Michael Lewis, who wrote about the madness of Wall Street in 1989’s Liar’s Poker, has an amazing article in the December issue of Portfolio magazine, detailing the ridiculous evolution of subprime-backed securities and the irresponsible, incompetent business culture that embraced them. This is great journalism — and I love the earthy, blunt language used throughout the article.
Here’s an excerpt:
The funny thing, looking back on it, is how long it took for even someone who predicted the disaster to grasp its root causes. They were learning about this on the fly, shorting the bonds and then trying to figure out what they had done. [Steve] Eisman knew subprime lenders could be scumbags. What he underestimated was the total unabashed complicity of the upper class of American capitalism. For instance, he knew that the big Wall Street investment banks took huge piles of loans that in and of themselves might be rated BBB, threw them into a trust, carved the trust into tranches, and wound up with 60 percent of the new total being rated AAA.
But he couldn’t figure out exactly how the rating agencies justified turning BBB loans into AAA-rated bonds. “I didn’t understand how they were turning all this garbage into gold,” he says. He brought some of the bond people from Goldman Sachs, Lehman Brothers, and UBS over for a visit. “We always asked the same question,” says Eisman. “Where are the rating agencies in all of this? And I’d always get the same reaction. It was a smirk.” He called Standard & Poor’s and asked what would happen to default rates if real estate prices fell. The man at S&P couldn’t say; its model for home prices had no ability to accept a negative number. “They were just assuming home prices would keep going up,” Eisman says.
As an investor, Eisman was allowed on the quarterly conference calls held by Moody’s but not allowed to ask questions. The people at Moody’s were polite about their brush-off, however. The C.E.O. even invited Eisman and his team to his office for a visit in June 2007. By then, Eisman was so certain that the world had been turned upside down that he just assumed this guy must know it too. “But we’re sitting there,” Daniel recalls, “and he says to us, like he actually means it, ‘I truly believe that our rating will prove accurate.’ And Steve shoots up in his chair and asks, ‘What did you just say?’ as if the guy had just uttered the most preposterous statement in the history of finance. He repeated it. And Eisman just laughed at him.”
“With all due respect, sir,” Daniel told the C.E.O. deferentially as they left the meeting, “you’re delusional.”
I’ve always said that one thing that’s been pounded out of people over the years is healthy skepticism. If there were more people on Wall Street with “negative attitudes,” we’d all be better for it. We need more cynical people in commerce, in politics, in journalism — in every field. We have to demand answers and not be satisfied with the easy ones.
Lewis makes the point that this economic catastrophe has been a long time in development — he suggests that it may have begun when Salomon Brothers became the first Wall Street public company, making shareholders take all the risk while Wall greed advanced its risk-taking methods. Through years of increasing home prices, the development of mortgage-backed bonds, through boom and bust, short selling and “mezzanine CDOs,” the industry charged toward disaster, blinded by insane profits gained at the expense of everything else.