Liar's Poker

by Michael Lewis

Liar’s Poker It was some time early in 1986, the first year of the decline of my firm, Salomon Brothers. Our chairman, John Gutfreund, left his desk at the head of the trading floor and went for a walk. At any given moment on the trading floor billions of dollars were being risked by bond traders. Gutfreund took the pulse of the place by simply wandering around it and asking questions of the traders. An eerie sixth sense guided him to wherever a crisis was unfolding. Gutfreund seemed able to smell money being lost. He was the last person a nerve-racked trader wanted to see. Gutfreund (pronounced Good friend) liked to sneak up from behind and surprise you. This was fun for him but not for you. Busy on two phones at once trying to stem disaster, you had no time to turn and look. You didn’t need to. You felt him. The area around you began to convulse like an epileptic ward. People were pretending to be frantically busy, and at the same time staring intently at a spot directly above your head. You felt a chill in your bones that I imagine belongs to the same class of intelligence as the nervous twitch of a small furry animal at the silent approach of a grizzly bear. An alarm shrieked in your head: Gutfreund! Gutfreund! Gutfreund! Often as not, our chairman just hovered quietly for a bit, then left. You might never have seen him. The only trace I found of him on two of these occasions was a turdlike ash on the floor beside my chair, left, I suppose, as a calling card. Gutfreund...

“casual empiricism”.

Up to the point of his transfer to the mortgage department, Ranieri had dominated every department he had joined. The firm encouraged both aggression and ability; it made a point never to interfere with natural jungle forces. In a matter of months after his appointment, power over the new mortgage department consolidated in Ranieri’s hands. In view of Ranieri’s ambition, even Dall concedes a coup was inevitable. Dall fell ill, and was often away. In his absence, Ranieri started a research department (“Mortgages are about maths,” he, the college drop-out, insisted) by asking Michael Waldman, a top mathematician, to join him. The request came, as Waldman recalls, “in Lewie’s usual forceful manner.” Then Ranieri persuaded the firm to give him a sales force to sell the god-forsaken mortgages he was being asked to trade. All of a sudden, a dozen salesmen learned they had to please Lew Ranieri, rather than whomever they had been pleasing before. Rich Shuster, who had been a thrift salesman in the Salomon Brothers’ Chicago office, now found himself a mortgage salesman working for Lewie Ranieri. “Once I misdialled the commercial paper department and got mortgages instead. Lewie happened to answer the phone and immediately realised what had happened. He started to shout at me, ‘What the fuck are you doing selling commercial paper? You are paid to sell mortgages!’” Salesmen began to focus on mortgages. Steve Joseph was the only other person who conceivably could have replaced Dall, ...

“No one wanted to get anywhere near the mortgage department,” says Kronthal. Even Ranieri admits that “Jeffery’s decision to join the mortgage department was regarded as remarkably stupid.” So why did Kronthal join? “I looked at it and said, one, I’m twenty-three years old and it doesn’t matter if it doesn’t work out. I don’t have to support anything but my own drinking. And, two, the firm must have faith in mortgages or they wouldn’t have Lewie doing it.”

The resentment the mortgage department felt towards those in power increased when it became known in early 1980 that those outside the department wanted it shut down. The mortgage department wasn’t making money. The other mortgage units on Wall Street – Merrill Lynch, First Boston, Goldman Sachs – were stillborn. They closed almost before they had opened. The prevailing wisdom was that mortgages were not for Wall Street. The business was reeling from what appeared to have been the knockout punch. Paul Volcker had made his historic speech on 6 October 1979. Short-term interest rates had skyrocketed. For a thrift manager to make a thirty-year home loan, he had to accept a rate of interest of 10 per cent. Meanwhile, to get the money, he was paying 12 per cent. He ceased, therefore, to make new loans, which suited the purpose of the Federal Reserve which was trying to slow the economy. New housing starts dropped to post-war lows. Before Volcker’s speech, Steve Joseph’s mortgage finance department had created roughly 2 billion dollars in mortgage securities. It was a laughably small amount – less than two-tenths of one per cent of outstanding American home mortgages. But it was a start. After Volcker’s speech the deals stopped. For Ranieri and Co. to create bonds, the thrifts had to want to make loans. They didn’t. The industry that held most of America’s home mortgages on its books was collapsing. In 1980 there were four thousand and two Savings and Loans in America. Over the ...

It was all a great mistake. The market wasn’t exploding because of the megatrends that Bob Dall had listed in his memo to Gutfreund – growth in housing, movement from rust belt to sun belt etc. – although those would later become factors. The market took off because of a simple tax break. It was as if Steven Jobs, who started Apple Computer in his garage, had bought office space, built an assembly line, hired two hundred thousand salesmen, and written brochures before he had anything to sell. Then someone else creates the personal computer and, seeing this, Jobs leaps into action, calling his previously useless infrastructure Apple Computer.

The situation was aggravated by the ignorance of the thrifts. The 3–6–3 Club members had not been stress tested for the bond market; they didn’t know how to play Liar’s Poker. They didn’t know the mentality of the people they were up against. They didn’t know the value of what they were selling. In some cases, they didn’t even know the terms (years to maturity, rates of interest) of their own loans. The only thing the thrift managers knew was how badly they wanted to sell. The truly incredible thing about them, noted by all the Salomon traders, was that no matter how roughly they were treated, they kept coming back for more. They were like ducks I once saw on a corporate hunt that were trained to fly repeatedly over the same field of hunters until shot dead. You didn’t have to be Charles Darwin to see that this breed was doomed.

Alexander had a knack for interpreting events around him. The most impressive aspect of this was its speed. When news broke, he seemed to have already planned his response. He trusted his nose completely. If he had a flaw, it was that he lacked the ability to question his own immediate reactions. He saw the markets as a tightly woven web. Yank on one filament in the web, and the other filaments had to move too. He therefore traded in all markets: the bonds, currencies and stocks of France*, Germany, the United States, Japan, Canada, and Britain; the markets in oil, precious metals, and bulk commodities; all interested him. * One of Alexander’s financial heroics found its distorted way to the centre of Tom Wolfe’s The Bonfire of the Vanities. Wolfe describes his protagonist, Sherman McCoy, getting himself in trouble with the gold-backed French government bonds, the so-called Giscard bonds. It was Alexander who had first discovered the Giscard was mispriced, and far from getting himself in trouble, made many millions of dollars exploiting the mispricing.

Many of the trades that Alexander suggested followed one of two patterns. First, when all investors were doing the same thing, he would actively seek to do the opposite. The word stockbrokers use for this approach is contrarian. Everyone wants to be one, but no one is, for the sad reason that most investors are scared of looking foolish. Investors do not fear losing money as much as they fear solitude, by which I mean taking risks that others avoid. When they are caught losing money alone, they have no excuse for their mistake; and most investors, like most people, need excuses. They are, strangely enough, happy to stand on the edge of a precipice as long as they are joined by a few thousand others. But when a market is widely regarded to be in a bad way, even if the problems are illusory, many investors get out.

second pattern to Alexander’s thought was that in the event of a major dislocation, such as a stock-market crash, a natural disaster, the breakdown of OPEC’s production agreements, he would look away from the initial focus of investor interest and seek secondary and tertiary effects. Remember Chernobyl? When news broke that the Soviet nuclear reactor had exploded, Alexander called. Only minutes before, confirmation of the disaster had blipped across our Quotron machines, yet Alexander had already bought the equivalent of two tankers of crude oil. The focus of investor attention was on the New York stock exchange, he said. In particular it was on any company involved in nuclear power. The stocks of those companies were plummeting. Never mind that, he said. He had just purchased, on behalf of his clients, oil futures. Instantly, in his mind, less supply of nuclear power equalled more demand for oil, and he was right. His investors made a large killing. Mine made a small killing. Minutes after I had persuaded a few clients to buy some oil, Alexander called back. “Buy potatoes,” he said. “Gotta hop.” Then he hung up. Of course. A cloud of fallout would threaten European food and water supplies, including the potato crop, placing a premium on uncontaminated American substitutes. Perhaps a few folks other than potato farmers think of the price of potatoes in America minutes after the explosion of a nuclear reactor in Russia, but if so, I have never met them. But Chernobyl and oi...

The markets in the long run are no doubt driven by fundamental economic laws; if the United States runs a persistent trade deficit the dollar will eventually plummet. But in the short run money flows less rationally. Fear and, to a lesser extent, greed are what make money move. That’s a fact. In watching the money move around, I began to anticipate its next move, and manoeuvre a few of my 50 billion dollars in front of the next wave.

“You don’t get rich in this business,” said Alexander when I complained privately to him, “you only attain new levels of relative poverty. You think Gutfreund feels rich? I’ll bet not.” Wise man. Alexander. He studied Buddhism, which he liked to use to explain his detachment.

It is always hard to say what it is about a man that makes him suited to overturn the conventions by which the rest of the world has been living for ages. In Milken’s case, it is especially difficult because he’s almost neurotically private and offers no helpful insights into his character to would-be biographers, other than the business he does. My view is that he combined two qualities that were, at the time of his ascendancy, regarded as mutually exclusive. They certainly did not co-exist within Salomon Brothers in the early 1980s. Milken possessed both raw bond trading skills and patience with ideas. He had an attention span.

Here Milken overcame great odds. Loss of concentration, a complete lack of ability to focus, was the chief occupational hazard of the trading floor. Dash Riprock was an excellent and typical case in point. Watching Dash was as disconcerting as watching a music video. There were brief moments, for example, when Dash was glum. On occasion, usually when his business had momentarily waned, he dropped his telephone with a thud and explained to me how one day he planned to quit investment banking and go back to school. He was going to bury himself in a library for a few years, then become a history professor. Or maybe a writer. The idea of Dash locked in quiet contemplation, even for five minutes, struck me as uniquely improbable, and these conversations of ours would end with me trying to say so, and him not listening because he was bored and wanted to change the topic. “I don’t mean I want to study now,” he’d say. “I mean when I’m thirty-five and have a few million dollars in the bank,” as if, after years of jamming bonds, a few million dollars in the bank would make him more likely to pay attention. After three years of bond sales, Dash couldn’t concentrate sufficiently to enjoy a decent period of moodiness. Almost as soon as it had occurred to him to sulk (“Don’t fuck with me, I’m in a bad mad mood,” he’d warn traders), he would have forgotten about it, for somehow, in the throes of his gloom, he’d sell a few hundred million dollars-worth of government bonds, and grow bright...

Michael Milken, who began in a job not dissimilar to Dash’s, was building a business, rather than making an endless series of trades. He was willing to look up from the blips on his trading screen and think clear and complete thoughts years into the future. Would a certain microchip company survive for twenty years to meet its sem...