by Michael Lewis
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.
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.
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
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,
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.
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
At some point, I gave up waiting for the
end. There was no scandal or reversal, I assumed, that could sink the
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.
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.
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
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
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
Having never heard of Eisman, I didn't think
anything of this. But a few months later, I called Whitney again and
asked her, as I was asking others, whom she knew who had anticipated
the cataclysm and set themselves up to make a fortune from it. There's
a long list of people who now say they saw it coming all along but a
far shorter one of people who actually did. Of those, even fewer had
the nerve to bet on their vision. It's not easy to stand apart from
mass hysteria -- to believe that most of what's in the financial news is
wrong or distorted, to believe that most important financial people are
either lying or deluded -- without actually being insane. A handful of
people had been inside the black box, understood how it worked, and bet
on it blowing up. Whitney rattled off a list with a half-dozen names on
it. At the top was Steve Eisman.
Eisman entered finance about the time I exited it. He'd grown up in New
York City and gone to a Jewish day school, the University of
Pennsylvania, and Harvard Law School. In 1991, he was a 30-year-old
corporate lawyer. "I hated it," he says. "I hated being a lawyer. My
parents worked as brokers at Oppenheimer. They managed to finagle me a
job. It's not pretty, but that's what happened."
He was hired as a junior equity analyst, a helpmate who didn't actually
offer his opinions. That changed in December 1991, less than a year
into his new job, when a subprime mortgage lender called Ames Financial
went public and no one at Oppenheimer particularly cared to express an
opinion about it. One of Oppenheimer's investment bankers stomped
around the research department looking 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."
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 finance.
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 fearless."
"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 Corp. is a perfectly hedged financial institution: It
loses money in every conceivable interest-rate environment.' I enjoyed
writing that sentence more than any sentence I ever wrote." A few
months after he'd delivered that line in his report, Lomas Financial
returned to bankruptcy.
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, was a bit less
fatalistic than Daniel or Eisman, but he nevertheless shared a general
sense that bad things can and do happen. When a Wall Street firm helped
him get into a trade that seemed perfect in every way, he said to the
salesman, "I appreciate 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 trade.
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
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.
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.
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 home owners 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."
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 merely needed to stay flat.)
The default rate in Georgia was five times higher than that in Florida
even though the two states had the same unemployment rate. Why? Indiana
had a 25 percent default rate; California's was only 5 percent. Why?
actually flew down to Miami and wandered around neighborhoods built
with subprime loans to see how bad things were. "He'd call me and say,
`Oh my God, this is a calamity here,'" recalls Eisman. All that was
required for the BBB bonds to go to zero was for the default rate on
the underlying loans to reach 14 percent. Eisman thought that, in
certain sections of the country, it would go far, far higher.
The funny thing, looking back on it, is how long it took for even
someone who predicted the disaster to grasp its root causes. They were
learning about this on the fly, shorting the bonds and then trying to
figure out what they had done. Eisman knew subprime lenders could be
scumbags. What he underestimated was the total unabashed complicity of
the upper class of American capitalism. For instance, he knew that the
big Wall Street investment banks took huge piles of loans that in and
of themselves might be rated BBB, threw them into a trust, carved the
trust into tranches, and wound up with 60 percent of the new total
being rated AAA.
But he couldn't figure out exactly
how the rating agencies justified turning BBB loans into AAA-rated
bonds. "I didn't understand how they were turning all this garbage into
gold," he says. He brought some of the bond people from Goldman Sachs,
Lehman Brothers, and UBS over for a visit. "We always asked the same
question," says Eisman. "Where are the rating agencies in all of this?
And I'd always get the same reaction. It was a smirk." He called
Standard & Poor's and asked what would happen to default rates if
real estate prices fell. The man at S&P couldn't say; its model for
home prices had no ability to accept a negative number. "They were just
assuming home prices would keep going up," Eisman says.
As an investor, Eisman was allowed on the quarterly conference calls
held by Moody's but not allowed to ask questions. The people at Moody's
were polite about their brush-off, however. The C.E.O. even invited
Eisman and his team to his office for a visit in June 2007. By then,
Eisman was so certain that the world had been turned upside down that
he just assumed this guy must know it too. "But we're sitting there,"
Daniel recalls, "and he says to us, like he actually means it, `I truly
believe that our rating will prove accurate.' And Steve shoots up in
his chair and asks, `What did you just say?' as if the guy had just
uttered the most preposterous statement in the history of finance. He
repeated it. And Eisman just laughed at him."
"With all due respect, sir," Daniel told the C.E.O. deferentially as they left the meeting, "you're delusional."
This wasn't Fitch or even S&P. This 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
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 sees Steve's
hand and says, `Yes?'"
"Would you say that 5 percent is a probability or a possibility?" Eisman asked.
A probability, said the C.E.O., and he
continued his speech.
had his hand up in the air again, waving it around. Oh, no, Moses
thought. "The one thing Steve always says," Daniel explains, "is you
must assume they are lying to you. They will always lie to you." Moses
and Daniel both knew what Eisman thought of these subprime lenders but
didn't see the need for him to express it here in this manner. For
Eisman wasn't raising his hand to ask a question. He had his thumb and
index finger in a big circle. He was using his fingers to speak on his
behalf. Zero! they said.
"Yes?" the C.E.O. said, obviously irritated. "Is that another question?"
"No," said Eisman. "It's a zero. There is zero probability that your
default rate will be 5 percent." The losses on subprime loans would be
much, much greater. Before the guy could reply, Eisman's cell phone
rang. Instead of shutting it off, Eisman reached into his pocket and
answered it. "Excuse me," he said, standing up. "But I need to take
this call." And with that, he walked out.
willingness to be abrasive in order to get to the heart of the matter
was obvious to all; what was harder to see was his credulity: He
actually wanted to believe in the system. As quick as he was to cry
bullshit when he saw it, he was still shocked by bad behavior. That
night in Vegas, he was seated at dinner beside a really nice guy who
invested in mortgage C.D.O.'s -- collateralized debt obligations. By then,
Eisman thought he knew what he needed to know about C.D.O.'s. He
didn't, it turned out.
Later, when I sit down with
Eisman, the very first thing he wants to explain is the importance of
the mezzanine C.D.O. What you notice first about Eisman is his lips. He
holds them pursed, waiting to speak. The second thing you notice is his
short, light hair, cropped in a manner that suggests he cut it himself
while thinking about something else. "You have to understand this," he
says. "This was the engine of doom." Then he draws a picture of several
towers of debt. The first tower is made of the original subprime loans
that had been piled together. At the top of this tower is the AAA
tranche, just below it the AA tranche, and so on down to the riskiest,
the BBB tranche -- the bonds Eisman had shorted. But Wall Street had used
these BBB tranches -- the worst of the worst -- to build yet another tower of
bonds: a "particularly egregious" C.D.O. The reason they did this was
that the rating agencies, presented with the pile of bonds backed by
dubious loans, 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 says.
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
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 companion.
"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
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.'"
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
difference between fantasy finance 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 shorting 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
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.'"
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."
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
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.
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
"It was like feeding the monster," Eisman
says of the market for subprime bonds. "We fed the monster until it
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 other.
There was an
umbilical cord running from the belly of the exploded beast back to the
financial 1980s. A friend of mine created the first mortgage derivative
in 1986, a year after we left the Salomon Brothers trading program.
("The problem isn't the tools," he likes to say. "It's who is using the
tools. Derivatives are like guns.")
published my book, the 1980s were supposed to be ending. I received a
lot of undeserved credit for my timing. The social disruption caused by
the collapse of the savings-and-loan industry and the rise of hostile
takeovers and leveraged buyouts had given way to a brief period of
recriminations. Just as most students at Ohio State read Liar's Poker
as a manual, most TV and radio interviewers regarded me as a
whistleblower. (The big exception was Geraldo Rivera. He put me on a
show called "People Who Succeed 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.
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.
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 more meaningful to do with
their lives. As he began to describe his career, he broke down and wept.
When I emailed him 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'd
lost a half-step and was more deliberate in his movements, but
otherwise he was completely recognizable. The same veneer of denatured
courtliness masked the same 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 curious.
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.
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
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 asked.
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