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Tales of greed and epic financial failures

Wall Street


The two men sat in a New York City restaurant: the author and the banker he had antagonized two decades earlier.

"I think we can agree about this," John Gutfreund, long ago the prince of Wall Street, told his lunch companion, Michael Lewis. "Your fucking book destroyed my career and it made yours."

Well, that puts a fine point on it, doesn't it?

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The book in question, Liar's Poker , quickly became a business classic when it was published in 1990. It propelled the absurdly talented Mr. Lewis to fame and put a spotlight on the unseemly side of high finance, with its insider's view of unchecked greed at Salomon, then a major investment bank and now part of Citigroup.

(It did not finish Mr. Gutfreund's financial career, but the year after it appeared in bookstores, a bond purchase scandal at Salomon did.) Liar's Poker described a culture, unflatteringly. What the book didn't do was change it. The Big Short , Mr. Lewis's new book on the American mortgage crisis, just might - if bankers and those who regulate them absorb the underlying message.

Mr. Lewis's genius has always been his ability to tell stories through interesting people, and The Big Short is full of characters. Many are oddballs, loners and misanthropes in the investment business who believed they were seeing an epic financial mistake - mortgages being given en masse to borrowers who couldn't afford them. These are the protagonists of the tale: the men and women who could see coming a historic bout of defaults, foreclosures and collapsing home prices, and who got rich betting on it.

Many of these bets were made with derivatives. But since derivatives trading, like poker, is a zero-sum game, one man's winning gamble is another man's loss. And one of the great riddles of the financial crisis is how the same financial firms who devised and sold toxic subprime mortgage bonds wound up losing billions of dollars on them. If they had a clue of what terrible loans were backing them, why didn't they steer clear?

To this, Mr. Lewis has many answers. Short-sightedness, for one. "The firms themselves became very short-term oriented," he said in an interview. "This perverted machine, the subprime machine, was a source of incredible revenue that nobody could ignore. But in order to run this machine, you had to be willing to warehouse huge amounts of subprime mortgage risk."

Complexity. Morgan Stanley, for example, nearly failed in part because a massive trade in mortgage securities, executed by a guy named Howie Hubler, went sour. (That story alone is worth the price of the book.) CEO John Mack didn't understand it, "because the nature of the trade Howie had on was extremely complicated … [and]the way it was described to the chain of command was grotesquely simplified."

Greed, naturally. If employees are paid their bonuses based on one year's results, what incentive is there not to invest in something that makes money today but will likely implode three years from now, such as mortgages with teaser rates? "The firms were so poorly managed, in most cases, that there wasn't even a firm-wide policy on [mortgage securities]" said Mr. Lewis. "Individual traders were allowed to have individual views. So how did individual traders at these firms make such stupid mistakes? And the answer was in part how they were paid."

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Culture. Mr. Lewis left Wall Street at a time when the big investment banks were turning from partnerships into publicly-traded companies. This placed the ultimate risk on a new, and remote, participant: the public shareholder. "There was a very clear sense that we were behaving in ways with this money that we would not behave if it was our money."

Size. "People on the trading floors could be sitting two desks away from each other, and not have the first freaking clue what the other guy was doing. That the places had become so big and so balkanized that nobody had a really clear overview of their own firms."

On many of these things, Wall Street can't turn back the clock. Goldman Sachs isn't likely to revert to a partnership. Unless forced by the government to break up, it isn't likely to get smaller, either. Greed? That's just part of human nature.

Perhaps that's why so much attention is being put on trying to regulate the banks. If banks won't change, politicians must force them, goes the thinking. And there are no end of proposals to do so - Volcker rule (to limit trading activity by investment banks) and this plan and that bill, including a new one this week led by U.S. Senator Chris Dodd.

That so many ideas abound about how to keep Wall Street on a short leash merely highlights the fact that very little has actually been done. But just wait, said Mr. Lewis.

"It took four years before any serious reform passed through Congress after the crash of '29," he said. "I think the endgame here, and what's likely to happen, is that these big firms … are going to become much less profitable businesses and much less interesting places to work. Saner, duller. The political winds are so clearly blowing in the direction of changing the way these places operate. It's going to take some time for that to happen."

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