(c) 2010 F. Bruce Abel
Following up my last blog from The Baseline Scenario, this segment shows the other side of the coin:
To this day, the willingness of a Wall Street investment bank to pay me hundreds
of thousands of dollars to dispense investment advice to grownups remains a
mystery to me. I was 24 years old, with no experience of, or particular interest
in, guessing which stocks and bonds would rise and which would fall. The
essential function of Wall Street is to allocate capital—to decide who should
get it and who should not. Believe me when I tell you that I hadn’t the first
clue. I’d never taken an accounting course, never run a business, never even had
savings of my own to manage. I stumbled into a job at Salomon Brothers in 1985
and stumbled out much richer three years later, and even though I wrote a book
about the experience, the whole thing still strikes me as preposterous—which is
one of the reasons the money was so easy to walk away from. I figured the
situation was unsustainable. Sooner rather than later, someone was going to
identify me, along with a lot of people more or less like me, as a fraud. Sooner
rather than later, there would come a Great Reckoning when Wall Street would
wake up and hundreds if not thousands of young people like me, who had no
business making huge bets with other people’s money, would be expelled from
finance.When I sat down to write my account of the experience in 1989—Liar’s
Poker, it was called—it was in the spirit of a young man who thought he was
getting out while the getting was good. I was merely scribbling down a message
on my way out and stuffing it into a bottle for those who would pass through
these parts in the far distant future. Unless some insider got all of this down
on paper, I figured, no future human would believe that it happened. I thought I
was writing a period piece about the 1980s in America. Not for a moment did I
suspect that the financial 1980s would last two full decades longer or that the
difference in degree between Wall Street and ordinary life would swell into a
difference in kind. I expected readers of the future to be outraged that back in
1986, the C.E.O. of Salomon Brothers, John Gutfreund, was paid $3.1 million; I
expected them to gape in horror when I reported that one of our traders, Howie
Rubin, had moved to Merrill Lynch, where he lost $250 million; I assumed they’d
be shocked to learn that a Wall Street C.E.O. had only the vaguest idea of the
risks his traders were running. What I didn’t expect was that any future reader
would look on my experience and say, “How quaint.”I had no great agenda, apart
from telling what I took to be a remarkable tale, but if you got a few drinks in
me and then asked what effect I thought my book would have on the world, I might
have said something like, “I hope that college students trying to figure out
what to do with their lives will read it and decide that it’s silly to phony it
up and abandon their passions to become financiers.” I hoped that some bright
kid at, say, Ohio State University who really wanted to be an oceanographer
would read my book, spurn the offer from Morgan Stanley, and set out to sea.
Somehow that message failed to come across. Six months after Liar’s Poker was
published, I was knee-deep in letters from students at Ohio State who wanted to
know if I had any other secrets to share about Wall Street. They’d read my book
as a how-to manual.In the two decades since then, I had been waiting for the end
of Wall Street. The outrageous bonuses, the slender returns to shareholders, the
never-ending scandals, the bursting of the internet bubble, the crisis following
the collapse of Long-Term Capital Management: Over and over again, the big Wall
Street investment banks would be, in some narrow way, discredited. Yet they just
kept on growing, along with the sums of money that they doled out to
26-year-olds to perform tasks of no obvious social utility. The rebellion by
American youth against the money culture never happened. Why bother to overturn
your parents’ world when you can buy it, slice it up into tranches, and sell off
the pieces?
At some point, I gave up waiting for the end. There was no
scandal or reversal, I assumed, that could sink the system.
Then came
Meredith Whitney with news. Whitney was an obscure analyst of financial firms
for Oppenheimer Securities who, on October 31, 2007, ceased to be obscure. On
that day, she predicted that Citigroup had so mismanaged its affairs that it
would need to slash its dividend or go bust. It’s never entirely clear on any
given day what causes what in the stock market, but it was pretty obvious that
on October 31, Meredith Whitney caused the market in financial stocks to crash.
By the end of the trading day, a woman whom basically no one had ever heard of
had shaved $369 billion off the value of financial firms in the market. Four
days later, Citigroup’s C.E.O., Chuck Prince, resigned. In January, Citigroup
slashed its dividend. From that moment, Whitney became E.F. Hutton: When she
spoke, people listened. Her message was clear. If you want to know what these
Wall Street firms are really worth, take a hard look at the crappy assets they
bought with huge sums of borrowed money, and imagine what they’d fetch in a
fire sale. The vast assemblages of highly paid people inside the firms were
essentially worth nothing. For better than a year now, Whitney has responded to
the claims by bankers and brokers that they had put their problems behind them
with this write-down or that capital raise with a claim of her own: You’re
wrong. You’re still not facing up to how badly you have mismanaged your
business. Rivals accused Whitney of being overrated; bloggers accused her of
being lucky. What she was, mainly, was right. But it’s true that she was, in
part, guessing. There was no way she could have known what was going to happen
to these Wall Street firms. The C.E.O.’s themselves didn’t know. Now, obviously,
Meredith Whitney didn’t sink Wall Street. She just expressed most clearly and
loudly a view that was, in retrospect, far more seditious to the financial order
than, say, Eliot Spitzer’s campaign against Wall Street corruption. If mere
scandal could have destroyed the big Wall Street investment banks, they’d have
vanished long ago. This woman wasn’t saying that Wall Street bankers were
corrupt. She was saying they were stupid. These people whose job it was to
allocate capital apparently didn’t even know how to manage their own. At some
point, I could no longer contain myself: I called Whitney. This was back in
March, when Wall Street’s fate still hung in the balance. I thought, If she’s
right, then this really could be the end of Wall Street as we’ve known it. I was
curious to see if she made sense but also to know where this young woman who was
crashing the stock market with her every utterance had come from.It turned out
that she made a great deal of sense and that she’d arrived on Wall Street in
1993, from the Brown University history department. “I got to New York, and I
didn’t even know research existed,” she says. She’d wound up at Oppenheimer and
had the most incredible piece of luck: to be trained by a man who helped her
establish not merely a career but a worldview. His name, she says, was Steve
Eisman. Eisman had moved on, but they kept in touch. “After I made the Citi
call,” she says, “one of the best things that happened was when Steve called and
told me how proud he was of me.”Having never heard of Eisman, I didn’t think
anything of this. But a few months later, I called 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. Steve 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.”Ames Financial belonged to a
category of firms known as nonbank financial institutions. The category didn’t
include J.P. Morgan, but it did encompass many little-known companies that one
way or another were involved in the early-1990s boom in subprime mortgage
lending—the lower class of American 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.
Eisman wasn’t, in short, an analyst with a
sunny disposition who expected the best of his fellow financial man and the
companies he created. “You have to understand,” Eisman says in his defense, “I
did subprime first. I lived with the worst first. These guys lied to infinity.
What I learned from that experience was that Wall Street didn’t give a shit what
it sold.” Harboring suspicions about people’s morals and telling investors
that companies don’t deserve their capital wasn’t, in the 1990s or at any other
time, the fast track to success on Wall Street. Eisman quit Oppenheimer in 2001
to work as an analyst at a hedge fund, but what he really wanted to do was run
money. FrontPoint Partners, another hedge fund, hired him in 2004 to invest in
financial stocks. Eisman’s brief was to evaluate Wall Street banks,
homebuilders, mortgage originators, and any company (General Electric or General
Motors, for instance) with a big financial-services division—anyone who touched
American finance. An insurance company backed him with $50 million, a paltry
sum. “Basically, we tried to raise money and didn't really do it,” Eisman says.
Instead of money, he attracted people whose worldviews were as shaded as his
own—Vincent Daniel, for instance, who became a partner and an analyst in charge
of the mortgage sector. Now 36, Daniel grew up a lower-middle-class kid in
Queens. One of his first jobs, as a junior accountant at Arthur Andersen, was to
audit Salomon Brothers’ books. “It was shocking,” he says. “No one could explain
to me what they were doing.” He left accounting in the middle of the internet
boom to become a research analyst, looking at companies that made subprime
loans. “I was the only guy I knew covering companies that were all going to go
bust,” he says. “I saw how the sausage was made in the economy, and it was
really freaky.” Danny Moses, who became Eisman’s head trader, was another who
shared his perspective. Raised in Georgia, Moses, the son of a finance
professor, 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 proposition.
--from Liar's Poker
