Michael Lewis: 'The credit crisis was foreseeable'

In the Eighties he laid bare Wall Street excess in his book Liar's Poker. Now Michael Lewis is taking on the global recession. He talks to David Prosser about sleaze, shorting and Goldman Sachs
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The Independent Online

This would not have been acceptable to Michael Lewis during his days as a hotshot bond salesman at Salomon Brothers, the world's preeminent merchant bank. Back then, Lewis the banker had a recurring nightmare in which his five-star hotel room had no fruit bowl and the bellboy forgot to fold the end of the toilet paper into a neat triangle; the idea that a cloud of volcanic ash might interrupt his travel plans would simply have been intolerable.

Today, however, Lewis is calmer. True, he has been unable to make it to Europe to promote his new book, The Big Short, which effectively completes the writing project he began 20 years ago when he left Salomon and published Liar's Poker, the definitive insider's account of Wall Street excess in the 1980s. On the plus side, he is stuck in the right place to enjoy the exquisite agony of Goldman Sachs, the bank that long ago toppled Salomon and other rivals from the top rung of the Wall Street hierarchy.

Since it was charged with fraud a week ago by the Securities and Exchange Commission, the US financial regulator, Goldman has been tying itself up in knots as it scrambles to protect its reputation and Lewis has enjoyed every minute of its travails.

"I'm not surprised Goldman was doing this, but I am surprised the SEC has finally had the nerve to bring a suit against it," he says. "The SEC has shone a light right at the centre of Goldman's business and that is going to lead to lots of other revelations."

It should be said that Goldman strongly disputes the fraud allegations. The facts of the case are that three years ago, before the collapse of America's sub-prime housing market plunged the world into financial crisis and economic downturn, the bank launched an investment product that offered clients exposure to that market.

Unbeknown to clients, the securities in the product were picked by a wealthy hedge fund, Paulson & Co, which would subsequently become famous for making a $13bn profit betting on the crisis (and figures prominently in Lewis's The Big Short). Goldman's defence is that it broke no laws – the SEC says that by failing to disclose the involvement of Paulson, which even then was known to be betting on mortgage defaults, it fraudulently misrepresented the investment it was selling. Some of the clients who lost money – including Britain's taxpayer-owned Royal Bank of Scotland, which is out of pocket to the tune of $850m – are presumably pretty cheesed off too.

"The consensus in the US is that this scandal won't be too serious for Goldman in the long run," Lewis says. "I disagree: I think this is the end of the bank as we know it – the people at the top are going to have to step aside and the bank is going to have to restructure, maybe even go back to being a partnership."

Wall Street firms have ridden out such scandals before, of course, but Lewis says the nature of the financial crisis has changed everything. "Wall Street is not being made a scapegoat for the crisis: they really did this," he argues. "And what is different to previous crises is that people now understand Wall Street has been enriching itself while impoverishing the rest of us."

As a result, in Lewis' analysis, the world is finally moving towards bringing the banking industry to book. Whether through fraud cases against its flagship institution, via the new taxes on the sector to be discussed at this weekend's meeting of the International Monetary Fund, or through "the sea change in our relationship with financial culture" that took place when governments stepped in to stand behind the global financial system at the height of the crisis, the credit crunch has been a "game-changer". Lewis says: "When the markets went through their turmoil in September 2008 and the banks' risk was socialised, their relationship with society was suddenly turned on its head – they went from being the master class to wards of the state and now, finally, to enemies of the people.

"The bailout was the moment when society realised that our economies have become perverse: when we had socialism for the capitalists and capitalism for everyone else."

If you detect a hint of glee in Lewis's tone, you're right. This is a moment for which he has had to wait far longer than he ever expected – one which he says he finally began to think would never come. "At some point I gave up waiting – there was no scandal or reversal, I assumed, sufficiently great to sink the system."

Forgive him the loss of faith. Two decades ago, after three gruelling years in the London office of Salomon, and having gathered sufficient material for Liar's Poker, Lewis thought he needed to get the book out as quickly as possible once he had quit the bank in 1988. He couldn't quite believe the "most absurd money game ever" would continue long enough for his account of it to feel relevant.

"I thought Liar's Poker was a message in a bottle – that in 20 years' time, no one would believe people behaved like that," he says.

Lewis could not have been more wrong. It would be more than two decades before he got to publish a sequel to Liar's Poker chronicling the collapse of the money making machine for which he had watched the assembly line being built at Salomon. The Big Short tells the stories of the small handful of investors who foresaw the collapse of American's housing market – and the staggeringly enormous, blindingly complex financial contracts linked to it – and made more money than anyone in the history of Wall Street.

Some of those investors faced the same sort of nerves Lewis had felt when rushing to publish Liar's Poker. Steve Eisman, a New York hedge fund manager regarded as a maverick, was, by late 2005, desperate to find ways to bet on a blow-up of the sub-prime mortgage market – he was convinced the implosion was so obvious that the rest of the world's investment professionals could not fail to spot it coming, wiping out his chance to score big.

As it turned out, Lewis explains, Eisman need not have worried. "A small number of people – more than 10, fewer than 20 – made a straightforward bet against the entire multi-trillion-dollar sub-prime mortgage market and, by extension, the global financial system," he writes in The Big Short. "The catastrophe was foreseeable, yet only a handful noticed."

In the years between the publication of Liar's Poker and the collapse in 2008 that prompted The Big Short, the excesses of Wall Street had telescoped. Salomon, Lewis's former employer, had invented the mortgage bond – a group of mortgage loans parcelled up and sold on to investors – in the 1980s. By the mid 1990s the sub-prime end of the market – the loans made to less creditworthy customers – was worth $30bn a year or so. By 2005 that figure had reached more than $500bn, with huge numbers of those bonds linked to mortgages taken out by borrowers in such dire financial straits that even the most unprincipled of lenders would never have considered advancing money to them few years previously.

The world had become surreal. What was once metaphorically the case had become literally true. In Liar's Poker, Lewis used a wonderful aphorism: "In the land of the blind, the one-eyed man is king" (meaning that even a little information is valuable, if you have more of it than the next guy in the market). The Big Short tells the tale of one of Eisman's contemporaries, a fellow gambler on a sub-prime disaster: Michael Burry really did have sight in only one of his eyes.

In one sense, these are the heroes of Lewis's book and the credit crisis – the tiny handful of men (and a couple of women) who did not swallow Wall Street's received wisdom. "What I hope people will take away from my book is that I do feel very positively disposed to people who are prepared to stick their necks out," says Lewis. "But they're complicated heroes: it is pretty sleazy to have made so much money from the collapse of the housing market, from the end of so many ordinary folk's dreams."

Why didn't more people – particularly those who might have warned the world about the impending disaster, rather than rubbing their hands with glee at the greatest money-making opportunity in history – see the crisis coming?

"Wall Street was a Ponzi scheme that nobody wanted to look into more closely," Lewis says. "Look at Bernie Madoff: he pulled the wool over the eyes of investors for so long because people only wanted to look at his success, at the investors getting rich – they didn't want to understand how it was done, so he wasn't found out."

In fairness to those who might have been expected to look more closely, by the time of the crash, the bond market had long since spiralled out of control. Most people outside of financial circles think of investment in terms of buying and selling shares – little slices of ownership – in companies. That's the stock market, a relatively well controlled environment that, size-wise, is piddling in relation to the bond market, where supervisory standards have always been weaker.

The genius, once-upon-a-time, of finance houses such as Salomon, Lehman Brothers, Goldman Sachs and others was to recognise the potential for the bond market – on which the debts of people, companies, public bodies and governments are traded – and, eventually, the derivative and insurance contracts linked to it. Not only would it grow to be worth trillions of dollars, but regulators did not control it, or even require the most basic of disclosure standards

"Complexity and opacity baffled almost everyone," says Lewis, who is nonetheless scathing about the watchdogs who allowed themselves to be so ignorant, the credit rating agencies who offered the banks a free pass, and the investors who bought ever greater amounts of investment products without having the first clue about what they were getting for their money.

"The regulators did absolutely nothing," he says. "They were content with a financial order in which even the CEOs of these giant Wall Street firms did not understand what their employees were doing.

"And as for the people who allowed themselves to be manipulated, it's outrageous – why is no-one going after them?"

What about Lewis himself, who has written regularly about the most complicated financial products – and, of course, worked in the business – and might therefore have been expected to sound an alarm bell? "My instinct is to defend all the journalists who cover this beat and who might have exposed this," he says. "The entire system was dumb."

In fact, Lewis's greater responsibility, much as he hates the idea, may be for having attracted people to places such as Wall Street and the City of London in the first place. Lunching last year with his former boss, John Gutfreund, the once all-powerful master of the universe who ran Salomon, Lewis got a taste of some of the bitterness some on Wall Street feel about Liar's Poker. "I think we can agree about this," Gutfreund told him. "Your fucking book destroyed my career and made yours." But such anger is far from universal.

While Liar's Poker was intended as an exposé, an account of an environment in which greed and selfishness ruled and obese men threw telephones at the heads of their subordinates just for fun, the colour and vivacity it exuded was intoxicating. So much so, that Lewis has met countless Wall Street professionals who say they were inspired to join the profession by reading Liar's Poker.

"It is funny that people reacted that way – it is not what I meant to happen and I find it astonishing," he says. "For myself, I stumbled into a job on Wall Street and it made fantastic material, but I could just have easily wound up as an art critic."

Stumble into the job he did, however, and for a short while he was even one of the "big swinging dicks", selling great armfuls of those accursed bonds. Lewis even admits that for a short period after quitting, he missed certain parts of his life on the trading floor: "The collaboration and feeling at the centre of the flow of information," above all.

Those days are long gone, however, and Lewis feels no guilt about the past as he enjoys life in Berkeley, California, as far away from Wall Street as an American might get, both physically and philosophically.

"My interaction with Wall Street was so superficial that I don't even think about it any more," he says. "Wall Street's bad behaviour was not my bad behaviour: I do not feel implicated." On the contrary, finally, he feels vindicated.

The Big Short by Michael Lewis is published in hardback by Allen Lane (£25). To order a copy for the special price of £22.50 (free P&P) call Independent Books Direct on 08430 600 030, or visit www. independentbooksdirect.co.uk

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