by Michael Lewis Nov 11 2008

The era that defined Wall Street is finally, officially over. Michael
Lewis, who chronicled its excess in Liar's Poker, returns to his old
haunt to figure out what went wrong.

To this day, the willingness of a Wall Street investment bank to pay
me hundreds of thousands of dollars to dispense investment advice to
grownups remains a mystery to me. I was 24 years old, with no
experience of, or particular interest in, guessing which stocks and
bonds would rise and which would fall. The essential function of Wall
Street is to allocate capital—to decide who should get it and who
should not. Believe me when I tell you that I hadn't the first clue.

I'd never taken an accounting course, never run a business, never
even had savings of my own to manage. I stumbled into a job at
Salomon Brothers in 1985 and stumbled out much richer three years
later, and even though I wrote a book about the experience, the whole
thing still strikes me as preposterous—which is one of the reasons
the money was so easy to walk away from. I figured the situation was
unsustainable. Sooner rather than later, someone was going to
identify me, along with a lot of people more or less like me, as a
fraud. Sooner rather than later, there would come a Great Reckoning
when Wall Street would wake up and hundreds if not thousands of young
people like me, who had no business making huge bets with other
people's money, would be expelled from finance.

When I sat down to write my account of the experience in 1989—Liar's
Poker, it was called—it was in the spirit of a young man who thought
he was getting out while the getting was good. I was merely
scribbling down a message on my way out and stuffing it into a bottle
for those who would pass through these parts in the far distant
future.

Unless some insider got all of this down on paper, I figured, no
future human would believe that it happened.

I thought I was writing a period piece about the 1980s in America.
Not for a moment did I suspect that the financial 1980s would last
two full decades longer or that the difference in degree between Wall
Street and ordinary life would swell into a difference in kind. I
expected readers of the future to be outraged that back in 1986, the
C.E.O. of Salomon Brothers, John Gutfreund, was paid $3.1 million; I
expected them to gape in horror when I reported that one of our
traders, Howie Rubin, had moved to Merrill Lynch, where he lost $250
million; I assumed they'd be shocked to learn that a Wall Street
C.E.O. had only the vaguest idea of the risks his traders were
running. What I didn't expect was that any future reader would look
on my experience and say, "How quaint."

I had no great agenda, apart from telling what I took to be a
remarkable tale, but if you got a few drinks in me and then asked
what effect I thought my book would have on the world, I might have
said something like, "I hope that college students trying to figure
out what to do with their lives will read it and decide that it's
silly to phony it up and abandon their passions to become
financiers." I hoped that some bright kid at, say, Ohio State
University who really wanted to be an oceanographer would read my
book, spurn the offer from Morgan Stanley, and set out to sea.

Somehow that message failed to come across. Six months after Liar's
Poker was published, I was knee-deep in letters from students at Ohio
State who wanted to know if I had any other secrets to share about
Wall Street. They'd read my book as a how-to manual.

In the two decades since then, I had been waiting for the end of Wall
Street. The outrageous bonuses, the slender returns to shareholders,
the never-ending scandals, the bursting of the internet bubble, the
crisis following the collapse of Long-Term Capital Management: Over
and over again, the big Wall Street investment banks would be, in
some narrow way, discredited. Yet they just kept on growing, along
with the sums of money that they doled out to 26-year-olds to perform
tasks of no obvious social utility. The rebellion by American youth
against the money culture never happened. Why bother to overturn your
parents' world when you can buy it, slice it up into tranches, and
sell off the pieces?

At some point, I gave up waiting for the end. There was no scandal
or reversal, I assumed, that could sink the system.

Then came Meredith Whitney with news. Whitney was an obscure analyst
of financial firms 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 never 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 had 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. Her message was clear. If you want to know what these Wall
Street firms are really worth, take a hard look at the crappy assets
they bought with huge sums of ­borrowed money, and imagine what they'd
fetch in a fire sale. The vast assemblages of highly paid people
inside the firms were essentially worth nothing. For better than a
year now, Whitney has responded to the claims by bankers and brokers
that they had put their problems behind them with this write-down or
that capital raise with a claim of her own: You're wrong. You're
still not facing up to how badly you have mismanaged your business.

Rivals accused Whitney of being overrated; bloggers accused her of
being lucky. What she was, mainly, was right. But it's true that she
was, in part, guessing. There was no way she could have known what
was going to happen to these Wall Street firms. The C.E.O.'s
themselves didn't know.

Now, obviously, Meredith Whitney didn't sink Wall Street. She just
expressed most clearly and loudly a view that was, in retrospect, far
more seditious to the financial order than, say, Eliot Spitzer's
campaign against Wall Street corruption. If mere scandal could have
destroyed the big Wall Street investment banks, they'd have vanished
long ago. 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.

At some point, I could no longer contain myself: I called Whitney.
This was back in March, when Wall Street's fate still hung in the
balance. I thought, If she's right, then this really could be the end
of Wall Street as we've known it. I was curious to see if she made
sense but also to know where this young woman who was crashing the
stock market with her every utterance had come from.

It turned out that she made a great deal of sense and that she'd
arrived on Wall Street in 1993, from the Brown University history
department. "I got to New York, and I didn't even know research
existed," she says. She'd wound up at Oppenheimer and had the most
incredible piece of luck: to be trained by a man who helped her
establish not merely a career but a worldview. His name, she says,
was Steve Eisman.

Eisman had moved on, but they kept in touch. "After I made the Citi
call," she says, "one of the best things that happened was when Steve
called and told me how proud he was of me."

Having never heard of Eisman, I didn't think anything of this. But a
few months later, I called Whitney again and asked her, as I was
asking others, whom she knew who had anticipated the cataclysm and
set themselves up to make a fortune from it. There's a long list of
people who now say they saw it coming all along but a far shorter one
of people who actually did. Of those, even fewer had the nerve to bet
on their vision. It's not easy to stand apart from mass hysteria—to
believe that most of what's in the financial news is wrong or
distorted, to believe that most important financial people are either
lying or deluded—without actually being insane. A handful of people
had been inside the black box, understood how it worked, and bet on
it blowing up. Whitney rattled off a list with a half-dozen names on
it. At the top was Steve Eisman.

Steve Eisman entered finance about the time I exited it. He'd grown
up in New York City and gone to a Jewish day school, the University
of Pennsylvania, and Harvard Law School. In 1991, he was a 30-year-
old corporate lawyer. "I hated it," he says. "I hated being a lawyer.
My parents worked as brokers at Oppenheimer. They managed to finagle
me a job. It's not pretty, but that's what happened."

He was hired as a junior equity analyst, a helpmate who didn't
actually offer his opinions. That changed in December 1991, less than
a year into his new job, when a subprime mortgage lender called Ames
Financial went public and no one at Oppenheimer particularly cared to
express an opinion about it. One of Oppenheimer's investment bankers
stomped around the research department looking for anyone who knew
anything about the mortgage business. Recalls Eisman: "I'm a junior
analyst and just trying to figure out which end is up, but I told him
that as a lawyer I'd worked on a deal for the Money Store." He was
promptly appointed the lead analyst for Ames Financial. "What I
didn't tell him was that my job had been to proofread the ­documents
and that I hadn't understood a word of the fucking things."

Ames Financial belonged to a category of firms known as nonbank
financial institutions. The category didn't include J.P. Morgan, but
it did encompass many little-known companies that one way or another
were involved in the early-1990s boom in subprime mortgage lending—
the lower class of American finance.

The second company for which Eisman was given sole responsibility was
Lomas Financial, which had just emerged from bankruptcy. "I put a
sell rating on the thing because it was a piece of shit," Eisman
says. "I didn't know that you weren't supposed to put a sell rating
on companies. I thought there were three boxes—buy, hold, sell—and
you could pick the one you thought you should." He was pressured
generally to be a bit more upbeat, but upbeat wasn't Steve Eisman's
style. Upbeat and Eisman didn't occupy the same planet. A hedge fund
manager who counts Eisman as a friend set out to explain him to me
but quit a minute into it. After describing how Eisman exposed
various important people as either liars or idiots, the hedge fund
manager started to laugh. "He's sort of a prick in a way, but he's
smart and honest and fearless."

"A lot of people don't get Steve," Whitney says. "But the people who
get him love him." Eisman stuck to his sell rating on Lomas
Financial, even after the company announced that investors needn't
worry about its financial condition, as it had hedged its market
risk. "The single greatest line I ever wrote as an analyst," says
Eisman, "was after Lomas said they were hedged." He recited the line
from memory: " `The Lomas Financial Corp. is a perfectly hedged
financial institution: It loses money in every conceivable interest-
rate environment.' I enjoyed writing that sentence more than any
sentence I ever wrote." A few months after he'd delivered that line
in his report, Lomas Financial returned to bankruptcy.

Then came Meredith Whitney with news. Whitney was an obscure analyst
of financial firms 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 never 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 had 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. Her message was clear. If you want to know what these Wall
Street firms are really worth, take a hard look at the crappy assets
they bought with huge sums of ­borrowed money, and imagine what they'd
fetch in a fire sale. The vast assemblages of highly paid people
inside the firms were essentially worth nothing. For better than a
year now, Whitney has responded to the claims by bankers and brokers
that they had put their problems behind them with this write-down or
that capital raise with a claim of her own: You're wrong. You're
still not facing up to how badly you have mismanaged your business.

Rivals accused Whitney of being overrated; bloggers accused her of
being lucky. What she was, mainly, was right. But it's true that she
was, in part, guessing. There was no way she could have known what
was going to happen to these Wall Street firms. The C.E.O.'s
themselves didn't know.

Now, obviously, Meredith Whitney didn't sink Wall Street. She just
expressed most clearly and loudly a view that was, in retrospect, far
more seditious to the financial order than, say, Eliot Spitzer's
campaign against Wall Street corruption. If mere scandal could have
destroyed the big Wall Street investment banks, they'd have vanished
long ago. 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.

At some point, I could no longer contain myself: I called Whitney.
This was back in March, when Wall Street's fate still hung in the
balance. I thought, If she's right, then this really could be the end
of Wall Street as we've known it. I was curious to see if she made
sense but also to know where this young woman who was crashing the
stock market with her every utterance had come from.

It turned out that she made a great deal of sense and that she'd
arrived on Wall Street in 1993, from the Brown University history
department. "I got to New York, and I didn't even know research
existed," she says. She'd wound up at Oppenheimer and had the most
incredible piece of luck: to be trained by a man who helped her
establish not merely a career but a worldview. His name, she says,
was Steve Eisman.

Eisman had moved on, but they kept in touch. "After I made the Citi
call," she says, "one of the best things that happened was when Steve
called and told me how proud he was of me."

Having never heard of Eisman, I didn't think anything of this. But a
few months later, I called Whitney again and asked her, as I was
asking others, whom she knew who had anticipated the cataclysm and
set themselves up to make a fortune from it. There's a long list of
people who now say they saw it coming all along but a far shorter one
of people who actually did. Of those, even fewer had the nerve to bet
on their vision. It's not easy to stand apart from mass hysteria—to
believe that most of what's in the financial news is wrong or
distorted, to believe that most important financial people are either
lying or deluded—without actually being insane. A handful of people
had been inside the black box, understood how it worked, and bet on
it blowing up. Whitney rattled off a list with a half-dozen names on
it. At the top was Steve Eisman.

Steve Eisman entered finance about the time I exited it. He'd grown
up in New York City and gone to a Jewish day school, the University
of Pennsylvania, and Harvard Law School. In 1991, he was a 30-year-
old corporate lawyer. "I hated it," he says. "I hated being a lawyer.
My parents worked as brokers at Oppenheimer. They managed to finagle
me a job. It's not pretty, but that's what happened."

He was hired as a junior equity analyst, a helpmate who didn't
actually offer his opinions. That changed in December 1991, less than
a year into his new job, when a subprime mortgage lender called Ames
Financial went public and no one at Oppenheimer particularly cared to
express an opinion about it. One of Oppenheimer's investment bankers
stomped around the research department looking for anyone who knew
anything about the mortgage business. Recalls Eisman: "I'm a junior
analyst and just trying to figure out which end is up, but I told him
that as a lawyer I'd worked on a deal for the Money Store." He was
promptly appointed the lead analyst for Ames Financial. "What I
didn't tell him was that my job had been to proofread the ­documents
and that I hadn't understood a word of the fucking things."

Ames Financial belonged to a category of firms known as nonbank
financial institutions. The category didn't include J.P. Morgan, but
it did encompass many little-known companies that one way or another
were involved in the early-1990s boom in subprime mortgage lending—
the lower class of American finance.

The second company for which Eisman was given sole responsibility was
Lomas Financial, which had just emerged from bankruptcy. "I put a
sell rating on the thing because it was a piece of shit," Eisman
says. "I didn't know that you weren't supposed to put a sell rating
on companies. I thought there were three boxes—buy, hold, sell—and
you could pick the one you thought you should." He was pressured
generally to be a bit more upbeat, but upbeat wasn't Steve Eisman's
style. Upbeat and Eisman didn't occupy the same planet. A hedge fund
manager who counts Eisman as a friend set out to explain him to me
but quit a minute into it. After describing how Eisman exposed
various important people as either liars or idiots, the hedge fund
manager started to laugh. "He's sort of a prick in a way, but he's
smart and honest and fearless."

"A lot of people don't get Steve," Whitney says. "But the people who
get him love him." Eisman stuck to his sell rating on Lomas
Financial, even after the company announced that investors needn't
worry about its financial condition, as it had hedged its market
risk. "The single greatest line I ever wrote as an analyst," says
Eisman, "was after Lomas said they were hedged." He recited the line
from memory: " `The Lomas Financial Corp. is a perfectly hedged
financial institution: It loses money in every conceivable interest-
rate environment.' I enjoyed writing that sentence more than any
sentence I ever wrote." A few months after he'd delivered that line
in his report, Lomas Financial returned to bankruptcy.

Eisman wasn't, in short, an analyst with a sunny disposition who
expected the best of his fellow financial man and the companies he
created. "You have to understand," Eisman says in his defense, "I did
subprime first. I lived with the worst first. These guys lied to
infinity. What I learned from that experience was that Wall Street
didn't give a shit what it sold."

Harboring suspicions about ­people's morals and telling investors that
companies don't deserve their capital wasn't, in the 1990s or at any
other time, the fast track to success on Wall Street. Eisman quit
Oppenheimer in 2001 to work as an analyst at a hedge fund, but what
he really wanted to do was run money. FrontPoint Partners, another
hedge fund, hired him in 2004 to invest in financial stocks. Eisman's
brief was to evaluate Wall Street banks, homebuilders, mortgage
originators, and any company (General Electric or General Motors, for
instance) with a big financial-services division—anyone who touched
American finance. An insurance company backed him with $50 million, a
paltry sum. "Basically, we tried to raise money and didn't really do
it," Eisman says.

Instead of money, he attracted people whose worldviews were as shaded
as his own—Vincent Daniel, for instance, who became a partner and an
analyst in charge of the mortgage sector. Now 36, Daniel grew up a
lower-middle-class kid in Queens. One of his first jobs, as a junior
accountant at Arthur Andersen, was to audit Salomon Brothers'
books. "It was shocking," he says. "No one could explain to me what
they were doing." He left accounting in the middle of the internet
boom to become a research analyst, looking at companies that made
subprime loans. "I was the only guy I knew covering companies that
were all going to go bust," he says. "I saw how the sausage was made
in the economy, and it was really freaky."

Danny Moses, who became Eisman's head trader, was another who shared
his perspective. Raised in Georgia, Moses, the son of a finance
professor, was a bit less fatalistic than Daniel or Eisman, but he
nevertheless shared a general sense that bad things can and do
happen. When a Wall Street firm helped him get into a trade that
seemed perfect in every way, he said to the salesman, "I appreciate
this, but I just want to know one thing: How are you going to screw
me?"

Heh heh heh, c'mon. We'd never do that, the trader started to say,
but Moses was politely insistent: We both know that unadulterated
good things like this trade don't just happen between little hedge
funds and big Wall Street firms. I'll do it, but only after you
explain to me how you are going to screw me. And the salesman
explained how he was going to screw him. And Moses did the trade.

Both Daniel and Moses enjoyed, immensely, working with Steve Eisman.
He put a fine point on the absurdity they saw everywhere around
them. "Steve's fun to take to any Wall Street meeting," Daniel
says. "Because he'll say `Explain that to me' 30 different times.
Or `Could you explain that more, in English?' Because once you do
that, there's a few things you learn. For a start, you figure out if
they even know what they're talking about. And a lot of times, they
don't!"

At the end of 2004, Eisman, Moses, and Daniel shared a sense that
unhealthy things were going on in the U.S. housing market: Lots of
firms were lending money to people who shouldn't have been borrowing
it. They thought Alan Greenspan's decision after the internet bust to
lower interest rates to 1 percent was a travesty that would lead to
some terrible day of reckoning. Neither of these insights was
entirely original. Ivy Zelman, at the time the housing-market analyst
at Credit Suisse, had seen the bubble forming very early on. There's
a simple measure of sanity in housing prices: the ratio of median
home price to income. Historically, it runs around 3 to 1; by late
2004, it had risen nationally to 4 to 1. "All these people were
saying it was nearly as high in some other countries," Zelman
says. "But the problem wasn't just that it was 4 to 1. In Los
Angeles, it was 10 to 1, and in Miami, 8.5 to 1. And then you coupled
that with the buyers. They weren't real buyers. They were
speculators." Zelman alienated clients with her pessimism, but she
couldn't pretend everything was good. "It wasn't that hard in
hindsight to see it," she says. "It was very hard to know when it
would stop." Zelman spoke occasionally with Eisman and always left
these conversations feeling better about her views and worse about
the world. "You needed the occasional assurance that you weren't
nuts," she says. She wasn't nuts. The world was.

By the spring of 2005, FrontPoint was fairly convinced that something
was very screwed up not merely in a handful of companies but in the
financial underpinnings of the entire U.S. mortgage market. In 2000,
there had been $130 billion in subprime mortgage lending, with $55
billion of that repackaged as mortgage bonds. But in 2005, there was
$625 billion in subprime mortgage loans, $507 billion of which found
its way into mortgage bonds. Eisman couldn't understand who was
making all these loans or why. He had a from-the-ground-up
understanding of both the U.S. housing market and Wall Street. But
he'd spent his life in the stock market, and it was clear that the
stock market was, in this story, largely irrelevant. "What most
people don't realize is that the fixed-income world dwarfs the equity
world," he says. "The equity world is like a fucking zit compared
with the bond market." He shorted companies that originated subprime
loans, like New Century and Indy Mac, and companies that built the
houses bought with the loans, such as Toll Brothers. Smart as these
trades proved to be, they weren't entirely satisfying. These
companies paid high dividends, and their shares were often expensive
to borrow; selling them short was a costly proposition.

Enter Greg Lippman, a mortgage-bond trader at Deutsche Bank. He
arrived at FrontPoint bearing a 66-page presentation that described a
better way for the fund to put its view of both Wall Street and the
U.S. housing market into action. The smart trade, Lippman argued, was
to sell short not New Century's stock but its bonds that were backed
by the subprime loans it had made. Eisman hadn't known this was even
possible—because until recently, it hadn't been. But Lippman, along
with traders at other Wall Street investment banks, had created a way
to short the subprime bond market with precision.

Here's where financial technology became suddenly, urgently relevant.
The typical mortgage bond was still structured in much the same way
it had been when I worked at Salomon Brothers. The loans went into a
trust that was designed to pay off its investors not all at once but
according to their rankings. The investors in the top tranche, rated
AAA, received the first payment from the trust and, because their
investment was the least risky, received the lowest interest rate on
their money. The investors who held the trusts' BBB tranche got the
last payments—and bore the brunt of the first defaults. Because they
were taking the most risk, they received the highest return. Eisman
wanted to bet that some subprime borrowers would default, causing the
trust to suffer losses. The way to express this view was to short the
BBB tranche. The trouble was that the BBB tranche was only a tiny
slice of the deal.



But the scarcity of truly crappy subprime-mortgage bonds no longer
mattered. The big Wall Street firms had just made it possible to
short even the tiniest and most obscure subprime-mortgage-backed bond
by creating, in effect, a market of side bets. Instead of shorting
the actual BBB bond, you could now enter into an agreement for a
credit-default swap with Deutsche Bank or Goldman Sachs. It cost
money to make this side bet, but nothing like what it cost to short
the stocks, and the upside was far greater.

The arrangement bore the same relation to actual finance as fantasy
football bears to the N.F.L. Eisman was perplexed in particular about
why Wall Street firms would be coming to him and asking him to sell
short. "What Lippman did, to his credit, was he came around several
times to me and said, `Short this market,' " Eisman says. "In my
entire life, I never saw a sell-side guy come in and say, `Short my
market.' "

And short Eisman did—then he tried to get his mind around what he'd
just done so he could do it better. He'd call over to a big firm and
ask for a list of mortgage bonds from all over the country. The
juiciest shorts—the bonds ultimately backed by the mortgages most
likely to default—had several characteristics. They'd be in what Wall
Street people were now calling the sand states: Arizona, California,
Florida, Nevada. The loans would have been made by one of the more
dubious mortgage lenders; Long Beach Financial, wholly owned by
Washington Mutual, was a great example. Long Beach Financial was
moving money out the door as fast as it could, few questions asked,
in loans built to self-destruct. It specialized in asking home­owners
with bad credit and no proof of income to put no money down and defer
interest payments for as long as possible. In Bakersfield,
California, a Mexican strawberry picker with an income of $14,000 and
no English was lent every penny he needed to buy a house for
$720,000.

More generally, the subprime market tapped a tranche of the American
public that did not typically have anything to do with Wall Street.
Lenders were making loans to people who, based on their credit
ratings, were less creditworthy than 71 percent of the population.
Eisman knew some of these people. One day, his housekeeper, a South
American woman, told him that she was planning to buy a townhouse in
Queens. "The price was absurd, and they were giving her a low-down-
payment option-ARM," says Eisman, who talked her into taking out a
conventional fixed-rate mortgage. Next, the baby nurse he'd hired
back in 1997 to take care of his newborn twin daughters phoned
him. "She was this lovely woman from Jamaica," he says. "One day she
calls me and says she and her sister own five townhouses in Queens. I
said, `How did that happen?' " It happened because after they bought
the first one and its value rose, the lenders came and suggested they
refinance and take out $250,000, which they used to buy another one.
Then the price of that one rose too, and they repeated the
experiment. "By the time they were done," Eisman says, "they owned
five of them, the market was falling, and they couldn't make any of
the payments."

In retrospect, pretty much all of the riskiest subprime-backed bonds
were worth betting against; they would all one day be worth zero. But
at the time Eisman began to do it, in the fall of 2006, that wasn't
clear. He and his team set out to find the smelliest pile of loans
they could so that they could make side bets against them with
Goldman Sachs or Deutsche Bank. What they were doing, oddly enough,
was the analysis of subprime lending that should have been done
before the loans were made: Which poor Americans were likely to jump
which way with their finances? How much did home prices need to fall
for these loans to blow up? (It turned out they didn't have to fall;
they merely needed to stay flat.) The default rate in Georgia was
five times higher than that in Florida even though the two states had
the same unemployment rate. Why? Indiana had a 25 percent default
rate; California's was only 5 percent. Why?

Moses actually flew down to Miami and wandered around neighborhoods
built with subprime loans to see how bad things were. "He'd call me
and say, `Oh my God, this is a calamity here,' " recalls Eisman. All
that was required for the BBB bonds to go to zero was for the default
rate on the underlying loans to reach 14 percent. Eisman thought
that, in certain sections of the country, it would go far, far higher.

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. 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."
This wasn't Fitch or even S&P. This was Moody's, the aristocrats of
the rating business, 20 percent owned by Warren Buffett. And the
company's C.E.O. was being told he was either a fool or a crook by
one Vincent Daniel, from Queens.

A full nine months earlier, Daniel and ­Moses had flown to Orlando for
an industry conference. It had a grand title—the American
Securitization Forum—but it was essentially a trade show for the ­
subprime-mortgage business: the people who originated subprime
mortgages, the Wall Street firms that packaged and sold subprime
mortgages, the fund managers who invested in nothing but subprime-
mortgage-backed bonds, the agencies that rated subprime-­mortgage
bonds, the lawyers who did whatever the lawyers did. Daniel and Moses
thought they were paying a courtesy call on a cottage industry, but
the cottage had become a castle. "There were like 6,000 people
there," Daniel says. "There were so many people being fed by this
industry. The entire fixed-income department of each brokerage firm
is built on this. Everyone there was the long side of the trade. The
wrong side of the trade. And then there was us. That's when the
picture really started to become clearer, and we started to get more
cynical, if that was possible. We went back home and said to
Steve, `You gotta see this.' "

Eisman, Daniel, and Moses then flew out to Las Vegas for an even
bigger subprime conference. By now, Eisman knew everything he needed
to know about the quality of the loans being made. He still didn't
fully understand how the apparatus worked, but he knew that Wall
Street had built a doomsday machine. He was at once opportunistic and
outraged.

Their first stop was a speech given by the C.E.O. of Option One, the
mortgage originator owned by H&R Block. When the guy got to the part
of his speech about Option One's subprime-loan portfolio, he claimed
to be expecting a modest default rate of 5 percent. Eisman raised his
hand. Moses and Daniel sank into their chairs. "It wasn't a Q&A,"
says Moses. "The guy was giving a speech. He sees Steve's hand and
says, `Yes?'"

"Would you say that 5 percent is a probability or a possibility?"
Eisman asked.

A probability, said the C.E.O., and he continued his speech.

Eisman had his hand up in the air again, waving it around. Oh, no,
Moses thought. "The one thing Steve always says," Daniel
explains, "is you must assume they are lying to you. They will always
lie to you." Moses and Daniel both knew what Eisman thought of these
subprime lenders but didn't see the need for him to express it here
in this manner. For Eisman wasn't raising his hand to ask a question.
He had his thumb and index finger in a big circle. He was using his
fingers to speak on his behalf. Zero! they said.

"Yes?" the C.E.O. said, obviously irritated. "Is that another
question?"

"No," said Eisman. "It's a zero. There is zero probability that your
default rate will be 5 percent." The losses on subprime loans would
be much, much greater. Before the guy could reply, Eisman's cell
phone rang. Instead of shutting it off, Eisman reached into his
pocket and answered it. "Excuse me," he said, standing up. "But I
need to take this call." And with that, he walked out.

Eisman's willingness to be abrasive in order to get to the heart of
the matter was obvious to all; what was harder to see was his
credulity: He actually wanted to believe in the system. As quick as
he was to cry bullshit when he saw it, he was still shocked by bad
behavior. That night in Vegas, he was seated at dinner beside a
really nice guy who invested in mortgage C.D.O.'s—collateralized debt
obligations. By then, Eisman thought he knew what he needed to know
about C.D.O.'s. He didn't, it turned out.

Later, when I sit down with Eisman, the very first thing he wants to
explain is the importance of the mezzanine C.D.O. What you notice
first about Eisman is his lips. He holds them pursed, waiting to
speak. The second thing you notice is his short, light hair, cropped
in a manner that suggests he cut it himself while thinking about
something else. "You have to understand this," he says. "This was the
engine of doom." Then he draws a picture of several towers of debt.
The first tower is made of the original subprime loans that had been
piled together. At the top of this tower is the AAA tranche, just
below it the AA tranche, and so on down to the riskiest, the BBB
tranche—the bonds Eisman had shorted. But Wall Street had used these
BBB tranches—the worst of the worst—to build yet another tower of
bonds: a "particularly egregious" C.D.O. The reason they did this was
that the rating agencies, presented with the pile of bonds backed by
dubious loans, would pronounce most of them AAA. These bonds could
then be sold to investors—pension funds, insurance companies—who were
allowed to invest only in highly rated securities. "I cannot fucking
believe this is allowed—I must have said that a thousand times in the
past two years," Eisman says.

His dinner companion in Las Vegas ran a fund of about $15 billion and
managed C.D.O.'s backed by the BBB tranche of a mortgage bond, or as
Eisman puts it, "the equivalent of three levels of dog shit lower
than the original bonds."

FrontPoint had spent a lot of time digging around in the dog shit and
knew that the default rates were already sufficient to wipe out this
guy's entire portfolio. "God, you must be having a hard time," Eisman
told his dinner companion.

"No," the guy said, "I've sold everything out."

After taking a fee, he passed them on to other investors. His job was
to be the C.D.O. "expert," but he actually didn't spend any time at
all thinking about what was in the C.D.O.'s. "He managed the
C.D.O.'s," says Eisman, "but managed what? I was just appalled.
People would pay up to have someone manage their C.D.O.'s—as if this
moron was helping you. I thought, You prick, you don't give a fuck
about the investors in this thing."

Whatever rising anger Eisman felt was offset by the man's genial
disposition. Not only did he not mind that Eisman took a dim view of
his C.D.O.'s; he saw it as a basis for friendship. "Then he said
something that blew my mind," Eisman tells me. "He says, `I love guys
like you who short my market. Without you, I don't have anything to
buy.' "

That's when Eisman finally got it. Here he'd been making these side
bets with Goldman Sachs and Deutsche Bank on the fate of the BBB
tranche without fully understanding why those firms were so eager to
make the bets. Now he saw. There weren't enough Americans with shitty
credit taking out loans to satisfy investors' appetite for the end
product. The firms used Eisman's bet to synthesize more of them.
Here, then, was the difference between fantasy finance and fantasy
football: When a fantasy player drafts Peyton Manning, he doesn't
create a second Peyton Manning to inflate the league's stats. But
when Eisman bought a credit-default swap, he enabled Deutsche Bank to
create another bond identical in every respect but one to the
original. The only difference was that there was no actual homebuyer
or borrower. The only assets backing the bonds were the side bets
Eisman and others made with firms like Goldman Sachs. Eisman, in
effect, was paying to Goldman the interest on a subprime mortgage. In
fact, there was no mortgage at all. "They weren't satisfied getting
lots of unqualified borrowers to borrow money to buy a house they
couldn't afford," Eisman says. "They were creating them out of whole
cloth. One hundred times over! That's why the losses are so much
greater than the loans. But that's when I realized they needed us to
keep the machine running. I was like, This is allowed?"

This particular dinner was hosted by Deutsche Bank, whose head
trader, Greg Lippman, was the fellow who had introduced Eisman to the
subprime bond market. Eisman went and found Lippman, pointed back to
his own dinner companion, and said, "I want to short him." Lippman
thought he was joking; he wasn't. "Greg, I want to short his paper,"
Eisman repeated. "Sight unseen."

Eisman started out running a $60 million equity fund but was now
short around $600 million of various ­subprime-related securities. In
the spring of 2007, the market strengthened. But, says
Eisman, "credit quality always gets better in March and April. And
the reason it always gets better in March and April is that people
get their tax refunds. You would think people in the securitization
world would know this. We just thought that was moronic."

He was already short the stocks of mortgage originators and the
homebuilders. Now he took short positions in the rating agencies—
"they were making 10 times more rating C.D.O.'s than they were rating
G.M. bonds, and it was all going to end"—and, finally, the biggest
Wall Street firms because of their exposure to C.D.O.'s. He wasn't
allowed to short Morgan Stanley because it owned a stake in his fund.
But he shorted UBS, Lehman Brothers, and a few others. Not long after
that, FrontPoint had a visit from Sanford C. Bernstein's Brad Hintz,
a prominent analyst who covered Wall Street firms. 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 1980s, 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 neighborhood.
Merrill Lynch was the little fat kid assigned the least pleasant
roles, just happy to be a 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.

There was only one thing that bothered Eisman, and it continued to
trouble him as late as May 2007. "The 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-1980s. In late 2006, he
decided to investigate these things called C.D.O.'s. Or rather, he
had 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.' "

Eisman read Grant's piece as independent confirmation of what he
knew in his bones about the C.D.O.'s he had shorted. "When I read it,
I thought, Oh my God. This is like owning a gold mine. When I read
that, I was the only guy in the equity world who almost had an
orgasm."

On July 19, 2007, the same day that Federal Reserve Chairman Ben
Bernanke told the U.S. Senate that he anticipated as much as $100
billion in losses in the subprime-mortgage market, FrontPoint did
something unusual: It hosted its own conference call. It had had
calls with its tiny population of investors, but this time FrontPoint
opened it up. Steve Eisman had become a poorly kept secret. Five
hundred people called in to hear what he had to say, and another 500
logged on afterward to listen to a recording of it. He explained the
strange alchemy of the C.D.O. and said that he expected losses of up
to $300 billion from this sliver of the market alone. To evaluate the
situation, he urged his audience to "just throw your model in the
garbage can. The models are all backward-looking.

The models don't have any idea of what this world has become…. For
the first time in their lives, people in the asset-backed-
securitization world are actually having to think." He explained that
the rating agencies were morally bankrupt and living in fear of
becoming actually bankrupt. "The rating agencies are scared to
death," he said. "They're scared to death about doing nothing because
they'll look like fools if they do nothing."

On September 18, 2008, Danny Moses came to work as usual at 6:30 a.m.
Earlier that week, Lehman Brothers had filed for bankruptcy. The day
before, the Dow had fallen 449 points to its lowest level in four
years. Overnight, European governments announced a ban on short-
selling, but that served as faint warning for what happened next.

At the market opening in the U.S., everything—every financial asset—
went into free fall. "All hell was breaking loose in a way I had
never seen in my career," Moses says. FrontPoint was net short the
market, so this total collapse should have given Moses pleasure. He
might have been forgiven if he stood up and cheered. After all, he'd
been betting for two years that this sort of thing could happen, and
now it was, more dramatically than he had ever imagined. Instead, he
felt this terrifying shudder run through him. He had maybe 100 trades
on, and he worked hard to keep a handle on them all. "I spent my
morning trying to control all this energy and all this information,"
he says, "and I lost control. I looked at the screens. I was staring
into the abyss. The end. I felt this shooting pain in my head. I
don't get headaches. At first, I thought I was having an aneurysm."

Moses stood up, wobbled, then turned to Daniel and said, "I gotta
leave. Get out of here. Now." Daniel thought about calling an
ambulance but instead took Moses out for a walk.

Outside it was gorgeous, the blue sky reaching down through the tall
buildings and warming the soul. Eisman was at a Goldman Sachs
conference for hedge fund managers, raising capital. Moses and Daniel
got him on the phone, and he left the conference and met them on the
steps of St. Patrick's Cathedral. "We just sat there," Moses
says. "Watching the people pass."

This was what they had been waiting for: total collapse. "The
investment-banking industry is fucked," Eisman had told me a few
weeks earlier. "These guys are only beginning to understand how
fucked they are. It's like being a Scholastic, prior to Newton.
Newton comes along, and one morning you wake up: `Holy shit, I'm
wrong!' " Now Lehman Brothers had vanished, Merrill had surrendered,
and Goldman Sachs and Morgan Stanley were just a week away from
ceasing to be investment banks. The investment banks were not just
fucked; they were extinct.

Not so for hedge fund managers who had seen it coming. "As we sat
there, we were weirdly calm," Moses says. "We felt insulated from the
whole market reality. It was an out-of-body experience. We just sat
and watched the people pass and talked about what might happen next.
How many of these people were going to lose their jobs. Who was going
to rent these buildings after all the Wall Street firms collapsed."
Eisman was appalled. "Look," he said. "I'm short. I don't want the
country to go into a depression. I just want it to fucking
deleverage." He had tried a thousand times in a thousand ways to
explain how screwed up the business was, and no one wanted to hear
it. "That Wall Street has gone down because of this is justice," he
says. "They fucked people. They built a castle to rip people off. Not
once in all these years have I come across a person inside a big Wall
Street firm who was having a crisis of conscience."

Truth to tell, there wasn't a whole lot of hand-wringing inside
FrontPoint either. The only one among them who wrestled a bit with
his conscience was Daniel. "Vinny, being from Queens, needs to see
the dark side of everything," Eisman says. To which Daniel
replies, "The way we thought about it was, `By shorting this market
we're creating the liquidity to keep the market going.' "

"It was like feeding the monster," Eisman says of the market for
subprime bonds. "We fed the monster until it blew up."

About the time they were sitting on the steps of the midtown
cathedral, I sat in a booth in a restaurant on the East Side, waiting
for John Gutfreund to arrive for lunch, and wondered, among other
things, why any restaurant would seat side by side two men without
the slightest interest in touching each other.

There was an umbilical cord running from the belly of the exploded
beast back to the financial 1980s. A friend of mine created the first
mortgage derivative in 1986, a year after we left the Salomon
Brothers trading program. ("The problem isn't the tools," he likes to
say. "It's who is using the tools. Derivatives are like guns.")

When I published my book, the 1980s were supposed to be ending. I
received a lot of undeserved credit for my timing. The social
disruption caused by the collapse of the savings-and-loan industry
and the rise of hostile takeovers and leveraged buyouts had given way
to a brief period of recriminations. Just as most students at Ohio
State read Liar's Poker as a manual, most TV and radio interviewers
regarded me as a whistleblower. (The big exception was Geraldo
Rivera. He put me on a show called "People Who Succeed Too Early in
Life" along with some child actors who'd gone on to become drug
addicts.) Anti-Wall Street feeling ran high—high enough for Rudy
Giuliani to float a political career on it—but the result felt more
like a witch hunt than an honest reappraisal of the financial order.
The public lynchings of Gutfreund and junk-bond king Michael Milken
were excuses not to deal with the disturbing forces underpinning
their rise. Ditto the cleaning up of Wall Street's trading culture.
The surface rippled, but down below, in the depths, the bonus pool
remained undisturbed. Wall Street firms would soon be frowning upon
profanity, firing traders for so much as glancing at a stripper, and
forcing male employees to treat women almost as equals. Lehman
Brothers circa 2008 more closely resembled a normal corporation with
solid American values than did any Wall Street firm circa 1985.

The changes were camouflage. They helped distract outsiders from the
truly profane event: the growing misalignment of interests between
the people who trafficked in financial risk and the wider culture.

I'd not seen Gutfreund since I quit Wall Street. I'd met him,
nervously, a couple of times on the trading floor. A few months
before I left, my bosses asked me to explain to Gutfreund what at the
time seemed like exotic trades in derivatives I'd done with a
European hedge fund. I tried. He claimed not to be smart enough to
understand any of it, and I assumed that was how a Wall Street C.E.O.
showed he was the boss, by rising above the details. There was no
reason for him to remember any of these encounters, and he didn't:
When my book came out and became a public-relations nuisance to him,
he told reporters we'd never met.

Over the years, I'd heard bits and pieces about Gutfreund. I knew
that after he'd been forced to resign from Salomon Brothers he'd
fallen on harder times. I heard later that a few years ago he'd sat
on a panel about Wall Street at Columbia Business School. When his
turn came to speak, he advised students to find something more
meaningful to do with their lives. As he began to describe his
career, he broke down and wept.

When I emailed him to invite him to lunch, he could not have been
more polite or more gracious. That attitude persisted as he was
escorted to the table, made chitchat with the owner, and ordered his
food. He'd lost a half-step and was more deliberate in his movements,
but otherwise he was completely recognizable. The same veneer of
denatured courtliness masked the same animal need to see the world as
it was, rather than as it should be.

We spent 20 minutes or so determining that our presence at the same
lunch table was not going to cause the earth to explode. We
discovered we had a mutual acquaintance in New Orleans. We agreed
that the Wall Street C.E.O. had no real ability to keep track of the
frantic innovation occurring inside his firm. ("I didn't understand
all the product lines, and they don't either," he said.) We agreed,
further, that the chief of the Wall Street investment bank had little
control over his subordinates. ("They're buttering you up and then
doing whatever the fuck they want to do.") He thought the cause of
the financial crisis was "simple. Greed on both sides—greed of
investors and the greed of the bankers." I thought it was more
complicated. Greed on Wall Street was a given—almost an obligation.
The problem was the system of incentives that channeled the greed.

But I didn't argue with him. For just as you revert to being about
nine years old when you visit your parents, you revert to total
subordination when you are in the presence of your former C.E.O. John
Gutfreund was still the King of Wall Street, and I was still a geek.
He spoke in declarative statements; I spoke in questions.

But as he spoke, my eyes kept drifting to his hands. His alarmingly
thick and meaty hands. They weren't the hands of a soft Wall Street
banker but of a boxer. I looked up. The boxer was smiling—though it
was less a smile than a placeholder expression. And he was saying,
very deliberately, "Your…fucking…book."

I smiled back, though it wasn't quite a smile.

"Your fucking book destroyed my career, and it made yours," he said.

I didn't think of it that way and said so, sort of.

"Why did you ask me to lunch?" he asked, though pleasantly. He was
genuinely curious.

You can't really tell someone that you asked him to lunch to let him
know that you don't think of him as evil. Nor can you tell him that
you asked him to lunch because you thought that you could trace the
biggest financial crisis in the history of the world back to a
decision he had made. John Gutfreund did violence to the Wall Street
social order—and got himself dubbed the King of Wall Street—when he
turned Salomon Brothers from a private partnership into Wall Street's
first public corporation. He ignored the outrage of Salomon's retired
partners. ("I was disgusted by his materialism," William Salomon, the
son of the firm's founder, who had made Gutfreund C.E.O. only after
he'd promised never to sell the firm, had told me.) He lifted a giant
middle finger at the moral disapproval of his fellow Wall Street
C.E.O.'s. And he seized the day. He and the other partners not only
made a quick killing; they transferred the ultimate financial risk
from themselves to their shareholders. It didn't, in the end, make a
great deal of sense for the shareholders. (A share of Salomon
Brothers purchased when I arrived on the trading floor, in 1986, at a
then market price of $42, would be worth 2.26 shares of Citigroup
today—market value: $27.) But it made fantastic sense for the
investment bankers.

From that moment, though, the Wall Street firm became a black box.
The shareholders who financed the risks had no real understanding of
what the risk takers were doing, and as the risk-taking grew ever
more complex, their understanding diminished. The moment Salomon
Brothers demonstrated the potential gains to be had by the investment
bank as public corporation, the psychological foundations of Wall
Street shifted from trust to blind faith.

No investment bank owned by its employees would have levered itself
35 to 1 or bought and held $50 billion in mezzanine C.D.O.'s. I doubt
any partnership would have sought to game the rating agencies or leap
into bed with loan sharks or even allow mezzanine C.D.O.'s to be sold
to its customers. The hoped-for short-term gain would not have
justified the long-term hit.

No partnership, for that matter, would have hired me or anyone
remotely like me. Was there ever any correlation between the ability
to get in and out of Princeton and a talent for taking financial
risk?

Now I asked Gutfreund about his biggest decision. "Yes," he
said. "They—the heads of the other Wall Street firms—all said what an
awful thing it was to go public and how could you do such a thing.
But when the temptation arose, they all gave in to it." He agreed
that the main effect of turning a partnership into a corporation was
to transfer the financial risk to the shareholders. "When things go
wrong, it's their problem," he said—and obviously not theirs alone.
When a Wall Street investment bank screwed up badly enough, its risks
became the problem of the U.S. government. "It's laissez-faire until
you get in deep shit," he said, with a half chuckle. He was out of
the game.

It was now all someone else's fault.

He watched me curiously as I scribbled down his words. "What's this
for?" he asked.

I told him I thought it might be worth revisiting the world I'd
described in Liar's Poker, now that it was finally dying. Maybe bring
out a 20th-anniversary edition.

"That's nauseating," he said.

Hard as it was for him to enjoy my company, it was harder for me not
to enjoy his. He was still tough, as straight and blunt as a butcher.
He'd helped create a monster, but he still had in him a lot of the
old Wall Street, where people said things like "A man's word is his
bond." On that Wall Street, people didn't walk out of their firms and
cause trouble for their former bosses by writing books about
them. "No," he said, "I think we can agree about this: Your fucking
book destroyed my career, and it made yours." With that, the former
king of a former Wall Street lifted the plate that held his appetizer
and asked sweetly, "Would you like a deviled egg?"

Until that moment, I hadn't paid much attention to what he'd been
eating. Now I saw he'd ordered the best thing in the house, this
gorgeous frothy confection of an earlier age. Who ever dreamed up the
deviled egg? Who knew that a simple egg could be made so complicated
and yet so appealing? I reached over and took one. Something for
nothing. It never loses its charm.


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