The Great Reckoning

The article is an exceptionally long one, but it’s worth the read.

In the article, Lewis tells the story of how Steve Eisman of Frontpoint Partners, along with his co-workers Vincent Daniel and Danny Moses, set out to unravel the Wall Street mendacities and black-box swindles that ultimately led to the mammoth financial beast going belly up, and on the way made some lucrative bets by shorting the mortgage-backed bond 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.”

“What he (Eisman) 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....... These bonds could then be sold to investors—pension funds, insurance companies—who were allowed to invest only in highly rated securities.”

“‘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 (Eisman) come across a person inside a big Wall Street firm who was having a crisis of conscience.’

After the story about the trio’s quest ends, Lewis goes on to record a recent interesting lunch meeting that he had with his former boss, John Gutfreund, the former CEO of Salomon Brothers, who was the innovator of the mortgage derivatives in 1986. Gutfreund, whom Lewis had thought of as a die-hard materialist, seemed to have been converted, probably due to his own personal misfortune after he had been forced to resign from Salomon Brothers. He told Lewis that he thought the main reason for the financial disaster was greed – both of investors and of the bankers. Lewis thought the problem was with the system of incentives that channeled the greed. Gutfreund also agreed that the main effect of turning a partnership into a corporation was to transfer the financial risk to the shareholders. In short, Gutfreund finally came round to admitting that many of Wall Street’s actions are unethical but unfortunately greed-driven investors often fall prey to those actions.

I think Lewis hit the nail on the head when he said the problem with Wall Street is with the system of incentives that channeled the greed. I’ve read somewhere that on average each Goldman Sachs staff earned US$600,000 last year. And at AIG Financial Products in London, where the head count was 377, each staff on average used to earn more than US$1 million a year before the bailout. It goes without saying that the most obscene compensation packages went to the CEOs.