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Michael Lewis Tells his Story

Dec 07, 2008

Michael Lewis is the author of Liar's Poker. It is a book about Wall Street investment banks and the presumed financial geniuses who often make money by accident and get paid for it.

Lewis tells about Meredith Whitney, who nudged the financial system into its present crash on October 31, 2007. That day happened to be the 490th anniversary of Martin Luther's 95 Thesesthat he nailed to the door at Wittenberg, sparking the Protestant Reformation. Some of Lewis' language is a bit crude, but I can avoid those parts. Lewis writes this in an article called "The End":

"Then came Meredith Whitney with news. Whitney was an obscure analyst of financial forms for Oppenheimer Securities, who, on October 31, 2007, ceased to be obscure. On that day she predicted that Citigroup had so mismanaged its affairs that it would need to slash its dividend or go bust. It's near entirely clear on any given day what causes what in the stock market, but it was pretty obvious that on October 31, Meredith Whitney caused the market in financial stocks to crash. By the end of the trading day, a woman whom basically no one had ever heard of shaved $369 billion off the value of financial firms in the market. Four days later, Citigroup's C.E.O., Chuck Prince, resigned. In January, Citigroup slashed its dividend.

"From that moment, Whitney became E.F. Hutton: When she spoke, people listened. . . .

"This woman wasn't saying that Wall Street bankers were corrupt. She was saying they were stupid. These people whose job it was to allocate capital apparently didn't even know how to manage their own. . ."

In the midst of all of this subprime madness going on since 2000, Whitney's mentor, Steve Eisman set up a hedge fund company with the knowledge that the big investment banks were going to be in serious trouble soon.

"Hintz wanted to know what Eisman was up to. 'We just shorted Merrill Lynch,' Eisman told him.

"Why?" asked Hintz.

"We have a simple thesis," Eisman explained. "There is going to be a calamity, and whenever there is a calamity, Merrill is there." When it came time to bankrupt Orange County with bad advice, Merrill was there. When the internet went bust, Merrill was there. Way back in the 1980's, when the first bond trader was let off his leash and lost hundreds of millions of dollars, Merrill was there to take the hit. That was Eisman's logic--the logic of Wall Street's pecking order. Goldman Sachs was the big kid who ran the games in this neighborhoos. Merrill Lynch was the little fat kid assigned the least pleasant roles, just happy to be part of things. The game, as Eisman saw it, was Crack the Whip. He assumed Merrill Lynch had taken its assigned place at the end of the chain."

Last September 15, Merrill Lynch was taken over by Bank of America at the same time that Lehman Brothers was sent into bankruptcy. Eisman was right. Lewis writes:

"There was only one thing that bothered Eisman, and it continued to trouble him as late as May 2007. The one thing we couldn't figure out is: It's so obvious. Why hasn't everyone else figured out that the machine is done? Eisman had long subscribed to Grant's Interest Rate Observer, a newsletter famous in Wall Street circles and obscure outside them. Jim Grant, its editor, had been prophesying doom ever since the great debt cycle began, in the mid-1980's. In late 2006 he decided to investigate these things called C.D.O.'s. Or rather, he asked his young assistant, Dan Gertner, a chemical engineer with an M.B.A., to see if he could understand them. Gertner went off with the documents that purported to explain C.D.O's to potential investors and for several days sweated and groaned and heaved and suffered. "Then he came back," says Grant, "and said, I can't figure this thing out. And I said, I think we have our story".

In other words, most of these things are beyond the grasp of those who are actually managing money for people. The investors think they are dealing with financial experts, when in fact much of this stuff is too complicated for them, too. They are acting as sales people for a financial product they don't even understand themselves.

The result is that in late September, Goldman Sachs and Morgan Stanley ceased to be investment banks. The monster was dead by internal explosion.

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Dr. Stephen Jones

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