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March 16, 2019 - September 3, 2023
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.
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.
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.
Therein lies the trap.
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 of 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
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Clever people are never as clever as they think they are.
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.
Danger, Will Robinson.
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 questions—like, 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
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The shell game.
“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.
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.
The accounting rules allowed them to assume the loans would be repaid, and not prematurely. This assumption became the engine of their doom.
“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!’”
Reality bites.
Eisman left work at noon every Wednesday so that he might be present at Midtown Comics when the new shipment of stories arrived. He knew more than any grown man should about the lives of various superheroes. He knew the Green Lantern oath by heart, for instance, and understood Batman’s inner life better than the Caped Crusader himself. Before the death of his son, Eisman had read the adult versions of the comics he’d read as a child—Spider-Man was his favorite. Now he read only the darkest adult comics, and favored those that took familiar fairy tales and rearranged them without changing any
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Reading is FUNdamental.
If the first act of subprime lending had been freaky, this second act was terrifying. Thirty billion dollars was a big year for subprime lending in the mid-1990s. In 2000 there had been $130 billion in subprime mortgage lending, and 55 billion dollars’ worth of those loans had been repackaged as mortgage bonds. In 2005 there would be $625 billion in subprime mortgage loans, $507 billion of which found its way into mortgage bonds. Half a trillion dollars in subprime mortgage–backed bonds in a single year.
Whee!
Burry had read Greenblatt’s book You Can Be a Stock Market Genius. (“I hated the title but liked the book.”)
I read that!
He’d made a close study of Warren Buffett, who had somehow managed to be both wildly popular and hugely successful. Buffett had had trouble with people, too, in his youth. He’d used a Dale Carnegie course to learn how to interact more profitably with his fellow human beings.
Mike Burry came of age in a different money culture. The Internet had displaced Dale Carnegie. He didn’t need to meet people. He could explain himself online and wait for investors to find him. He could write up his elaborate thoughts and wait for people to read them and wire him their money to handle. “Buffett was too popular for me,” said Burry. “I won’t ever be a kindly grandfather figure.”
“While capital raising may be a popularity contest,” Burry wrote to his investors, perhaps to reassure them that it didn’t matter if they loved their money manager, or even knew him, “intelligent investment is quite the opposite.”
Warren Buffett had an acerbic partner, Charlie Munger, who evidently cared a lot less than Buffett did about whether people liked him. Back in 1995, Munger had given a talk at Harvard Business School called “The Psychology of Human Misjudgment.” If you wanted to predict how people would behave, Munger said, you only had to look at their incentives.
Mike Burry found places to invest money shrewdly. He used no leverage and avoided shorting stocks. He was doing nothing more promising than buying common stocks and nothing more complicated than sitting in a room reading financial statements. For roughly $100 a year he became a subscriber to 10-K Wizard.
Scion Capital’s decision-making apparatus consisted of one guy in a room, with the door closed and the shades drawn, poring over publicly available information and data on 10-K Wizard. He went looking for court rulings, deal completions, or government regulatory changes—anything that might change the value of a company.
“That was a classic Mike Burry trade,” says one of his investors. “It goes up by ten times but first it goes down by half.”
This isn’t the sort of ride most investors enjoy, but it was, Burry thought, the essence of value investing. His job was to disagree loudly with popular sentiment. He couldn’t do this if he was at the mercy of very short-term market moves, and so he didn’t give his investors the ability to remove their money on short notice, as most hedge funds did. If you gave Scion your money to invest, you were stuck for at least a year. Burry also designed his fund to attract people who wanted to be long the stock market—who wanted to bet on stocks going up rather than stocks going down. “I am not a short
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You didn’t buy insurance on the entire subprime mortgage bond market but on a particular bond, and Burry had devoted himself to finding exactly the right ones to bet against.
He’d read dozens of prospectuses and scoured hundreds more, looking for the dodgiest pools of mortgages, and was still pretty certain even then (and dead certain later) that he was the only human being on earth who read them, apart from the lawyers who drafted them. In doing so, he likely also became the only investor to do the sort of old-fashioned bank credit analysis on the home loans that should have been done before they were made. He was the opposite of an old-fashioned banker, however. He was looking not for the best loans to make but the worst loans—so that he could bet against them.
In August he wrote a proposal for a fund he called Milton’s Opus and sent it out to his investors. (“The first question was always, ‘What’s Milton’s Opus?’” He’d say, “Paradise Lost,” but that usually just raised another question.)
Even as it came to dwarf the stock market, the bond market eluded serious regulation. Bond salesmen could say and do anything without fear that they’d be reported to some authority. Bond traders could exploit inside information without worrying that they would be caught. Bond technicians could dream up ever more complicated securities without worrying too much about government regulation—one reason why so many derivatives had been derived, one way or another, from bonds. The bigger, more liquid end of the bond market—the market for U.S. Treasury bonds, for example—traded on screens, but in
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At some point in between 1986 and 2006 a memo had gone out on Wall Street, saying that if you wanted to keep on getting rich shuffling bits of paper around to no obvious social purpose, you had better camouflage your true nature. Greg Lippmann was incapable of disguising himself or his motives. “I don’t have any particular allegiance to Deutsche Bank,” he’d say. “I just work there.” This was not an unusual attitude. What was unusual was that Lippmann said it.
Ah, Wall Street.
That was the pitch in a nutshell: Home prices didn’t even need to fall. They merely needed to stop rising at the unprecedented rates they had the previous few years for vast numbers of Americans to default on their home loans.
Can we find an analogy to any part of today's economy? Yes. Several.
Lippmann brimmed, also, with Lippmann. He hinted Eisman might get so rich from the trade he could buy the Los Angeles Dodgers. (“I’m not saying you’re going to be able to buy the Dodgers.”) Eisman might become so rich that movie stars would crave his body. (“I’m not saying you’re going to date Jessica Simpson.”) With one hand Lippmann presented the facts of the trade; with the other he tap-tap-tapped away, like a dowser probing for a well hidden deep in Eisman’s character.
Eisman really only had a couple of questions. The first: Tell me again how the hell a credit default swap works? The second: Why are you asking me to bet against bonds your own firm is creating, and arranging for the rating agencies to mis-rate? “In my entire life I never saw a sell-side guy come in and say, ‘Short my market,’” said Eisman. Lippmann wasn’t even a bond salesman; he was a bond trader who might be expected to be long these very same subprime mortgage bonds. “I didn’t mistrust him,” says Eisman. “I didn’t understand him. Vinny was the one who was sure he was going to fuck us in
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Financial risk had been created out of thin air, and it begged to be either honestly accounted for or disguised.
All of these places were central to what happened in the last two decades; without them, the new risks being created would have had no place to hide and would have remained in full view of bank regulators. All of these places, when the crisis came, would be washed away by the general nausea felt in the presence of complicated financial risks, but there was a moment when their existence seemed cartographically necessary to the financial world.
The banks that used AIG FP to insure piles of loans to IBM and GE now came to it to insure much messier piles, which included credit card debt, student loans, auto loans, prime mortgages, aircraft leases, and just about anything else that generated a cash flow. As there were many different sorts of loans, to different sorts of people, the logic that had applied to corporate loans seemed to apply to them, too: They were sufficiently diverse that they were unlikely all to go bad at once.
All he knew was that, in rapid succession, Goldman created a bunch of multibillion-dollar deals that transferred to AIG the responsibility for all future losses from $20 billion in triple-B-rated subprime mortgage bonds. It was incredible: In exchange for a few million bucks a year, this insurance company was taking the very real risk that $20 billion would simply go poof.
The deals with Goldman had gone down in a matter of months and required the efforts of just a few geeks on a Goldman bond trading desk and a Goldman salesman named Andrew Davilman, who, for his services, soon would be promoted to managing director. The Goldman traders had booked profits of somewhere between $1.5 billion and $3 billion—even by bond market standards, a breathtaking sum.
In the process, Goldman Sachs created a security so opaque and complex that it would remain forever misunderstood by investors and rating agencies: the synthetic subprime mortgage b...
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The CDO was, in effect, a credit laundering service for the residents of Lower Middle Class America. For Wall Street it was a machine that turned lead into gold.
Back in the 1980s, the original stated purpose of the mortgage-backed bond had been to redistribute the risk associated with home mortgage lending. Home mortgage loans could find their way to the bond market investors willing to pay the most for them. The interest rate paid by the homeowner would thus fall. The goal of the innovation, in short, was to make the financial markets more efficient. Now, somehow, the same innovative spirit was being put to the opposite purpose: to hide the risk by complicating it.
On its surface, the booming market in side bets on subprime mortgage bonds seemed to be the financial equivalent of fantasy football: a benign, if silly, facsimile of investing. Alas, there was a difference between fantasy football and fantasy finance: When a fantasy football player drafts Peyton Manning to be on his team, he doesn’t create a second Peyton Manning. When Mike Burry bought a credit default swap based on a Long Beach Savings subprime–backed bond, he enabled Goldman Sachs to create another bond identical to the original in every respect but one: There were no actual home loans or
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Fantasy Football (and Liar's Poker) are popular games in Wall St. shops.
Wall Street’s newest technique for squeezing profits out of the bond markets should have raised a few questions. Why were supposedly sophisticated traders at AIG FP doing this stuff? If credit default swaps were insurance, why weren’t they regulated as insurance? Why, for example, wasn’t AIG required to reserve capital against them? Why, for that matter, were Moody’s and Standard & Poor’s willing to bless 80 percent of a pool of dicey mortgage loans with the same triple-A rating they bestowed on the debts of the U.S. Treasury? Why didn’t someone, anyone, inside Goldman Sachs stand up and say,
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And we're just as blind today.
Their meetings acquired the flavor of a postmodern literary puzzle: The story rang true even as the narrator seemed entirely unreliable. At some point during each of these sessions, Vinny would stop him to ask, “Greg, I’m trying to figure out why you are even here.”
Check out this quote.
They hired a PhD student from the statistics department at the University of California at Berkeley to help them, but he quit after they asked him to study the market for pork belly futures. “It turned out that he was a vegetarian,” said Jamie. “He had a problem with capitalism in general, but the pork bellies pushed him over the edge.” They were left to grapple on their own with a lot of complicated financial theory.
Students.
“We turned off CNBC,” said Danny Moses. “It became very frustrating that they weren’t in touch with reality anymore. If something negative happened, they’d spin it positive. If something positive happened, they’d blow it out of proportion. It alters your mind. You can’t be clouded with shit like that.”
Still true.
On top were The Complete Guide to Asperger’s Syndrome, by a clinical psychologist named Tony Attwood, and Attwood’s Asperger’s Syndrome: A Guide for Parents and Professionals. “Marked impairment in the use of multiple non-verbal behaviors such as eye-to-eye gaze…” Check. “Failure to develop peer relationships…” Check. “A lack of spontaneous seeking to share enjoyment, interests, or achievements with other people…” Check. “Difficulty reading the social/emotional messages in someone’s eyes…” Check. “A faulty emotion regulation or control mechanism for expressing anger…” Check. “…One of the
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IS ME.
He thought what was happening was critically important. The banking system was insolvent, he assumed, and that implied some grave upheaval. When banking stops, credit stops, and when credit stops, trade stops, and when trade stops—well, the city of Chicago had only eight days of chlorine on hand for its water supply. Hospitals ran out of medicine. The entire modern world was premised on the ability to buy now and pay later.
Check out this quote.
The big Wall Street firms, seemingly so shrewd and self-interested, had somehow become the dumb money. The people who ran them did not understand their own businesses, and their regulators obviously knew even less.
And today?
