the partnership sentiment. There was a residue of the partnership sentiment that was still hovering around Salomon Brothers when I got there, because it had been a partnership not that long ago.
That has been completely replaced by this new antiseptic, raw financial relationship. It was curious to see that people could function in that environment and feel like that was a satisfying thing to be doing with their lives.
SCHATZKER: A lot of people would say there never, ever was a golden age of investment banking, even when the firms were privately held. Do you agree with that?
LEWIS: Well golden age might be a bit strong. But the incentives were organized much more properly. The right incentive now is the hedge fund incentive. There are things that are screwed up about it, but typically the person who runs the hedge fund has all his money in his own hedge fund. And that’s how it’s got to be. He’s on the hook for losses.
Goldman Sachs, in the ‘50s and ‘60s and the early ‘70s was run by a man named Gus Levy. I may have my dates slightly wrong, but that’s roughly when he was there. And Gus Levy used to give a speech about the importance of being long-term greedy. It wasn’t “don’t be greedy,” it was “be long-term greedy.”
That’s the problem now. The problem now is there’s no long- term greed, it’s all short-term greed. It’s not institution- building or career-building, it’s quick kills. I do think that aspect of the business, that approach to finance, is a healthier, more golden age-like approach than what we have now.
I’m not arguing that investment banks were ever perfect institutions. That’s silly. I’m just saying that there’s a smarter way of organizing.
SCHATZKER: Who’s the biggest villain in the subprime debacle?
LEWIS: You have a lot to choose from. You also have to make a distinction amongst the villains, within the hearts of the villains. You have to honestly ask yourself: Were they corrupt or stupid or deluded? Because nobody’s stupid. In a lot of cases, you wish they were corrupt and wish they’d done an illegal thing. In fact, they were just deluded.
There are obvious ones, like the ratings agencies. Moody’s and Standard & Poor’s should be ashamed of themselves. On the other hand, the more you get to know the people at Moody’s and Standard & Poor’s, the more you feel sorry for them, because they are pathetic in relation to the people who manipulated them.
They were manipulated by the people at Goldman Sachs and Morgan Stanley and Merrill Lynch. And they got paid one-tenth what those people got paid. And they all wished they’d worked there. Some part of them was currying favor with the big investment banks.
It feels a little bit like kicking the butler after the master does something bad. But they clearly were villains.
You asked me who the greatest villain was, so I don’t want to give you a long list of villains. If I had to put my finger on one person or one kind of person, one role player in this crisis who I would like to string up, or rather I’d like to have him have to answer questions honestly to the public, I think it would be the people who I know knew better.
I would like for the people who designed synthetic CDOs at Goldman Sachs and persuaded AIG to insure them, to essentially take all the risk in the subprime mortgage market in 2005, I would like for them to explain what they thought they were doing.
There was nothing illegal about what they did. It was just exploitative. It was just wrong. But they were smart enough, and their position in the society was elevated enough that you would have thought that they would have paused and said, “I have some responsibility here not to do this or to prevent this from happening.” Not to actually make it happen.
There’s a very obvious status structure on Wall Street. Ratings agencies aren’t even in it. But at the very top of the status structure is Goldman Sachs, certain traders at Goldman Sachs, and hedge funds. And when the people at the top set such a bad example, everything else, in a weird way, follows from it.
I’d like the genuine elites to explain why they did, why they behaved in the way they did. Because I think in the end, if you’re going to get back to a saner relationship between our financial system and the rest of the economy and the rest of the society, you have to have people at the very top of that structure who have some sense of social obligation. And they don’t right now.
It’s a question of how do you restore that. And you restore it with shame, with a sense of you should be ashamed that you did not behave in the way you should have behaved. How do we fix that, how do we get you to reframe your relationship to the rest of the society? That’s where I’d go. That’s who I’d like to see dragged in front of the public and have to explain themselves.
SCHATZKER: Does that make Goldman evil?
LEWIS: Evil’s too strong a word. I think the system is evil, and the system is capable, obviously capable and likely to do great wrong. And the rules in the system need to be changed.
And people are just badly incentivized. And they’re badly incentivized inside Goldman Sachs. And I’m sure individually they’re all bright, they’re all smart.
SCHATZKER: In some cases delightful.
LEWIS: Absolutely. Maybe not at the end of their careers, but certainly the beginning.
It’s not that these are bad people. And it’s a mistake to say what you need to do is get rid of some bad people and put some good people in. Because if you put the good people into the same system, they’ll become bad people. They’re badly incentivized.
SCHATZKER: So what happens if the rules of the game aren’t changed?
LEWIS: Well, the popular thing to say is it’s all going to happen again. But if it does all happen again, it’s going to happen in such a different way it’s going to require an elaborate explanation to show people how it all connects up. But it will all happen again.
The bigger problem is: What is Wall Street supposed to do? It’s not a creator of wealth. It’s a handmaiden to creators of wealth. It occupies an essentially parasitic, but usefully parasitic relationship with the rest of the society. It’s totally out of control. It’s not making America a great place; it’s making America a worse place right now.
That’s the problem. Finance needs to occupy a healthier, more productive relationship with the rest of the society. It isn’t just an economic relationship; it’s got the social, cultural component to it. It is not healthy that our financial system has rules in it that enable the returns to individual traders that it enables.
And it leaves half the smartest kids from the best schools wanting to be, more than anything else in their lives, bond traders or investment bankers. It’s a waste of talent. The wrong economic signals are being sent by the system that’s in place. I think if the rules were changed in some obvious ways, the returns to the finance sector would decline and talent would find more useful avenues of endeavor.
SCHATZKER: Wall Street hasn’t disappeared. The firms that survived may be even stronger now than they were before. And a whole lot of the people, the traders, for example, who lost their jobs, are back employed by the firms that survived. So where is the justice?
LEWIS: It’s not over. We’re living through this big transition right now, I think. But Wall Street has changed dramatically. And Wall Street’s relationship to the rest of the world has changed dramatically. And the way people view Wall Street has changed dramatically.
These firms have gone from being unquestioned Masters of the Universe and an unquestioned upper class that everyone aspired to be in, to being essentially enemies of the people inside the last two years. They do have a lot of political influence, and there is natural resistance, an impediment to changing the rules of their road.
But there is also, on the other side of that, enormous anger and cynicism that is going to find a political expression. You can’t expect democracy to move as quickly as finance. Financial markets panic. They change very rapidly. Democracy moves very slowly. In 1929, the markets collapsed. It wasn’t until 1933 that Glass-Steagall was introduced. It took several years to have proper hearings in Congress.
The reason for that is that the engine for democratic change is elections, and elections don’t happen every day. Essentially, the relationship between these firms and the rest of society has changed in a way that’s permanent, and that we are going to see changes in their political oversight. That is going to change their returns. That is going to change the prestige associated with working for them, all the rest. This comeuppance is going to be gradual.
SCHATZKER: Are you personally outraged?
LEWIS: Yes, because it’s outrageous. Absolutely. If the markets had been allowed to function, if the government had not stepped in to rescue these firms, they’d all be out of business, all of them. They’re all failed. There are different degrees of idiocy.
Maybe Goldman Sachs doesn’t fail because it has lots of subprime mortgage bonds on its books. It fails because it’s got credit default swaps with people who do. But nevertheless, it fails.
Because of the position they occupy in the financial system, they can’t be allowed to fail. I think that you can forgive; that step I can forgive. I completely understand. I can understand how the decisions made in the midst of the crisis were necessarily self-contradictory, ad hoc, hard to understand, in retrospect, all the rest.
But now we’re out of that. And what I find outrageous is that the people who were in positions of influence and power when the crisis occurred were by definition people who didn’t see it coming. They were, by definition, ignorant of what was going on right under their noses.
That there has been so little change in that regime is a little outrageous to me. I think it’s outrageous that, essentially, the U.S. government took the position, unlike the U.K. government, that these firms were so central to our way of life that not only could we not let them fail, but we can’t even suggest their creditors take a hit. Essentially, they’re failed institutions that we need to prop up, so we are going to gift them money until they get out of their problems, which they appear to be doing now.
So that’s what we’ve done. We’ve gifted them money. In the beginning, we gifted the money in very overt ways, direct investment in the firms or buying their securities at inflated prices or whatever. Those are obvious ways. But now they’re able to tap the Fed for money at zero percent, reinvest the money into agency bonds and take the spread as a gift.
It’s outrageous that they’re essentially being gifted out of their problems, and that their view is that their employees deserve a large chunk of the rewards of those gifts.
It’s outrageous. But on the other hand, it’s understandable, because they have a way of life that has existed for 30 years on Wall Street. It’s very hard to change people’s habits, especially if they don’t have to change. And they’ve proved that they don’t have to change.
I think that the end result of this, however, is just to stoke the political anger that is going to change the system. In the end, in a weird way, the behavior of the Wall Street firms currently is the best friend that reform has, because they’re not doing a very good job of disguising their interests in the rest of the world. |
