The former Salomon Brothers bond trader who lifted the lid on sharp practice in Wall Street with Liar’s Poker in 1989 has returned to his former stamping ground.
In a new book, The Big Short: Inside the Doomsday Machine, Michael Lewis focuses not on bulge-bracket banks but on a small band of wacky outsiders, including one described as “a loner with a glass eye, a medical degree and Asperger’s syndrome.”
These near-cranks include tiny hedge fund players and short-sellers from the fringes of society who, in the mid-Noughties, had the nouse to recognise that the mortgage-backed securities (MBSs) and collateralized debt obligations (CDOs) markets were accidents waiting to happen.
Rather than blindly accumulating such dross, as many dumb bankers did in 2004-8, they chose to short-sell it, and they never lost their nerve even as more establishment Wall Street and other financial firms continued to amass such products.
I won’t go further into this extraordinary group of individuals — Lewis does that far better than I ever could in his book. Suffice to say that Reuters financial blogger Felix Salmon has described The Big Short as “probably the single best piece of financial journalism ever written.”
In an interview with Bloomberg‘s Erik Schatzker [published 15 March 2010], Michael Lewis explained how he feels Wall Street has changed since the 1960s and 1970s.
He traced the roots of the cultural shift to the late 1970s and 1980s. That was when the old “partnership model” — whereby Wall Street (and City of London) firms were small, specialised, had a long-term perspective, and focused on serving their clients’ needs — was abandoned.
As Wall Street firms changed their ownership structures, their ethos changed. The “long-term greed” advocated by former Goldman Sachs boss Gus Levy, and individuals whose first loyalty was to their customers and to their institutions, fell by the wayside to be replaced by an uglier, more rapacious, and short-termist culture.
In the Bloomberg interview, Michael Lewis said: “No partnership would have ever allowed itself to own billions of dollars of AAA-rated CDOs backed by subprime. It just wouldn’t have happened. They would have scrutinised it in a different way.”
Lewis argued that another change on Wall Street was that it became “intellectualised and over-complicated” with the arrival of things like the Black–Scholes options pricing model. He argues this made it easier for Wall Streeters to pull the wool over the eyes of less-knowledgeable clients, or “counterparties” and, even more dangerously, over the eyes of their own bosses.
Their erstwhile legitimate business of efficiently allocating capital lost attraction as it became less profitable, so investment bankers branched out into areas such as proprietary trading and the launch of ever more “innovative” products in their relentless pursuit of higher profits. He said: “The minute you’re starting to think, ‘The way I make money is exploiting the idiocy of my customers,’ is the minute you start creating securities that are designed to explode, that you could be on the other side of.”
Lewis concluded by saying that Wall Street currently has a parasitic relationship with the rest of the society. “It’s totally out of control. It’s not making America a great place; it’s making America a worse place right now.”
He said that finance urgently needs to find a way of developing a healthier, more symbiotic relationship with the real economy and the rest of society.
This blog post was published on Qfinance on 22 March 2010