A month or two ago, I saw The Big Short. I thoroughly enjoyed it. As I was watching it, I flashed back to two books: Too Big to Fail by Andrew Sorkin, and a book that I read many years ago, The Den of Thieves by James B. Stewart. They’re both about Wall Street excesses. However, they have different themes.
The Den of Thieves is about the high finance, junk bond, LBO days of the mid-80’s. The poster boys of this era were the firm of Drexel Burnham Lambert and Michael Milken.
What was shocking about this book was the simple amorality of all of the players, best typified by Ivan Boesky’s Greed is Good speech to the graduating class at Stanford (I might be wrong in my history, but if I recollect he was arrested shortly after that speech).
It wasn’t even subtle. Ivan Boesky had a bagman that delivered briefcases of money to some of the various players. The bagman himself always took a little off the top of the delivery, so the recipients learned to inflate the sums requested so that they could get the amount that they wanted. Dennis Levine got caught as he was making all of his inside trades because the bank that he was working for started illegally shadowing his trades. On top of that, the broker that the bank used to make their illegal trades was himself shadowing their trades. Eventually all of this illicit traffic got the SEC’s attention. They investigated and eventually unspooled all of these threads.
These were people who knew the difference between right and wrong and consciously chose wrong just for the sole purpose of greed. I mean, when you receive a suitcase full of money, that’s a pretty solid cue that probably what you’re doing is not kosher.
Too Big to Fail is the story of the Wall street collapse of 2008. Here again are similar types of players. They are, almost to a man (and yes, to a very large extent, nearly all men), driven to succeed and become fabulously, occasionally ostentatiously, rich. The difference here is that you do not get a sense of evil. What you get is a sense of incompetence. Not that these people were complete idiots, but they just did not really understand what they were doing.
A brief aside…there is one theory that this is what happened to Joseph Jett. He was a rising star at Kidder Peabody in the mid 1990’s. He was a moderately successful trader who for a time became a huge star. He was making Peabody Kidder tons of money. When you factor in that he was just about the only African-American trader to be found on Wall Street, he became huge and in two years went from making $50,000 a year to something over $9,000,000.
However, at one point his trades were researched carefully, and although I can’t even pretend to understand exactly what happened, it turned out that all of his trades were being falsely reported as profits. Peabody Kidder claimed that Jett exploited a vulnerability in their internal systems and claimed that he defrauded them. He put up a vigorous defense and was acquitted by the SEC. To this day, Jett probably thinks he was a genius trader. He literally did not understand the trades that he was making.
A similar thing writ large seemed to have occurred all over Wall Street up to 2007 or 2008. The Wall Street people thought that they had figured out a way to eliminate risk. They came up with a scheme to group mortgages by the thousands and then slice them up and group them as investment funds. It worked perfectly because after all, everyone makes their house payments, right?
The problem became of course that everyone wanted a piece of the action. Therefore, there became a huge incentive to create more mortgages just so that they could be aggregated and sliced up. Of course, the people making the loans promptly just re-sold them so that the funds could be created. Since they had effectively no risk, the loan originators could and did make crazy loans on crazy terms with virtually no paperwork involved.
All of the crazy loans were packaged up with all of the normal loans and then sliced up. When the economy slowed down, people couldn’t make their crazy loan payments. With the economy in bad shape, people couldn’t sell their homes either. Therefore, they couldn’t make their loan payments. These funds in turn that were accumulation of these loans couldn’t themselves make their payments, which were based upon receiving mortgage payments.
Since the bad loans were sliced and diced and split into all kinds of different funds, no one could tell which funds were good and which were bad. When that happens, there is no way to determine the fair market price of a fund. And when that happens, capitalism stops working because there become a whole lot of sellers and zero buyers. Since companies don’t know which other companies have toxic loans on their books, not only will they not buy another firm’s funds, they won’t even lend each other money because, without valid valuations, no one knows who will be able to pay their bills. Since pretty much all companies need very short term loans to make payroll and pay suppliers, quite literally the capitalist system was in danger of collapsing. When you read about it, it’s actually fucking scary how close we came to bartering for goats in the town square (I’m only partially kidding here).
The Wall Street geniuses thought that they had invented a new way of doing business that was completely risk free. What they did not understand until far too late was that what they created was something that disseminated risk throughout the entire system to such an extent that effectively risk became invisible.
In hindsight, all of these seems obvious. I’m not an economist but even I can understand how this is really a horrible idea. However, the fact is that there are several people in the book, very successful people, people with 30 years of experience of business, CEO’s, who simply didn’t get it. They were insanely over-leveraged in horrible business dealings but did not understand it. Some were willful. All Wall Street firms have Chief Risk Officers, but in at least one case the Chief Risk Officer was explicitly not invited to executive committee meetings in which such items were discussed. Some of these people came of age during the 70’s and the 80’s, when trading was much simpler. They never learned the new ways of doing business and never really showed any inclination to learn. As long as the money wheel was turning, why bother?
So, my question to you is…with due apologies to Tom Wolfe, would you rather your Masters of the Universe be evil or ignorant?