Book Review Preview
Eve of Destruction
By DANIEL GROSS
Published: April 16, 2010
Eighteen months after the failure of Lehman Brothers, writers seeking to make sense of the debacle have had their say: the first responders and e-booksters, the polemicists and shoe-leather reporters, the boardroom whisperers and I-told-you-so scolds, the would-be screenwriters and former policy makers. For those fortunate enough to be on the receiving end of publishers’ entreaties, a certain amount of Panic of 2008 fatigue has set in. I’ve read at least five times that the JPMorgan Chase chief executive Jamie Dimon’s 52nd-birthday dinner at the midtown Greek restaurant Avra was interrupted by a call about Bear Stearns’s travails.
So if you’re showing up late to this party, you had better come either with a strikingly original take that offers an enhanced understanding of the debacle or with an elegantly constructed narrative that covers the story from origins to bailout. Michael Lewis has done the former; Roger Lowenstein has done the latter.
Since his first book, the autobiographical “Liar’s Poker,” Lewis has tackled big, engaging stories — the 1980s Wall Street collapse, the 1996 presidential campaign, the dot-com boom, the use of quantitative analysis in baseball — by finding and developing characters whose personal narratives reveal a larger truth. He’s done it again. The story of the crash is, overwhelmingly, a tale of failure. But Lewis managed to find quirky investors who minted fortunes by making unpopular, calculated bets on a financial meltdown. Ditching the aloof irony of his earliest works, he constructs a story that is funny, incisive, profanity-laced and illuminating — full of difficult-to-like underdogs whose vindication and enrichment we end up cheering.
“The Big Short” is a group portrait of misfits at the margins of the business. In Wall Street parlance, going short means betting that stocks — or any other financial instrument — will fall. And in 2005 and 2006, shorting the massive, heavily subsidized housing and lending industries required not just fortitude, but a kind of sociopathy. Steve Eisman, a graduate of the University of Pennsylvania and Harvard Law School, “identified with the little guy and the underdog without ever exactly being one himself.” The death of an infant son and his experience analyzing the early subprime lending industry had made him suspicious, dyspeptic, contrarian. “Even on Wall Street, people think he’s rude and obnoxious and aggressive,” his wife says. Soon after setting up a small hedge fund in 2004, backed by Morgan Stanley, Eisman looked for ways to bet against the crop of bold new subprime lenders. He decided the best way to do so was by shorting the debt backed by newly issued mortgages.
In California, Michael Burry reached a similar conclusion. Burry, who had an eye removed when he was a toddler, had difficulty picking up on social cues and was prone to obsessions. “His mind had no temperate zone; he was either possessed by a subject or not interested in it at all.” Later in life, when he learned his son had Asperger’s syndrome, Burry realized the description fit him perfectly. “Only someone who has Asperger’s would read a subprime mortgage bond prospectus,” he said. Trained as a physician, Burry began posting on stock message boards in the 1990s and became a value-investing savant. Starting an investment fund with $40,000 of his own cash, he won backing from prominent New York investors and achieved excellent results. In early 2005, Burry, like Eisman, was seeking to short the subprime market. But how?
At the time, investors could bet against bonds of corporations through credit-default swaps — contracts that function as insurance policies that pay off in the event of default. But credit-default swaps didn’t exist on subprime bonds. Burry pestered Wall Street firms until Deutsche Bank agreed to sell him swaps on a batch of subprime bonds in May 2005. By July, he had amassed credit-default swaps on $750 million in bonds. Deutsche Bank’s Greg Lippmann, a living caricature of a bond trader, was at the middle of this booming market. “If you mapped the spread of the idea, as you might a virus, most of the lines pointed back to Lippmann,” Lewis writes. “He was Patient Zero.”
We follow Burry, Eisman and other investors as they build their credit-default-swap positions. As our guide, Lewis provides the best description to date of the way mortgages, and side bets on the health of those mortgages, turned into gigantic liabilities that sank the mighty insurance group A.I.G. Wall Street firms sold the credit-default swaps on bonds cheaply, then repackaged them into collateralized debt obligations. When certain chunks of them got the right stamp of approval from credit rating agencies, A.I.G. was willing to insure them for even less. But the pace of lending, frenetic as it was, couldn’t keep up with Wall Street firms’ demands for raw material. And so they began to sell credit-default swaps and package those into collateralized debt obligations. Eisman suddenly understands after attending a mortgage investing meeting in (where else?) Las Vegas. There weren’t enough subprime borrowers out there “taking out loans to satisfy investors’ appetite for the end product. Wall Street needed his bets in order to synthesize more of them.”
Shorting is difficult. “When you’re short, the whole world is against you,” as Eisman put it. And as John Maynard Keynes noted, the market can stay irrational longer than an investor can stay solvent. The short bets on subprime mortgages didn’t pay off in 2006, even as the underlying housing market began to weaken. Burry’s investors, who expected him to ferret out undervalued stocks, were angry when they learned of his large position in credit-default swaps. When some asked for their money back, Burry essentially ignored them.
In 2007, however, it all came down: marginal lenders defaulted, subprime firms went belly up, two Bear Stearns hedge funds that invested heavily in subprime collapsed. The big short positions paid off handsomely. Not all the shorts stuck with their bets. Howie Hubler, a Morgan Stanley trader who built up a big position in credit-default swaps on subprime bonds, sought to book some short-term profits by selling swaps on $16 billion of highly rated collateralized debt obligations. When Hubler resigned in October 2007, he left behind $9 billion in losses, “the single largest trading loss in the history of Wall Street.” For those who stuck it out, however, the collapse was a life-changing event. In 2007, Lewis writes, Eisman’s subprime short paid off so well that his fund’s assets rose “from a bit over $700 million to $1.5 billion,” and Eisman’s wife noted that her vindicated husband suddenly developed a capacity for tact. Michael Burry racked up $720 million in profits for his investors, but took little satisfaction in it. In October 2008 he closed down his fund with a cryptic farewell message. “What had happened was that he had been right, the world had been wrong, and the world hated him for it,” Lewis writes.
“The Big Short” ends just as “The End of Wall Street” begins to gain momentum. Roger Lowenstein, a contributor to The New York Times Magazine and the author of previous books on Warren Buffett and on the failure of Long-Term Capital Management, is a connoisseur of investing intelligence and folly. In constructing a precise, condensed version of the origins, climax and fallout of the “dark and powerful storm front that had long been gathering at Wall Street’s shores,” he finds much more folly than intelligence.
Lowenstein nicely sets up the kindling. Deregulation starting in the 1970s transformed finance from “a static business that played merely a supporting role in the U.S. economy” into a powerful engine. The names so familiar to credit-bubble cognoscenti played their part: Fannie Mae and Freddie Mac and their Washington patrons; Angelo Mozilo, the heavily tanned C.E.O. of Countrywide Financial; the Federal Reserve chairman Alan Greenspan and his successor, Ben Bernanke, with their easy money and regulation-lite policies. Reckless lenders met reckless borrowers. In a great little passage, Lowenstein does what Eisman and Burry did: He looks into a pool of mortgages he calls Subprime XYZ, issued in the spring of 2006 and packaged into bonds. On 43 percent of the loans, the lender hadn’t bothered to get written verification of the borrower’s income.
But it took Wall Street chief executives, a bunch of feckless dolts, to light the bonfire. The Merrill Lynch C.E.O. Stanley O’Neal, taking a break from his frequent golf games, was completely surprised in the summer of 2007 when he learned Merrill was stuck with $48 billion of collateralized debt obligations it couldn’t sell. Chuck Prince, the chief executive of Citigroup, wrote a shareholder letter in early 2007 in which “he devoted precisely two sentences to credit markets, which, he forecast, without elaboration, would most likely suffer ‘moderate deterioration’ in 2007.”
Farce turned into tragedy in the summer and fall of 2008 when the chief executives were forced to band together to save themselves, one another and the system. The book’s highlight is a blow-by-blow account of the frenzied, exhausting, demoralizing weekend before Lehman Brothers’ failure in September 2008. “We’re here to facilitate,” the Federal Reserve Bank of New York’s president, Tim Geithner, told Wall Street’s top bankers as they met that September to try to avert Lehman’s collapse. “You guys need to come up with a solution.” They didn’t. The chief executive, Richard Fuld, “nervously hung back at Lehman, like a general who didn’t know which of his officers would report next with news from the front.” Learning that his firm would be allowed to fail, a Lehman banker turned to a New York Fed official and warned, “You’re unleashing the forces of evil.”
Indeed — and this is another theme — federal officials charged with supervising Wall Street were continually caught unprepared. In the summer of 2008, when Kendrick Wilson, a former Goldman banker brought on as an aide to Treasury Secretary Henry Paulson, asked a colleague what would happen in the case of a repeat of the Bear Stearns failure, the response was that they had no plan. In the weeks after Lehman failed, Lowenstein reports, the Federal Reserve governor, Kevin Warsh, called Wachovia’s chief executive, Robert Steel, “and urged him to sell his bank to Goldman Sachs,” and Geithner and Paulson called Morgan Stanley’s C.E.O., John Mack, and “ordered him to sell his company to either JPMorgan or Citigroup.” Absurd ideas, both: none of those firms were in a position to buy.
Careful and meticulous, “The End of Wall Street” covers a lot of well-trodden ground. Still, there’s plenty of telling detail. John Thain, the button-down Merrill Lynch chief executive, slammed a door when he heard about poor results. Well into the crisis, with Citi’s stock price in single digits, its chief executive, Vikram Pandit, was spotted having lunch “at Le Bernardin, the top-rated restaurant in New York.” Seeing nothing he wanted by the glass, he “ordered a $350 bottle so that, as he explained, he could savor ‘a glass of wine worth drinking.’ Pandit drank just one glass.” The tableau suggests that Lowenstein’s book is misnamed. Judging by the recent bonuses; by the Goldman Sachs chief executive Lloyd Blankfein’s declaration that investment bankers are “doing God’s work”; and by the opposition to comprehensive reform as well as by Pandit’s $350 glass of wine, Wall Street is still very much alive.
Wall Street didn’t end because, after the big shorts came good, the Federal Reserve and American taxpayers stepped in with extraordinary assistance. In a somewhat discordant note, Lowenstein concludes that the bailouts mean the “government is playing a conspicuous role in formerly private affairs” and that there’s a throwback to “industrial planning of the ’70s.” But we’ve always had an industrial policy of incentivizing, subsidizing and bailing out the housing and credit industries. Whether we realize it or not, the public has always been long on Wall Street.
“The Big Short” also circles around to a lunch with a banker. Lewis sits down with his former boss, John Gutfreund, the former chief executive of Salomon Brothers, who tartly sums up Wall Street’s enduring philosophy. Laissez-faire is all well and good until something goes wrong.