[BITList] Fwd: I am glad I left Goldman Schs in 1988

[John Feltham]

This is a long read but....... interesting.






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----- Original Message -----

Sent: Tuesday, November 18, 2008 4:42 AM
Subject: I am glad I left Goldman Schs in 1988


The End

by Michael Lewis Nov 11 2008

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.

Most economists predict a recovery late next year. Don’t bet on  
it.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.
The crash did more than wipe out money. It also reordered the power on  
Wall
Street.

Most economists predict a recovery late next year. Don’t bet on  
it.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.

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.
Here’s 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.

The 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 homeowners 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."

In 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?
Moses 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—but 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.
Eisman 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.

Eisman’s 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
bonds."

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 this thing."

Whatever 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.’ "

That’s 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 short 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 chain.

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.’ "

Eisman 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."

On 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 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."

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 going.’ "

"It was like feeding the monster," Eisman says of the market for  
subprime
bonds. "We fed the monster until it blew up."

About 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.")

When I 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.

The 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.

I’d 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,
"Your…fucking…book."

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.

No investment 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
long-term hit.

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  
charm.
=======