Liar's Poker

by Michael Lewis

That was somewhere near the middle of a modern gold rush. Never before have so many unskilled twenty-four-year-olds made so much money in so little time as we did this decade in New York and London. There has never before been such a fantastic exception to the rule of the market-place that one takes out no more than one puts in. Now I do not object to money. I generally would rather have more than less. But I’m not holding my breath waiting for another windfall. What happened was a rare and amazing glitch in the fairly predictable history of getting and spending.

An eerie sixth sense guided him to wherever a crisis was unfolding. Gutfreund seemed able to smell money being lost.

He had, I think, a profound ability to control the two emotions that commonly destroy traders (fear and greed) and it made him as noble as a man who pursues his self-interest so fiercely can be.

Fair enough, Gutfreund had once been a trader, but that was as relevant as an old woman’s claim that she was once very beautiful.

I want to be an investment banker. If you had 10,000 sheres (sic) I sell them for you. I make a lot of money. I will like my job very, very much. I will help people. I will be a millionaire. I will have a big house. It will be fun for me. ‘What I Want To Be When I Grow Up’ Seven-year-old Minnesota schoolboy, March 1985

The lady from Salomon fell silent at the end of my little speech. Then, in a breath, she said limp-wristed, overly groomed fellows on small salaries worked in corporate finance. Where was my chutzpah? Did I want to sit in an office all day? What was I – some numbnut?

I had always had a soft spot for the royals, and especially the Queen Mother. But from that moment on I found Salomon Brothers, the bleacher bums of St James’s, equally irresistible. I mean it. To some, they were crude, rude and socially unacceptable. But I wouldn’t have had them any other way. These were, as much as any investment bankers could be, my people. And there was no doubt in my mind that this unusually forceful product of the Salomon Brothers’ culture could persuade her husband to give me a job.

There was one sure way, and only one sure way, to get ahead, and everyone with eyes in 1982 saw it: major in economics; use your economics degree to get an analyst job on Wall Street; use your analyst job to get into Harvard or Stanford Business Schools; and worry about the rest of your life later.

The first thing you learn on the trading floor is that when large numbers of people are after the same commodity, be it a stock, a bond, or a job, the commodity quickly becomes overvalued.

Art history was the opposite of economics; no one wanted it on his résumé. Art history, as an economics major once told me, “is for preppy girls from Connecticut”.

Investment bankers had a technique known as the stress interview. If you were invited to Lehman’s New York offices, your first interview might begin with the interviewer asking you to open the window. You were on the 43rd floor overlooking Water Street. The window was sealed shut. That was, of course, the point. The interviewer just wanted to see whether your inability to comply with his request led you to yank, pull and sweat until finally you melted into a puddle of foiled ambition. Or, as one sad applicant was rumoured to have done, throw a chair through the window.

Another stress-inducing trick was the silent treatment. You’d walk into the interview chamber. The man in the chair would say nothing. You’d say hello. He’d stare. You’d say that you’d come for a job interview. He’d stare some more. You’d make a stupid joke. He’d stare and shake his head. You were on tenterhooks. Then he’d pick up a newspaper (or, worse, your résumé) and begin to read. He was testing your ability to take control of a meeting. In this case, presumably, it was acceptable to throw a chair through a window.

“When they ask you why you want to be an investment banker, you’re supposed to talk about the challenges, and the thrill of doing deals, and the excitement of working with such high-calibre people, but never, ever mention money.”

Whether Lehman’s misfortune was directly related to their unwillingness to admit they were out to make money, I do not know.

Salomon Brothers had written to me in London to announce that they would pay me an MBA’s wage – though I had no MBA – of forty-two thousand dollars plus a bonus after the first six months of six thousand more. At that time I hadn’t the education required to feel poor on forty-eight thousand dollars (then equivalent to forty-five thousand pounds) a year. Receiving the news in England, the land of limp paycheques, accentuated the generosity of Salomon’s purse. A chaired professor of the London School of Economics, who took a keen interest in material affairs, stared at me bug-eyed and gurgled when he heard what I was to be paid. It was twice what he earned. He was in his mid-forties and at the top of his profession. I was twenty-four years old and at the bottom of mine. There was no justice in the world, and thank goodness for that.

There is a magic moment, during which a man has surrendered a treasure, and during which the man who is about to receive it has not yet done so. An alert lawyer [read bond trader] will make that moment his own, possessing the treasure for a magic microsecond, taking a little of it, passing it on.

The astute investor Warren Buffett is fond of saying that any player unaware of the fool in the market probably is the fool in the market.

Knowing about markets is knowing about other people’s weaknesses. And a fool, they would say, was a person who was willing to sell a bond for less or buy a bond for more than it was worth. A bond was worth only as much as the person who valued it properly was willing to pay. And Salomon, to complete the circle, was the firm that valued the bonds properly.

But none of this explains why Salomon Brothers was particularly profitable in the 1980s. Making profits on Wall Street is a bit like eating the stuffing from a turkey. Some higher authority must first put the stuffing into the turkey. The turkey was stuffed more generously in the 1980s than ever before. And Salomon Brothers, because of its expertise, had second and third helpings before other firms even knew that supper was on.

At a rare Saturday press conference, on 6 October 1979, Volcker announced that the money supply would cease to fluctuate with the business cycle; money supply would be fixed, and interest rates would float. The event, I think, marks the beginning of the golden age of the bond man. Had Volcker never pushed through his radical change in policy the world would be many bond traders and one memoir the poorer. For in practice, the shift in the focus of monetary policy meant that interest rates would swing wildly. Bond prices move inversely, lock step, to rates of interest. Allowing interest rates to swing wildly meant allowing bond prices to swing wildly. Before Volcker’s speech bonds had been conservative investments, into which investors put their savings when they didn’t fancy a gamble in the stock market. After Volcker’s speech, bonds became objects of speculation, a means of creating wealth rather than merely storing it. Overnight the bond market was transformed from a backwater into a casino. Turnover boomed at Salomon. Many more people were hired to handle the new business, on starting salaries of forty-eight grand.

The combined debt of the three groups in 1977 was 323 billion dollars, much of which wasn’t bonds but loans made by commercial banks. By 1985, the three groups had borrowed 7 trillion dollars. What is more, thanks to financial entrepreneurs at places like Salomon, and the shakiness of commercial banks, a much greater percentage of the debt was cast in the form of bonds than ever before.

“Don’t let them see you on the trading floor in those things,” he said. “Managing directors are the only guys who can get away with wearing suspenders. They’ll take one look at you and say, ‘who the fuck does he think he is anyway?’ ”

again. The ratio of support staff to professional (we were, believe it or not, the “professionals”) was five to one; so a hundred and twenty-seven of us meant six hundred and thirty-five more support staff.

Good traders tend to do the unexpected. We, as a group, were painfully predictable. By coming to Salomon Brothers we were doing only what every sane money-hungry person would do. If we were unable to buck convention in our lives, would we be likely to buck convention in the market? After all, the job market is a market.

We sat in rows of interconnected school chairs – twenty-two rows of white male trainees, in white shirts, punctuated by the occasional female in a blue blazer, two blacks, and a cluster of Japanese.

This was the punch line. Beer. The guys in the back row liked it. They fell all over each other slapping palms, and looked as silly as white men in suits do when they pretend to be black soul brothers.

I considered myself an exception, of course. I was accused by some of being a front-row person because I liked to sit next to the man from the Harvard School and watch him draw the organisation charts. I wondered if he would succeed (he didn’t). Also, I asked too many questions. It was assumed that I did this to ingratiate myself with the speakers, like a front-row person. This was untrue. But try telling that to the back row. I lamely compensated for my curiosity by hurling a few paper wads at important traders. And my stock rose dramatically in the back row when I was thrown out of class for reading the newspaper while a trader spoke. But I was never an intimate of those in the back row.

The Japanese were a protected species, and I think they knew it. Their homeland, as a result of its trade surpluses, was accumulating an enormous pile of dollars. A great deal of money could be made shepherding these dollars from Tokyo back into United States government bonds and other dollar investments.

In joining Salomon Brothers, they traded in sushi and job security for cheeseburgers and yuppie disease, which few were willing to do. The rare Japanese who Salomon had been able to snatch away were worth many times their weight in gold, and were treated like the family china. The traders who spoke to us never uttered so much as a peep against them. In addition, while Salomon Brothers was otherwise insensitive to foreign cultures, it was strangely aware that the Japanese were different. Not that there was a generally accepted view of how they might be different. The Japanese could have rubbed noses and practised the Kiwanis Club handshake each morning, and I’ll bet no one would have thought it out of character.

Why were we so well paid? A back-row person, who had just taken an MBA from the University of Chicago, explained to the readers of the Times: “It’s supply and demand,” he said. “My sister teaches kids with learning disabilities. She enjoys her work as much as I do, but earns much less. If nobody else wanted to teach, she’d make more money.”

On braver days, you cruised the trading floor to find a manager who would take you under his wing, a mentor, commonly referred to as a rabbi.

Though perhaps not articulated by every trainee, the ultimate message was lost on no one: join equities and kiss ass like Willy Loman; join bonds and kick ass like Rambo.

Quotes from stock-market legend Benjamin Graham were wheeled in to defend their position: “In the stock market the more elaborate and abstruse the mathematics the more uncertain and speculative the conclusion we draw therefrom . . . Whenever calculus is brought in, or higher algebra, you could take it as a warning signal that the operator was trying to substitute theory for experience.”

I thought instead of a good rule for survival on Wall Street: never agree to anything proposed on someone else’s boat, or you’ll regret it in the morning. I was extraordinarily agile and found a way to avoid trouble.

The stupidity of the “fuckin’ frogs” disgusted the Piranha. He associated it with their habit of quitting work at five p.m. The European work ethic was his bête noire, though he put it differently. He had once derided a simpering group of Salomon’s Englishmen and continental Europeans who had complained of being overworked, by calling them “Eurofaggots”.

The only thing history teaches us, a wise man once said, is that history doesn’t teach us anything.

I don’t do favours. I accumulate debts. – Ancient Sicilian motto

Nudged by a friendly public policy, Savings and Loans grew, and the volume of outstanding mortgage loans swelled from 55 billion dollars in 1950 to 700 billion dollars in 1976. In January 1980 that figure became 1.2 trillion dollars, and the mortgage market surpassed the combined United States stock markets as the largest capital market in the world.

The CEOs of home mortgages were Savings and Loan presidents. The typical Savings and Loan president was a leader in a tiny community. He was the sort of fellow who sponsored a float in the town parade; that said it all, didn’t it? He wore polyester suits, made a five-figure income, and worked one-figure hours. He belonged to the Lions or Rotary Club, and also to a less formal group known within the “thrift”* industry as the 3–6–3 Club: he borrowed money at 3 per cent, lent money at 6 per cent, and arrived on the golf course by 3 in the afternoon.

Trading money was nonetheless trading. It required at least one iron testicle and the same peculiar logic as bond trading. Witness: one day earlier in his career Dall was in the market to buy (borrow) 50 million dollars. He checked around and found the money market was 4 per cent–4.25 per cent, which meant he could buy (borrow) at 4.25 per cent, or sell (lend) at 4 per cent. When he actually tried to buy 50 million dollars at 4.25 per cent, however, the market moved to 4.25 per cent–4.5 per cent. The sellers were scared off by a large buyer. Dall bid 4.5. The market moved again, to 4.5 per cent–4.75 per cent. He raised his bid several more times with the same result, then went to Bill Simon’s office to tell him he couldn’t buy money. All the sellers were running like chickens. “Then you be the seller,” said Simon. So Dall became the seller, although he actually needed to buy. He sold 50 million dollars at 5.5 per cent. He sold another 50 million dollars at 5.5 per cent. Then, as Simon had guessed, the market collapsed. Everyone wanted to sell. There were no buyers. “Buy them back now,” said Simon, when the market reached 4 per cent. So Dall not only got his 50 million dollars at 4 per cent, but took a profit on the money he had sold at higher rates. That was how a Salomon bond trader thought: he forgot whatever it was that he wanted to do for a minute and put his finger on the pulse of the market. If the market felt fidgety, if people were scared or desperate, he herded th...

Together with Stephen Joseph, the brother of Drexel Burnham’s CEO, Fred Joseph, he created the first private issue of mortgage securities. They persuaded the Bank of America to sell the home loans it had made – in the form of bonds. They persuaded investors, such as insurance companies, to buy the new mortgage bonds. When they did, the Bank of America received the cash it had originally lent the homeowners, which it could then relend. The homeowner continued to write his mortgage payment cheques to the Bank of America, but the money was passed on to the Salomon Brothers’ clients who had purchased the Bank of America bonds.

There would be no more climbing through the ranks. In retrospect, his fears look laughably absurd. Six years later, in 1984, on the back of an envelope, Ranieri would argue, plausibly, that his mortgage trading department made more money that year than the rest of Wall Street combined in all their businesses. He would swell with pride as he discussed his department’s achievements. He would be named vice-chairman of Salomon Brothers, second only to Gutfreund. Gutfreund would regularly mention Ranieri as a possible successor. Yet Ranieri envisioned none of it in 1978. At the time of his appointment he felt cheated.

So Lewie took charge upstairs too, and came to treat the finance department as an amusing overhead into which even women could be hired. (The mortgage department was never exactly a bastion of sexual tolerance. As one woman who wished to trade mortgages but was denied the chance says, “You were acceptable to the trading desk as long as you were relatively white and male.” No women traded mortgage bonds until 1986.)

Donnie Green himself had been a trader at Salomon Brothers in the Dark Ages, when traders had more hair on their chests than on their heads. He is remembered as the man who stopped a callow young salesman on his way out of the door to catch a flight from New York to Chicago. Green tossed the salesman a ten-dollar bill. “Hey, take out some crash insurance for yourself in my name,” he said. “Why?” asked the salesman. “I feel lucky,” said Green.

Stupid customers (the fools in the market) were a wonderful asset, but at some level of ignorance they became a liability – they went broke.

Trader Tom DiNapoli fondly remembers a call from one thrift president. “He wanted to sell a hundred million dollars-worth of his thirty-year loans [bearing same rate of interest], and buy a hundred million dollars of some other loans with the cash from the sale. I told him I’d bid [buy] his loans at seventy-five [cents on the dollar] and offer him the others at eighty-five.” The thrift president scratched his head at the numbers. He was selling loans nearly identical to those he was buying, but the difference in yield would leave him out of pocket an unheard of ten million dollars. Or, to put it another way, the thrift was being asked to pay a transaction fee of 10 million dollars to Salomon Brothers. “That doesn’t sound like a very good trade for me,” he said. DiNapoli was ready for that one. “It isn’t, from an economic point of view,” he said, “but look at it this way, if you don’t do it, you’re out of a job.” A fellow trader talking to another thrift president on another line overheard DiNapoli, and cracked up. It was the funniest thing he had heard all day. He could picture the man on the other end of the phone, just oozing desperation.

Ranieri and Co intended to transform the “whole loans” into bonds as soon as possible by taking them for stamping to the United States Government. Then they could sell the bonds to Salomon’s institutional investors as, in effect, US government bonds. For that purpose, partly as the result of Ranieri’s persistent lobbying, two new facilities had sprung up in the federal government alongside Ginnie Mae. They guaranteed the mortgages that did not qualify for the Ginnie Mae stamp. The Federal Home Loan Mortgage Corporation (FHLMC, called Freddie Mac) and the Federal National Mortgage Association (FNMA, called Fannie Mae) between them, by giving their guarantees, were able to transform most home mortgages into government-backed bonds.

“The attitude at Salomon was always, ‘If you believe in it, go with it, but if it doesn’t work, you’re fucked.’

What was happening – and what is still happening – is that the guy who sponsored the float in the town parade, the 3–6–3 Club member and golfing man, had become America’s biggest bond trader. He was also America’s worst bond trader. He was the market’s fool.

“You don’t diet on Christmas Day,” says a former trader, “and you didn’t diet in the mortgage department. Every day was a holiday. We made money no matter what we looked like.” They began with a round of onion cheeseburgers, fetched by a trainee from the Trinity Deli at eight a.m. “I mean you didn’t really want to eat them,” recalls trader Gary Kilberg who joined the trading desk in 1985. “You were hung over. You were sipping coffee. But you’d get wind of that smell. Everyone else was eating them. So you grabbed one of the suckers.”