What went wrong on Wall St.
In the most illuminating article I’ve read on the Wall Street meltdown, Michael Lewis in this month’s Portfolio.com discusses what he learned about the products and policies that led not only to the meltdown of Wall Street as well as the destruction of the investment banking industry.
Michael Lewis, author of Liar’s Poker, writes candidly of his career on Wall Street, when as a young, no-nothing graduate, he was hired to by Salomon Brothers:
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.
But Michael Lewis goes one step further. He interviews and discusses the mortgage products that led the country into the financial mess that now exists and how Wall Street not only did not know what it was doing but did not care. Lewis recounts a long interview he had with Steve Eisman who was one of the first people to investigate, understand and predict the mortgage problems. Eisman began his career Oppenheimer Funds as a junior equity analyst. His job changed less than a year later:
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.”
Nevertheless, Eisman began learning about the financial world of sub-prime mortgages.
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.
At FrontPoint Partners, Eisman partnered with two other hedge fund traders who shared the same worldview he did: Vincent Daniel, who became a partner and an analyst in charge of the mortgage sector, and Danny Moses. Together they researched and analyzed every detail of the mortgage securities industry that grew up between the late 1990s through the fall of investment banking.
In this article, Eisman explains what happened and how it happened in the mortgage industry, including how mortgage companies pushed obviously unqualified people into subprime mortgages they could not afford. And he goes into detail on the two products that caused the meltdown – Credit Default Swaps and Collateralized Debt Obligations (CDOs) – and the ratings agencies’ (i.e. Moody’s) complicity in the meltdown.
Eisman, Moses and Daniel raised the red flag numerous times, but no one seemed interested in listening to them. The banks – and traders – were making too much money.
When the meltdown finally did occur,
“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 aneurysm.”
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.
Not so 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.”
Perhaps, on July 19, 2007, if Wall Street and the Senate had listened to Ben Bernanke, when he “warned that as much as $100 billion could be lost in the sub-prime mortgage market,” and Eisman, when he “said that he expected losses of up to $300 billion from this sliver of the market alone,” much of the resulting havoc could have been prevented. Unfortunately, no one listened. No one wanted to listen.
Even though this article is long, it is definitely well worth reading. I came away knowing a great deal more about Wall Street works and the greed that took hold of Wall Street as well as considerably more knowledge about how and why markets need to regulated to prevent future financial disasters.
In 1929, financial markets created products almost exactly like the products which caused the current financial crisis. Those products, and the concurrent leveraging, caused the crash of ’29.
We, as a whole, and our government need to understand not only what happened and take measures to prevent it from happening again. In addition, we must retain some kind of institutional and governmental knowledge to insure future generations do not have to deal with these same problems.
Greed always will exist as long as humans exist. But we can prevent the worst aspects of greed from destroying our economy. This story of Wall Street traders and Wall Street’s behavior over the last decade, presented by Lewis and Eisman, may – just may – provide the information we need to keep an event like this current one from happening again.