THE WALL/FALL STREET FINANCIAL BUST OF 2008
I am pleased to be able to bring you a small part of the first
pages of the recent book by Michael Lewis - "The Big Small" - a
book you must read if you really want the inside scoop to the USA
financial collapse of 2008, that took down most of the world with
it. It was the sin of GREED and selfishness - the love of money!
Keith Hunt
WHEN THE CRASH of the U.S. stock market became public knowledge
in the fall of 2008, it was already old news. The real crash, the
silent crash, had taken place over the previous year, in bizarre
feeder markets where the sun doesn't shine and the SEC doesn't
dare, or bother, to tread: the bond and real estate derivative
markets where geeks invent impenetrable securities to profit from
the misery of lower-and middle-class Americans who can't pay
their debts. The smart people who understood what was or might be
happening were paralyzed by hope and fear; in any case, they
weren't talking.
The crucial question is this: Who understood the risk inherent in
the assumption of ever-rising real estate prices, a risk
compounded daily by the creation of those arcane, artificial
securities loosely based on piles of doubtful mortgages?
Michael Lewis turns the inquiry on its head to create a fresh,
character-driven narrative brimming with indignation and dark
humor, a fitting sequel to his #l best-selling "Liar's Poker."
Who got it right? he asks. Who saw the real estate market for the
black hole it would become, and eventually made billions of
dollars from that: perception? And what qualities of character
made those few persist when their peers and colleagues dismissed
them as Chicken Littles? Out of this handful of unlikely-really
unlikely-heroes, Lewis fashions a story as compelling and unusual
as any of his earlier bestsellers, proving yet again that he is
the finest and funniest chronicler of our times.
......
The most difficult subjects can be explained to the most
slow-witted man if he has not formed any idea of them already;
but the simplest thing cannot be made clear to the most
intelligent man if he is firmly persuaded that he knows already,
without a shadow of doubt, what is laid before him.
-Leo Tolstoy, 1897
......
PROLOGUE
The willingness of a Wall Street investment bank to pay me
hundreds of thousands of dollars to dispense investment advice to
grown-ups remains a mystery to me to this day. I was twenty-four
years old, with no experience of, or particular interest in,
guessing which stocks and bonds would rise and which would fall.
Wall Street's essential function was 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'd stumbled into a job at Salomon Brothers
in 1985, and stumbled out, richer, in 1988, and even though I
wrote a book about the experience, the whole thing still strikes
me as totally preposterous-which is one reason 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 would come a Great Reckoning,
when Wall Street would wake up and hundreds, if not thousands, of
young people like me, who had no business making huge bets with
other people's money or persuading other people to make those
bets, would be expelled from finance.
When I sat down to write my account of the experience -
"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 and stuffing it into a
bottle for those who passed 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 had
happened.
Up to that point, just about everything written about Wall
Street had been about the stock market. The stock market had
been, from the very beginning, where most of Wall Street lived.
My book was mainly about the bond market, because Wall Street was
now making even bigger money packaging and selling and shuffling
around America's growing debts. This, too, I assumed was
unsustainable. I thought that I was writing a period piece about
the 1980s in America, when a great nation lost its financial
mind. I expected readers of the future would be appalled that,
back in 1986, the CEO of Salomon Brothers, John Gutfreund, was
paid $3.1 million as he ran the business into the ground. I
expected them to gape in wonder at the story of Howie Rubin, the
Salomon mortgage bond trader, who had moved to Merrill Lynch and
promptly lost $250 million. I expected them to be shocked that,
once upon a time on Wall Street, the CEOs had only the vaguest
idea of the complicated risks their bond traders were running.
And that's pretty much how I imagined it; what I never imagined
is that the future reader might look back on any of this, or on
my own peculiar experience, and say, "How quaint." How innocent.
Not for a moment did I suspect that the financial 1980s would
last for two full decades longer, or that the difference in
degree between Wall Street and ordinary economic life would swell
to a difference in kind. That a single bond trader might be paid
$47 million a year and feel cheated. That the mortgage bond
market invented on the Salomon Brothers trading floor, which
seemed like such a good idea at the time, would lead to the most
purely financial economic disaster in history. That exactly
twenty years after Howie Rubin became a scandalous household name
for losing $250 million, another mortgage bond trader named
Howie, inside Morgan Stanley, would lose $9 billion on a single
mortgage trade, and remain essentially unknown, without anyone
beyond a small circle inside Morgan Stanley ever hearing about
what he'd done, or why.
When I sat down to write my first book, I had no great
agenda, apart from telling what I took to be a remarkable tale.
If you'd gotten a few drinks in me and then asked what effect the
book would have on the world, I might have said something like,
"I hope that college students trying to decide what to do with
their lives might read it and decide that it's silly to phony it
up, and abandon their passions or even their faint interests, to
become financiers." I hoped that some bright kid at Ohio State
University who really wanted to be an oceanographer would read my
book, spurn the offer from Goldman Sachs, and set out to sea.
Somehow that message was mainly lost. Six months after "Liar's
Poker" was published, I was knee-deep in letters from students at
Ohio State University 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 after I left, I waited for the end of
Wall Street as I had known it. The outrageous bonuses, the
endless parade of rogue traders, the scandal that sank Drexel
Burnham, the scandal that destroyed John Gutfreund and finished
off Salomon Brothers, the crisis following the collapse of my old
boss John Meriwether's LongTerm Capital Management, the Internet
bubble: Over and over again, the financial system was, in some
narrow way, discredited. Yet the big Wall Street banks at the
center of it just kept on growing, along with the sums of money
that they doled out to twenty-six-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 and sell off the pieces
At some point, I gave up waiting. There was no scandal or
reversal, I assumed, sufficiently great to sink the system.
Then came Meredith Whitney, with news. Whitney was an
obscure analyst of financial firms for an obscure financial firm,
Oppenheimer and Co., 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 inside the stock market, but it was pretty clear
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, and who could have been
dismissed as a nobody, had shaved 8 percent off the shares of
Citigroup and $390 billion off the value of the U.S. stock
market. Four days later, Citigroup CEO Chuck Prince resigned. Two
weeks later, Citigroup slashed its dividend.
From that moment, Meredith 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 cold,
hard look at these crappy assets they're holding with borrowed
money, and imagine what they'd fetch in a fire sale. The vast
assemblages of highly paid people inside them were worth, in her
view, nothing. All through 2008, she followed the bankers' and
brokers' claims that they had put their problems behind them with
this write-down or that capital raise with her own claim: You're
wrong. You're still not facing up to how badly you have
mismanaged your business. You're still not acknowledging billions
of dollars in losses on subprime mortgage bonds. The value of
your securities is as illusory as the value of your people.
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, or
even the extent of their losses in the subprime mortgage market.
The CEOs themselves didn't know. "Either that or they are all
liars," she said, "but I assume they really just don't know."
Now, obviously, Meredith Whitney didn't sink Wall Street.
She'd just expressed most clearly and most loudly a view that
turned out to be far more seditious to the social order than,
say, the many campaigns by various New York attorneys general
against Wall Street corruption. If mere scandal could have
destroyed the big Wall Street investment banks, they would have
vanished long ago. This woman wasn't saying that Wall Street
bankers were corrupt. She was saying that they were stupid. These
people whose job it was to allocate capital apparently didn't
even know how to manage their own.
I confess some part of me thought, If only I'd stuck around,
this is the sort of catastrophe I might have created. The
characters at the center of Citigroup's mess were the very same
people I'd worked with at Salomon Brothers; a few of them had
been in my Salomon Brothers training class. At some point I
couldn't contain myself: I called Meredith Whitney. This was back
in March 2008, just before the failure of Bear Stearns, when the
outcome still hung in the balance. I thought, If she's right,
this really could be the moment when the financial world gets put
back into the box from which it escaped in the early 1980s. 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.
She'd arrived on Wall Street in 1994, out of the Brown
University Department of English. "I got to New York and I didn't
even know research existed," she says. She'd wound up landing a
job at Oppenheimer and Co. and then had the most incredible piece
of luck: to be trained by a man who helped her to establish not
merely a career but a worldview. His name, she said, was Steve
Eisman. "After I made the Citi call," she said, "one of the best
things that happened was when Steve called and told me how proud
he was of me." Having never heard of Steve Eisman, I didn't think
anything of this.
But then I read the news that a little-known New York hedge
fund manager named John Paulson had made $20 billion or so for
his investors and nearly $4 billion for himself. This was more
money than anyone had ever made so quickly on Wall Street.
Moreover, he had done it by betting against the very subprime
mortgage bonds now sinking Citigroup and every other big Wall
Street investment bank. Wall Street investment banks are like Las
Vegas casinos: They set the odds. The customer who plays zero-sum
games against them may win from time to time but never
systematically, and never so spectacularly that he bankrupts the
casino. Yet John Paulson had been a Wall Street customer. Here
was the mirror image of the same incompetence Meredith Whitney
was making her name pointing out. The casino had misjudged,
badly, the odds of its own game, and at least one person had
noticed. I called Whitney again to ask her, as I was asking
others, if she knew anyone who had anticipated the subprime
mortgage cataclysm, thus setting himself up in advance to make a
fortune from it. Who else had noticed, before the casino caught
on, that the roulette wheel had become predictable? Who else
inside the black box of modern finance had grasped the flaws of
its machinery?
It was then late 2008. By then there was a long and growing
list of pundits who claimed they predicted the catastrophe, but a
far shorter list 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, to believe that most important financial
people are either lying or deluded-without being insane. Whitney
rattled off a list with a halfdozen names on it, mainly investors
she had personally advised. In the middle was John Paulson. At
the top was Steve Eisman.
CHAPTER ONE
A SECRET ORIGIN STORY
Eisman entered finance about the time I exited it. He`d
grown up in New York City, gone to yeshiva schools, graduated
from the University of Pennsylvania magna cum laude, and then
with honors from Harvard Law School. In 1991 he was a
thirty-year-old corporate lawyer wondering why he ever thought
he'd enjoy being a lawyer. "I hated it," he says. "I hated being
a lawyer. My parents worked as brokers at Oppenheimer securities.
They managed to finagle me a job. It's not pretty but that's what
happened."
Oppenheimer was among the last of the old-fashioned Wall
Street partnerships and survived on the scraps left behind by
Goldman Sachs and Morgan Stanley. It felt less like a corporation
than a family business. Lillian and Elliot Eisman had been giving
financial advice to individual investors on behalf of Oppenheimer
since the early 1960s. (Lillian had created their brokerage
business inside of Oppenheimer, and Elliot, who had started out
as a criminal attorney, had joined her after being spooked once
too often by midlevel Mafia clients.) Beloved and respected by
colleagues and clients alike, they could hire whomever they
pleased. Before rescuing their son from his legal career they'd
installed his old nanny on the Oppenheimer trading floor. On his
way to reporting to his mother and father, Eisman passed the
woman who had once changed his diapers. Oppenheimer had a
nepotism rule, however; if Lillian and Elliot wanted to hire
their son, they had to pay his salary for the first year, while
others determined if he was worth paying at all.
Eisman's parents, old-fashioned value investors at heart,
had always told him that the best way to learn about Wall Street
was to work as an equity analyst. He started in equity analysis,
working for the people who shaped public opinion about public
companies. Oppenheimer employed twenty-five or so analysts, most
of whose analysis went ignored by the rest of Wall Street. "The
only way to get paid as an analyst at Oppenheimer was being right
and making enough noise about it that people noticed it," says
Alice Schroeder, who covered insurance companies for Oppenheimer,
moved to Morgan Stanley, and eventually wound up being Warren
Buffett's official biographer. She added, "There was a
counterculture element to Oppenheimer. The people at the big
firms were all being paid to be consensus." Eisman turned out to
have a special talent for making noise and breaking with
consensus opinion. He started as a junior equity analyst, a
helpmate, not expected to offer his own opinions. That changed in
December 1991, less than a year into the new job. A subprime
mortgage lender called Aames Financial went public, and no one at
Oppenheimer particularly cared to express an opinion about it.
One of Oppenheimer's bankers, who hoped to be hired by Aames,
stomped around the research department looking for anyone who
knew anything about the mortgage business. "I'm a junior analyst
and I'm just trying to figure out which end is up," says Eisman,
"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
Aames 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."
Aames Financial, like The Money Store, belonged to a new
category of firms extending loans to cash-strapped Americans,
known euphemistically as "specialty finance." The category did
not include Goldman Sachs or J.P.Morgan but did include many
little-known companies involved one way or another in the early
1990s boom in subprime mortgage lending. Aames was the first
subprime mortgage lender to go public. The second company for
which Eisman was given sole responsibility was called Lomas
Financial Corp. Lomas had just emerged from bankruptcy. "I put a
sell rating on the thing because it was a piece of shit. I didn't
know that you weren't supposed to put sell ratings on companies.
I thought there were three boxes-buy, hold, sell-and you could
pick the one you thought you should." He was pressured to be a
bit more upbeat, but upbeat did not come naturally to Steve
Eisman. He could fake upbeat, and sometimes did, but he was
happier not bothering. "I could hear him shouting into his phone
from down the hall," says a former colleague. "Joyfully engaged
in bashing the stocks of the companies he covered. Whatever he's
thinking, it comes out of his mouth." Eisman stuck to his sell
rating on Lomas Financial, even after the Lomas Financial
Corporation 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 Corporation 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 published
that line, the Lomas Financial Corporation returned to bank-
ruptcy.
Eisman quickly established himself as one of the few
analysts at Oppenheimer whose opinions might stir the markets.
"It was like going back to school for me," he said. "I would
learn about an industry and I would go and write a paper about
it." Wall Street people came to view him as a genuine character.
He dressed half-fastidiously, as if someone had gone to great
trouble to buy him nice new clothes but not told him exactly how
they should be worn. His short-cropped blond hair looked as if he
had cut it himself. The focal point of his soft, expressive, not
unkind face was his mouth, mainly because it was usually at least
half open, even while he ate. It was as if he feared that he
might not be able to express whatever thought had just flitted
through his mind quickly enough before the next one came, and so
kept the channel perpetually clear. His other features all
arranged themselves, almost dutifully, around the incipient
thought. It was the opposite of a poker face.
In his dealings with the outside world, a pattern emerged.
The growing number of people who worked for Steve Eisman loved
him, or were at least amused by him, and appreciated his
willingness and ability to part with both his money and his
knowledge. "He's a born teacher," says one woman who worked for
him. "And he's fiercely protective of women." He identified with
the little guy and the underdog without ever exactly being one
himself. Important men who might have expected from Eisman some
sign of deference or respect, on the other hand, often came away
from encounters with him shocked and outraged. "A lot of people
don't get Steve," Meredith Whitney had told me, "but the people
who get him love him." One of the people who didn't get Steve was
the head of a large U.S. brokerage firm, who listened to Eisman
explain in front of several dozen investors at lunch why he, the
brokerage firm head, didn't understand his own business, then
watched him leave in the middle of the lunch and never return.
("I had to go to the bathroom," says Eisman. "I don't know why I
never went back.") After the lunch, the guy had announced he'd
never again agree to enter any room with Steve Eisman in it. The
president of a large Japanese real estate firm was another. He'd
sent Eisman his company's financial statements and then followed,
with an interpreter, to solicit Eisman's investment. "You don't
even own stock in your company," said Eisman, after the typically
elaborate Japanese businessman introductions. The interpreter
conferred with the CEO.
"In Japan it is not customary for management to own stock,"
he said at length.
Eisman noted that the guy's financial statements didn't
actually disclose any of the really important details about the
guy's company; but, rather than simply say that, he lifted the
statement in the air, as if disposing of a turd. "This ... this
is toilet paper," he said. "Translate that."
"The Japanese guy takes off his glasses," recalled a witness
to the strange encounter. "His lips are quavering. World War
Three is about to break out."'Toy-lay paper? Toy-lay paper?"'
A hedge fund manager who counted Eisman as a friend set out
to explain him to me but quit a minute into it - after he'd
described Eisman exposing various bigwigs as either liars or
idiots - and started to laugh. "He's sort of a prick in a way,
but he's smart and honest and fearless."
"Even on Wall Street people think he's rude and obnoxious
and aggressive," says Eisman's wife, Valerie Feigen, who worked
at J.P.Morgan before quitting to open the women's clothing store
Edit New York, and to raise their children. "He has no interest
in manners. Believe me, I've tried and I've tried and I've
tried." After she'd brought him home for the first time, her
mother had said, "Well, we can't use him but we can definitely
auction him off at UJA." * Eisman had what amounted to a talent
for offending people. "He's not tactically rude," his wife
explains. "He's sincerely rude. He knows everyone thinks of him
as a character but he doesn't think of himself that way. Steven
lives inside his head."
......
* United Jewish Appeal.
......
When asked about the pattern of upset he leaves in his wake,
Eisman simply looks puzzled, even a bit wounded. "I forget myself
sometimes," he says with a shrug.
Here was the first of many theories about Eisman: He was
simply so much more interested in whatever was rattling around
his brain than he was in whoever happened to be standing in front
of him that the one overwhelmed the other. This theory struck
others who knew Eisman well as incomplete. His mother, Lillian,
offered a second theory. "Steven actually has two personalities,"
she said carefully. One was that of the boy to whom she had given
the brand-new bicycle he so desperately craved, only to have him
pedal it into Central Park, lend it to a kid he'd never met, and
watch it vanish into the distance. The other was that of the
young man who set out to study the Talmud, not because he had the
slightest interest in God but because he was curious about its
internal contradictions. His mother had been appointed chairman
of the Board of Jewish Education in New York City, and Eisman was
combing the Talmud for inconsistencies. "Who else studies Talmud
so that they can find the mistakes?" asks his mother. Later,
after Eisman became seriously rich and had to think about how to
give money away, he landed on an organization called Footsteps,
devoted to helping Hasidic Jews flee their religion. He couldn't
even give away his money without picking a fight.
By pretty much every account, Eisman was a curious
character. And he'd walked onto Wall Street at the very beginning
of a curious phase. The creation of the mortgage bond market, a
decade earlier, had extended Wall Street into a place it had
never before been: the debts of ordinary Americans. At first the
new bond market machine concerned itself with the more solvent
half of the American population. Now, with the extension of the
mortgage bond market into the affairs of less creditworthy
Americans, it found its fuel in the debts of the less solvent
half.
The mortgage bond was different in important ways from old-
fashioned corporate and government bonds. A mortgage bond wasn't
a single giant loan for an explicit fixed term. A mortgage bond
was a claim on the cash flows from a pool of thousands of
individual home mortgages. These cash flows were always
problematic, as the borrowers had the right to pay off any time
they pleased. This was the single biggest reason that bond
investors initially had been reluctant to invest in home mortgage
loans: Mortgage borrowers typically repaid their loans only when
interest rates fell, and they could refinance more cheaply,
leaving the owner of a mortgage bond holding a pile of cash, to
invest at lower interest rates. The investor in home loans didn't
know how long his investment would last, only that he would get
his money back when he least wanted it. To limit this
uncertainty, the people I'd worked with at Salomon Brothers, who
created the mortgage bond market, had come up with a clever
solution. They took giant pools of home loans and carved up the
payments made by homeowners into pieces, called tranches. The
buyer of the first tranche was like the owner oŁ the ground floor
in a flood: He got hit with the first wave of mortgage
prepayments. In exchange, he received a higher interest rate. The
buyer of the second tranche-the second story of the
skyscraper-took the next wave of prepayments and in exchange
received the second highest interest rate, and so on. The
investor in the top floor of the building received the lowest
rate of interest but had the greatest assurance that his
investment wouldn't end before he wanted it to.
The big fear of the 1980s mortgage bond investor was that he
would be repaid too quickly, not that he would fail to be repaid
at all. The pool of loans underlying the mortgage bond conformed
to the standards, in their size and the credit quality of the
borrowers, set by one of several government agencies: Freddie
Mac, Fannie Mae, and Ginnie Mae. The loans carried, in effect,
government guarantees; if the homeowners defaulted, the
government paid off their debts. When Steve Eisman stumbled into
this new, rapidly growing industry of specialty finance, the
mortgage bond was about to be put to a new use: making loans that
did not qualify for government guarantees. The purpose was to
extend credit to less and less creditworthy homeowners, not so
that they might buy a house but so that they could cash out
whatever equity they had in the house they already owned.
The mortgage bonds created from subprime home loans extended
the logic invented to address the problem of early repayment to
cope with the problem of no repayment at all. The investor in the
first floor, or tranche, would be exposed not to prepayments but
to actual losses. He took the first losses until his investment
was entirely wiped out, whereupon the losses hit the guy on the
second floor. And so on.
In the early 1990s, just a pair of Wall Street analysts
devoted their careers to understanding the effects of extending
credit into places where that sun didn't often shine. Steve
Eisman was one; the other was Sy Jacobs. Jacobs had gone through
the same Salomon Brothers training program that I had, and now
worked for a small investment bank called Alex Brown. "I sat
through the Salomon training program and got to hear what this
great new securitization model Lewie Ranieri was creating was
going to do," he recalls. (Ranieri was the closest thing the
mortgage bond market had to a founding father.) The implications
of turning home mortgages into bonds were mind-bogglingly vast.
One man's liability had always been another man's asset, but now
more and more of the liabilities could be turned into bits of
paper that you could sell to anyone. In short order, the Salomon
Brothers trading floor gave birth to small markets in bonds
funded by all sorts of strange stuff: credit card receivables,
aircraft leases, auto loans, health club dues. To invent a new
market was only a matter of finding a new asset to hock. The most
obvious untapped asset in America was still the home. People with
first mortgages had vast amounts of equity locked up in their
houses; why shouldn't this untapped equity, too, be securitized?
"The thinking in subprime," says Jacobs, "was there was this
social stigma to being a second mortgage borrower and there
really shouldn't be. If your credit rating was a little worse,
you paid a lot more-and a lot more than you really should. If we
can mass market the bonds, we can drive down the cost to
borrowers. They can replace high interest rate credit card debt
with lower interest rate mortgage debt. And it will become a
self-fulfilling prophecy."
The growing interface between high finance and
lower-middle-class America was assumed to be good for
lower-middle-class America. This new efficiency in the capital
markets would allow lower-middleclass Americans to pay lower and
lower interest rates on their debts. In the early 1990s, the
first subprime mortgage lenders - The Money Store, Greentree,
Aames - sold shares to the public, so that they might grow
faster. By the mid-1990s, dozens of small consumer lending
companies were coming to market each year. The subprime lending
industry was fragmented. Because the lenders sold many - though
not all - of the loans they made to other investors, in the form
of mortgage bonds, the industry was also fraught with moral
hazard. "It was a fast-buck business," says Jacobs. "Any business
where you can sell a product and make money without having to
worry how the product performs is going to attract sleazy people.
That was the seamy underbelly of the good idea. Eisman and I both
believed in the big idea and we both met some really sleazy
characters. That was our job: to figure out which of the
characters were the right ones to pull off the big idea."
Subprime mortgage lending was still a trivial fraction of
the U.S. credit markets-a few tens of billions in loans each
year-but its existence made sense, even to Steve Eisman. "I
thought it was partly a response to growing income inequality,"
he said. "The distribution of income in this country was skewed
and becoming more skewed, and the result was that you have more
subprime customers." Of course, Eisman was paid to see the sense
in subprime lending: Oppenheimer quickly became one of the
leading bankers to the new industry, in no small part because
Eisman was one of its leading proponents. "I took a lot of
subprime companies public," says Eisman. "And the story they
liked to tell was that 'we're helping the consumer. Because we're
taking him out of his high interest rate credit card debt and
putting him into lower interest rate mortgage debt.' And I
believed that story." Then something changed.
Vincent Daniel had grown up in Queens, without any of the
perks Steve Eisman took for granted. And yet if you met them you
might guess that it was Vinny who had grown up in high style on
Park Avenue and Eisman who had been raised in the small duplex on
Eighty-second Avenue. Eisman was brazen and grandiose and focused
on the big kill. Vinny was careful and wary and interested in
details. He was young and fit, with thick, dark hair and handsome
features, but his appearance was overshadowed by his concerned
expressionmouth ever poised to frown, eyebrows ever ready to
rise. He had little to lose but still seemed perpetually worried
that something important was about to be taken from him. His
father had been murdered when he was a small boy - though no one
ever talked about that - and his mother had found a job as a
bookkeeper at a commodities trading firm. She'd raised Vinny and
his brother alone. Maybe it was Queens, maybe it was what had
happened to his father, or maybe it was just the way Vincent
Daniel was wired, but he viewed his fellow man with the most
intense suspicion. It was with the awe of a champion speaking of
an even greater champion that Steve Eisman said, "Vinny is dark."
Eisman was an upper-middle-class kid who had been faintly
surprised when he wound up at Penn instead of Yale. Vinny was a
lowermiddle-class kid whose mother was proud of him for getting
into any college at all and prouder still when, in 1994, after
Vinny graduated from SUNY-Binghamton, he'd gotten himself hired
in Manhattan by Arthur Andersen, the accounting firm that would
be destroyed a few years later, in the Enron scandal. "Growing up
in Queens, you very quickly figure out where the money is," said
Vinny. "It's in Manhattan." His first assignment in Manhattan, as
a junior accountant, was to audit Salomon Brothers. He was
instantly struck by the opacity of an investment bank's books.
None of his fellow accountants was able to explain why the
traders were doing what they were doing. "I didn't know what I
was doing," said Vinny. "But the scary thing was, my managers
didn't know anything either. I asked these basic questionslike,
Why do they own this mortgage bond? Are they just betting on it,
or is it part of some larger strategy? I thought I needed to
know. It's really difficult to audit a company if you can't
connect the dots."
He concluded that there was effectively no way for an
accountant assigned to audit a giant Wall Street firm to figure
out whether it was making money or losing money. They were giant
black boxes, whose hidden gears were in constant motion. Several
months into the audit, Vinny's manager grew tired of his
questions. "He couldn't explain it to me. He said, 'Vinny, it's
not your job. I hired you to do XYZ, do XYZ and shut your mouth.'
I walked out of his office and said, 'I gotta get out of here.'"
Vinny went looking for another job. An old school friend of
his worked at a place called Oppenheimer and Co. and was making
good money. He handed Vinny's resume in to human resources, and
it made its way to Steve Eisman, who turned out to be looking for
someone to help him parse the increasingly arcane accounting used
by subprime mortgage originators. "I can't add," says Eisman. "I
think in stories. I need help with numbers." Vinny heard that
Eisman could be difficult and was surprised that, when they met,
Eisman seemed interested only in whether they'd be able to get
along. "He seemed to be just looking for a good egg," says Vinny.
They'd met twice when Eisman phoned him out of the blue. Vinny
assumed he was about to be offered a job, but soon after they
started to talk, Eisman received an emergency call on the other
line and put Vinny on hold. Vinny sat waiting for fifteen minutes
in silence, but Eisman never came back on the line.
Two months later, Eisman called him back. When could Vinny
start? Eisman didn't particularly recall why he had put Vinny on
hold and never picked up again, any more than he recalled why he
had gone to the bathroom in the middle of lunch with a big-time
CEO and never returned. Vinny soon found his own explanation:
When he'd picked up the other line, Eisman had been informed that
his first child, a newborn son named Max, had died. Valerie, sick
with the flu, had been awakened by a night nurse, who informed
her that she, the night nurse, had rolled on top of the baby in
her sleep and smothered him. A decade later, the people closest
to Eisman would describe this as an event that changed his
relationship to the world around him. "Steven always thought he
had an angel on his shoulder," said Valerie. "Nothing bad ever
happened to Steven. He was protected and he was safe. After Max,
the angel on his shoulder was done. Anything can happen to anyone
at any time." From that moment, she noticed many changes in her
husband, large and small, and Eisman did not disagree. "From the
point of view of the history of the universe, Max's death was not
a big deal," said Eisman. "It was just my big deal."
At any rate, Vinny and Eisman never talked about what had
happened. All Vinny knew was that the Eisman he went to work for
was obviously not quite the same Eisman he'd met several months
earlier. The Eisman Vinny had interviewed with was, by the
standards of Wall Street analysts, honest. He was not completely
uncooperative. Oppenheimer was among the leading bankers to the
subprime mortgage industry. They never would have been given the
banking business if Eisman, their noisiest analyst, had not been
willing to say nice things about them. Much as he enjoyed bashing
the less viable companies, he accepted that the subprime lending
industry was a useful addition to the U.S. economy. His
willingness to be rude about a few of these subprime originators
was, in a way, useful. It lent credibility to his recommendations
of the others.
Eisman was now about to become noticeably more negatively
disposed, in ways that, from the point of view of his employer,
were financially counterproductive. "It was like he'd smelled
something," said Vinny. "And he needed my help figuring out what
it was he'd smelled." Eisman wanted to write a report that more
or less damned the entire industry, but he needed to be more
careful than usual. "You can be positive and wrong on the sell
side," says Vinny. "But if you're negative and wrong you get
fired." Ammunition to cause trouble had just arrived a few months
earlier from Moody's: The rating agency now possessed, and
offered for sale, all sorts of new information about subprime
mortgage loans. While the Moody's database did not allow you to
examine individual loans, it offered a general picture of the
pools of loans underlying individual mortgage bonds: how many
were floating-rate, how many of the houses borrowed against were
owner-occupied. Most importantly: how many were delinquent.
"Here's this database," Eisman said simply "Go into that room.
Don't come out until you've figured out what it means." Vinny had
the feeling Eisman already knew what it meant.
Vinny was otherwise on his own. "I'm twenty-six years old,"
he says, "and I haven't really understood what mortgage-backed
securities really are." Eisman didn't know anything about them
either-he was a stock market guy, and Oppenheimer didn't even
have a bond department. Vinny had to teach himself. When he was
done, he had an explanation for the unpleasant odor wafting from
the subprime mortgage industry that Eisman had detected. These
companies disclosed their ever-growing earnings, but not much
else. One of the many items they failed to disclose was the
delinquency rate of the home loans they were making. When Eisman
had bugged them for these, they'd pretended that the fact was
irrelevant, as they had sold all the loans off to people who
packaged them into mortgage bonds: The risk was no longer theirs.
This was untrue. All retained some small fraction of the loans
they originated, and the companies were allowed to book as profit
the expected future value of those loans. The accounting rules
allowed them to assume the loans would be repaid, and not
prematurely. This assumption became the engine of their doom.
What first caught Vinny's eye were the high prepayments
coming in from a sector called "manufactured housing." "('It
sounds better than, mobile homes.') Mobile homes were different
from the wheel-less kind: Their value dropped, like cars', the
moment they left the store. The mobile home buyer, unlike the
ordinary home buyer, couldn't expect to refinance in two years
and take money out." Why were they prepaying so fast? Vinny asked
himself. "It made no sense to me. Then I saw that the reason the
prepayments were so high is that they were involuntary."
"Involuntary prepayment" sounds better than "default."
Mobile home buyers were defaulting on their loans, their mobile
homes were being repossessed, and the people who had lent them
money were receiving fractions of the original loans. "Eventually
I saw that all the subprime sectors were either being prepaid or
going bad at an incredible rate," said Vinny. "I was just seeing
stunningly high delinquency rates in these pools." The interest
rate on the loans wasn't high enough to justify the risk of
lending to this particular slice of the American population. It
was as if the ordinary rules of finance had been suspended in
response to a social problem. A thought crossed his mind: How do
you make poor people feel wealthy when wages are stagnant? You
give them cheap loans.
To sift every pool of subprime mortgage loans took him six
months, but when he was done he came out of the room and gave
Eisman the news. All these subprime lending companies were
growing so rapidly, and using such goofy accounting, that they
could mask the fact that they had no real earnings, just
illusory, accounting-driven, ones. They had the essential feature
of a Ponzi scheme: To maintain the fiction that they were
profitable enterprises, they needed more and more capital to
create more and more subprime loans. "I wasn't actually a hundred
percent sure I was right," said Vinny, "but I go to Steve and
say, 'This really doesn't look good.' That was all he needed to
know. I think what he needed was evidence to downgrade the
stock."
The report Eisman wrote trashed all of the subprime
originators; one by one, he exposed the deceptions of a dozen
companies. "Here is the difference," he said, "between the view
of the world they are presenting to you and the actual numbers."
The subprime companies did not appreciate his effort. "He created
a shitstorm," said Vinny. "All these subprime companies were
calling and hollering at him: You're wrong. Your data's wrong.
And he just hollered back at them, 'It's YOUR fucking data!'" One
of the reasons Eisman's report disturbed so many is that he'd
failed to give the companies he'd insulted fair warning. He'd
violated the Wall Street code. "Steve knew this was going to
create a shitstorm," said Vinny. "And he wanted to create the
shitstorm. And he didn't want to be talked out of it. And if he
told them, he'd have had all these people trying to talk him out
of it."
"We were never able to evaluate the loans before because we
never had the data," said Eisman later. "My name was wedded to
this industry. My entire reputation had been built on covering
these stocks. If I was wrong, that would be the end of the career
of Steve Eisman."
Eisman published his report in September 1997, in the middle
of what appeared to be one of the greatest economic booms in U.S.
history. Less than a year later, Russia defaulted and a hedge
fund called Long-Term Capital Management went bankrupt. In the
subsequent flight to safety, the early subprime lenders were
denied capital and promptly went bankrupt en masse. Their failure
was interpreted as an indictment of their accounting practices,
which allowed them to record profits before they were realized.
No one but Vinny, so far as Vinny could tell, ever really
understood the crappiness of the loans they had made. "It made me
feel good that there was such inefficiency to this market," he
said. "Because if the market catches on to everything, I probably
have the wrong job. You can't add anything by looking at this
arcane stuff, so why bother? But I was the only guy I knew who
was covering companies that were all going to go bust during the
greatest economic boom we'll ever see in my lifetime. I saw how
the sausage was made in the economy and it was really freaky."
That was the moment it first became clear that Eisman wasn't just
a little cynical. He held a picture of the financial world in his
head that was radically different from, and less flattering than,
the financial world's self-portrait. A few years later, he quit
his job and went to work for a giant hedge fund called Chilton
Investment. He'd lost interest in telling other people where to
put their money. He thought he might be able to remain interested
if he managed money himself and bet on his own judgments. Having
hired Eisman, Chilton Investment had second thoughts. "The whole
thing about Steve," said a Chilton colleague, "was, 'Yeah, he's a
really smart guy. But can he pick stocks?"' Chilton decided that
he couldn't and relegated him to his old role of analyzing
companies for the guy who actually made the investment decisions.
Eisman hated it, but he did it, and in doing it he learned
something that prepared him uniquely for the crisis that was
about to occur. He learned what was really going on inside the
market for consumer loans.
The year was now 2002. There were no public subprime lending
companies left in America. There was, however, an ancient
consumer lending giant called Household Finance Corporation.
Created in the 1870s, it had long been a leader in the field.
Eisman understood the company well, he thought, until he
realized that he didn't. In early 2002 he got his hands on
Household's new sales document offering home equity loans. The
company's CEO, Bill Aldinger, had grown Household even as his
competitors went bankrupt. Americans, digesting the Internet
bust, seemed in no position to take on new debts, and yet
Household was making loans at a faster pace than ever......
......................
If this was not all the truth of the matter in the financial
world of the USA a decade ago or so, you'd think this book by
Lewis was a masterful cloak-and-dagger Wall Street fiction story;
but sadly it was to all lead up to the big fall of the Wall
Street guys and most banks in the USA, with consequences that had
effects all around the world.
For a great insight and read, I recommend this book "The Big
Short."
Keith Hunt (May 2010)
