Finance for Beginners: Michael Lewis on Wall Street
Posted to Idiom on June 8
Lewis only lasted for three years, but his timing couldn’t have been better: Salomon CEO John Gutfreund (pronounced ‘good friend’) had just taken the firm public, setting off the domino effect that would soon normalize six-figure salaries—and five-figure bonuses—and play a role in the 1987 market collapse crisis. Young traders were getting in when the getting was good, and as a self-appointed embedded anthropologist, Lewis was there to watch as a profession historically regarded as tame gave way to all-expense-paid Wall Street culture. When he published his debut book Liar’s Poker the following year, the gods smiled on Lewis’ timing once again: Salomon was in the midst of its precipitous downfall, and junk bonds—a topic featured heavily in the book—were implicated in the crash.
In a 2008 essay for Portfolio magazine that would later serve as the introduction for his book on the financial crisis, Lewis laid out the central concerns motivating Liar’s Poker—the unmooring of global capital from immediate stakes; the cult of easy money growing up around deregulation, and the seemingly arbitrary individuals (such as himself) assigned as its caretakers. Picking up from earlier:
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.
Within months of being published, Liar’s Poker became required reading for anybody with either a passing interest in finance or the alpha male ecosystem of ‘80s bond trading. Two decades later, it’s often grouped with other rise-and-fall accounts of the period—The Bonfire of the Vanities and Barbarians at the Gate rank among its contemporaries—but as one critic observes, Liar’s Poker has long been considered “the gold standard for the genre.”
The book’s title comes from a betting game traders played on the floor, and in the opening anecdote, Gutfreund challenges a top bond trader to a $1 million bet, only to be outdone when the trader suggests raising the stakes to “ten million dollars. No tears.” This pretty much sets the mood of Lewis’ Wall Street—a high-stakes casino where the money is always somebody else’s, and fitting in means emulating a frat boy. While several critics have noted that Wall Street pay usually comes in the form of restricted stock—a policy that forces traders to have a stake in the game—it’s still tough to challenge Lewis’ free-wheeling account of ‘80s excess. In a memorable example of trading floor shenanigans, bankers steal clothes from a colleague’s suitcase before he departs on a business trip; and in another, Lewis recounts the head of the mortgage department pouring a bottle of Bailey’s Irish Cream into an employee’s jacket pockets and instructing him to “buy a new one” when the trader complains.
As a financial wonk and Berkeley liberal, Lewis’ books have the rare quality of appealing to two audiences at once: bankers and people who consider reading financial journalism on par with a trip to the dentist. (I fall into the latter camp). In Liar’s Poker, passages about mortgage-backed bonds and credit default swaps—boiled down to their most digestible essentials—are interspersed with accounts of the self-described “Big Swinging Dicks” that ran the show, casting doubt on any theories that statistical failures were entirely to blame for looming financial troubles.
Lewis once claimed that his unofficial goal for writing Liar’s was to convince “some bright kid at Ohio State University who really wanted to be an oceanographer [to]… spurn the offer from Goldman Sachs, and set out to sea.” This backfired dramatically. “Six months after Liar’s Poker was published,” Lewis writes, “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.”
If the cautionary aspects of the book were lost on readers, Lewis’ follow-up, The Big Short: Inside the Doomsday Machine, takes pains to avoiding repeating the same mistake, and this time, he’s got a painful recent history to help him make his case. In The Big Short, Lewis returns to Wall Street twenty-one years later to pick through the ruins of the post-crash markets and figure out who, if anybody, foresaw the apocalypse and came out triumphant. This isn’t the story of the crisis per se, but an account of how financial norms set the stage for disaster, and how several savvy Nostradamuses capitalized on the fall.
The anti-heroes of The Big Short are Steve Eisman, an abrasive subprime analyst; Mike Burry, an autistic one-eyed value investor; and Charlie Ledley and Jamie Mai, a pair of absent-minded money managers who take up residency in a Berkeley garage and never quite manage to shake their outsider status. For a variety of reasons, all these men recognize early on that the subprime mortgage market is built on sand, and despite sharing the insight with anybody that would listen—including Eisman’s dentist—they are largely ignored until the housing bubble pops. This is primarily a story of personalities, and though none of Lewis’ protagonists could be described as sympathetic, viewed against the amorphous forces of Wall Street, they come across as almost endearing, or at least only mildly distasteful.
While the rest of the financial world was busy gorging itself on the booming subprime market, the central insight of Lewis’ protagonists was unnervingly basic: a bond market that had grown to half a trillion dollars in 2005 (a figure that made the stock market look like “a zit” in comparison) was fundamentally worthless. Banks had developed sophisticated systems for extending credit to people who would never be able to pay it back, and thanks to increasing complex instruments for repackaging debt, few bankers selling bonds had any idea what they actually contained. For the benefit of non-wonky readers, Lewis explains the basic logic at work in subprime mortgages:
A giant number of individual loans got piled up into a tower. The top floors got their money back and so got the highest ratings from Moody’s and S&P and the lowest interest rate. The low floors got their money back last, suffered the first losses, and got the lowest ratings from Moody’s and S&P. Because they were taking on more risk, the investors in the bottom floor [the mezzanine] received a higher rater of interest than the investors in the top floor.
Theoretically, credit rating agencies were responsible for evaluating and policing these floors, but thanks to a loophole that allowed banks to shop around for ratings—not to mention a revolving door between Wall Street and rating agencies—the name of the game became hiding risk. Math and physics PhD were deployed to create opaque financial instruments that lumped together thousands of bonds—a process unironically called securitization—and the end products, collateralized debt obligations, ended up soliciting high ratings for risky loans and keeping naked emperors bragging about their respective wardrobes. While the internal dynamics were often poorly understood among their peddlers, the products were a runaway success, and ultimately, a main culprit in the crisis. When the SEC filed suit against Goldman Sachs last April for withholding information from investors, a key piece of evidence was an obscure CDO whose creator described his duplicitous product as the work of “intellectual masturbation.”
With varying degrees of insight about the landmines embedded in the financial system, Lewis’ protagonists set out to short the subprime mortgage market, essentially betting that one of the most profitable sectors of the economy was headed for implosion. And of course, they were right. By late 2007, only several months after the industry held a self-congratulatory conference in Vegas, the market started to melt. Banks were forced—for the first time—to accurately price subprime mortgages and come to terms with a numbers that were unthinkable only several months before. Suddenly, one of the largest crashes in financial history was on the brink of becoming reality, and only a handful of investors were left to say I told you so.
It’s worth mentioning that the people at the heart of the affair—buyers taking advantage of easy loans—are virtually absent from the narrative. Apart from the occasional reference to a Mexican strawberry picker with a $14,000 income and a $724,000 home (or the Vegas stripper with five mortgages) the crisis is mediated through hedge funders and analysts; financial insiders who happened to find themselves on the opposing side of mainstream opinion. Lewis isn’t particularly interested in getting the other side of the story, but in light of how much time he spends explaining how bankers justified risky practices to themselves, it would be helpful to know what things looked like on the other side of the financial divide.
With regard to the question of blame, in some respects, Lewis’ books resemble the films of documentarian Alex Gibney, a director best known for Academy Award-winning Taxi to the Dark Side, and Enron: The Smartest Guys in the Room. Gibney eschews the ‘bad apple’ theory of systemic collapse, and instead hones in on how insulated cultures—financial, political, military—become perverted, continually rationalizing and disguising their own inconsistencies until the burden becomes too great to bear. While Lewis does pick his villains—John Gutfreund returns to feast on deviled eggs in the final scene of The Big Short—he also reads the subprime crash as symptomatic of deeper, culturally sanctioned flaws. Neither Gibney nor Lewis ever suggest that they see disaster coming—although sometimes the clarity of their narratives lead readers to this conclusion—but they do provide compelling accounts of how things go wrong, and more significantly, the ways in which people learn how to miss what’s right in front of them.
Since its publication, The Big Short, as with Liar’s Poker before it, has become something of a handbook for its financial age. A recent Politico article notes that the book “has been mentioned at least 15 times on the Senate floor,” and there’s been speculation that several of the SEC’s recent lawsuits have taken their cues from Lewis’ narrative. As a longtime critic of banking culture, and more recently, a politically influential one, Lewis has become a powerful voice for reform—a process that’s largely swayed between pro-business interests and populist anti-bankerism. By drawing unlikely readers into one of the most important—and abstruse—national conversations of the day, Lewis is doing his part to carve out a third path between these camps. With the long process of financial reform only beginning to get off the ground, his timing, once again, couldn’t have been better.