Author Michael Lewis On Wall St's Delusion

(CBS)  If you had to pick someone to write the autopsy report on the Wall Street financial collapse 18 months ago, you couldn't do any better than Michael Lewis. He is one of the country's preeminent non-fiction writers with a knack for turning complicated, mind numbing material into fascinating yarns.

He wrote his first bestseller, "Liar's Poker," about his experiences as a young Wall Street bond trader when he was still in his 20s and has since followed up with seven more bestsellers on subjects ranging from Silicon Valley in "The New New Thing" to big time sports in "Money Ball" and "The Blind Side."

His new book, called "The Big Short: Inside the Doomsday Machine," comes out later this week and it explains how some of Wall Street's finest minds managed to destroy $1.75 trillion of wealth in the subprime mortgage markets.

"60 Minutes" and correspondent Steve Kroft spent two days debriefing Lewis at his home in California.

Full Segment, Part 1: Inside The Collapse
Full Segment, Part 2: Inside The Collapse
Web Extra: Is Wall Street Overpaid?
Web Extra: Bailout Blues
Web Extra: The $8.4 Billion Bet
Web Extra: Wall Street Misfit
Web Extra: "The Blind Side"

"This was an episode where capitalism was almost destroyed, just by the capitalists. And, in the most sensational way, they were sort of destroyed by their own folly," Lewis told Kroft.

Asked what happened, Lewis said, "The incentives for people on Wall Street got so screwed up, that the people who worked there became blinded to their own long term interests. And because the short term interests were so overpowering. And so they behaved in ways that were antithetical to their own long term interests."

Lewis, a one-time wonder boy on Wall Street, is about to turn 50 now, ensconced in a hillside compound in Berkeley, Calif. The property has a main house and three cottages and he is much happier writing about business than actually conducting it.

Asked which book produced the money to buy the home, Lewis said, "This would've been 'The New, New Thing,' that bought this place."

Lewis estimates he has sold "some millions" of books. "I don't know how many millions. Not John Grisham millions, but millions," he said.

He lives in Berkeley with his wife, former MTV News correspondent Tabitha Soren and their three children - a three-year-old son and two young daughters who he takes to all of Cal Berkley women's basketball games.

It's one of the few breaks that Lewis allowed himself over the past 18-months as he dug into the idiocy and negligence that produced the worst financial crisis since the Great Depression.

"I'm afraid that our culture will come to the conclusion, 'cause it's always the easy conclusion, that everybody was just a bunch of criminals. I think the story is much more interesting than that. I think it's a story of mass delusion," Lewis said.

Lewis' forte has always been discovering little-known facts and characters that change people's perception about a story. So when he finally sat down at his computer with sacks full of research to write about this calamity, he had no interest in Treasury Secretary Hank Paulson, or Ben Bernanke, or the CEOs of Wall Street's big investment banks, who he believes had no clue what was going on while it was going on.

He wanted to tell the story through the eyes of people who were paying attention and who knew that a financial disaster was inevitable.

"There are a handful of characters who actually had seen it coming and made a fortune off of it. And there were so few of them, and there were so many people who had been on the other side that I thought that I kind of wondered who they were and why they got themselves into that position," Lewis said. "What they saw. Almost more how they saw."

Asked how many people he thinks were in the world who understood what was going on, Lewis told Kroft, "Between 10 and 20 investors at most and this is from the universe of tens of thousands of people who could have conceivably made that bet."

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[suntszu]

A couple of points that bear mentioning: (where Mr. Lewis did not go far enough)

1.) Any issue can be rated AAA, as it is simply of a function of the level of subordination (the first loss piece or "waterfall" for defaulted loans). In other words relative to the risk profile on a given issuance, by example say 30% of the issue is deemed by the rating agency to be subordinate, meaning that an investor in said AAA bond would have protection equal to 30% of the collateral having to default before they would experience a loss. Said 30% in this example would be referred to as the "first loss piece" or "residual interest." The "residual interest" would either be kept on the books of the issuer or more frequently sold as a separate security.

2.) Speaking to sub prime loans, the large originators ($1b+ per month in volume, most of which were centered in or around Orange County, CA - referred to as the "sub prime ghetto" by those in the business) had no incentive to either underwrite the loans or even fight aggressively to get them purchased in the secondary market. No, you did not read the last part of my statement incorrectly, as Wall Street whole loan buyers of sub prime were generally given what amounted to a free put (the ability to reject loan from a given trade without cause) on 3%-5% of the aggregate balance. Why, simply because they could sell the fall out from a given trade at a price that was still higher than par (AKA 100 cents on the dollar)

3.) Between 2002-mid 2006 there were literally NO LOSSES on defaulted loans. Borrowers in default were able to simply refinance the loan out of a default or the real estate had appreciated to a level that in the rare cases of liquidation everyone was made whole. I attended trade conferences were sellers of whole loans told me they sold xxx$millions (fill in the number) worth of loans to our competitors and never had a single claim for repurchase or an early payment default (EPD). We all knew of course that is would have been a statistically anomaly on the grounds of the "big bang theory" where even 1-loan (even in a superior credit pool) had not gone into default or had resulted in a claim. What was happening here is that any defaults were either cured by a refinance or it was more profitable for the servicer of the loans (working on behalf of either the Wall St. acquirer or the bond holders depending where in the process the loan defaulted) to work it out internally versus issuing a put back for a claim.

4.) The Wall St. compensation model was in fact skewed towards short term P&L results. While there were in fact hold backs on annual compensation and some firms paid a percentage of compensation in stock, large annual cash bonus payments were the norm and many senior traders that moved from firm to firm had massive multi year guarantees.

So what really went wrong? In mid 2006 I was called into a darkened conference room and informed that one of my "right hands", a VP that worked primarily on bulk transactions was being let go and that I had essentially "maxed out" from a compensatory perspective and should "strongly consider" the offered position in Residential Conduit Sales. I was even offered a relo package to Los Angeles. The underlying issue at hand was that I (or we in Residential Credit), despite being well respected within both the company and the industry in general, were too conservative relative to where our firm placed on the competitive risk matrix. I relay my personal experience only as cogent background color to the onset of the downward spiral.

What happened next?

1.) The real estate market started to "cool down"

2.) The "scratch and dent" bid price (the price paid for assets that were kicked out of trades) fell to a level below par (when this happened and the large sellers decided that it was time to start underwriting their loans and to fight harder to keep loans in trades, I was actually contacted to gage my interest for a head of credit position at a large sub prime originator)

3.) The concept of recourse back to the originator was a virtual fallacy. Even the larger originators could not with stand even a relatively small number of repurchase requests where the smaller originators were often doing volume of $20m or more per month with a tangible net worth of $1m or less!

I could go on, however, the 3-stated events likely contributed more to the downward spiral and what was soon to be called toxic debt than any other factors. One could of course get granular and make the argument that borrower who took a loan that they knew they couldn't afford is just as culpable as anyone else, though they seem to be getting a pass these days.

[MyBizInterest]

Almost everyone knew from 2003 on that there were no lending standards. To get a loan all you had to do to qualify was be able to "Fog a mirror", or the common expression "Liar Loans" ... these were common jokes during the bubble.
It's irresponsible of the media to pretend that what was happening was unknown but to a select few. This perception is promoted by the media, politicians and bankers to absolve them of their gross neglegence at best and corruption at worst.

[newerdeal]

Good job ! ! ! This was all going on while the USA was thick in the wars too.

Bin Laden said he wanted to ruin the US economy. Looks like Wall Street was helping him !

[EmileRandon]

GREED KILLS! PEOPLE, FAMILIES, SOCIETIES, AND EVEN WHOLE CULTURES!
Michael Lewis' story has me pondering 1 question I feel is deeply rooted in the largest single cause of the pain most American's now suffer from.(Which is unbridled greed.)
It also makes me think back to the integrity my grandparents' seemed to have woven into their DNA. (My parents' are living proof it can be passed down through generations of families.)
I don't think the Founding Fathers of our country wanted as small a Federal Government as possible because they wanted future generations to take advantage of people who couldn't be expected to understand the complexities of sub-prime mortgages,(or junk bonds,etc.). I also believe they would be shocked to see the lack of integrity in those who signed for them. (They had to know they did not make the money the application said they were.) They also couldn't have foreseen former government employees taking (usually high paying) jobs with the companies they once regulated. If greed were a living organism, it would be at the top of the food chain.
The problem seems to be how much government is the right amount. We may won't know as long as the two parties that run our government won't work together. (Could regulating the use of soundbites for professional gain be the answer to that problem?)
Now to my grandparents integrity. My maternal grandfather kept his business going during the Great Depression. When I asked him why, he said it was because he had people depending on him. Not only his family but the families' of his employees. (He had a woman running his office, who happened to be black. This happened when the south had not put civil rights into writing, much less effect. When I asked him if people were uncomfortable with his decision, he replied that she was trustworthy, a good person as well as a good worker. That was all the job required. Then he added: I don't tell others how to run their businesses, so I don't let them tell me how to run mine.
One current trend is "Old School" at least as far as fashion, etc. is concerned. I wonder why "Old School" integrity has been overlooked?
Emile L. Randon

[tsweeny9369]

Legalized robbery.....and people like Mr. Paulson, CEO's who are reaking millions in bonuses, and congress members who supported the legislation to allow this to happen should be held accountable and prosecuted. I would have been prosecuted for the same behavior why are they above the law. Where's my million dollar bonus? I deserve just as much as the people who got us into this fiasco....

I think Congress ought to have their pensions cut, health care cut, all their perks cut before even touching the American people's programs. They are the leaders of the this country, right, so why not lead the charge by saying cut our perks first. Why don't the American people stand up and vote to cut their perks..... yea like that's going to happen.

The American middle class needs to stand, be heard and start the movement to throw every political incumbent out of office, demand legislation be passed to stop these PAC's, special interest groups, and lobbists from associating with the political process. The American political system is broken and until the middle class says NO MORE, it will continue to plague the middle class. I say stand up, use your vote to elect members who will pass legistion for term limits and vote against ALL incumbents.

Without this change, the American people's disgust is growing and widening. Their will come a time for revolution against the "good ole boys network". The Tea Party and Coffee Party movements is just the start.

Congress, do you get the hint the American People are fed up. We are.... I'm voting against every incumbent and will make sure my vote counts for change. Sorry for the rants and raves but everyone I talk to in my community feels the same way.

[cottonelle-2009]

This interview seemed like a CBS's mea culpa amending their first story aired on 60 Minutes looking at AIG behind the scenes. Michael Lewis knows better than what he entertainingly chats up, completely absolving AIG of any part in this funny business. There's a smell to this C-R-A-P, that ignores a "Conspiracy to Remove All (govt.) Protections" beginning with the ascension of Ronald "Charlie McCarthy" Reagan to the presidency on a "get govt. out of our business" platform that Republicans have been bleating ever since, enacting law after law from 1979 thru 1999 that has completely dismantled the Glass-Stegall Act of 1933 creating the perfect conditions to storm the people's bank accounts. Betting parlors in big buildings, the kind previously banned by Glass-Stegall, set up Joe Public like they knew we wouldn't be able to come up with the cash for quadrupled loans from the very houses the people were sold from. D/b/a usual, they reward "their Arrogances" handsomely for "failure", who actually are walking unhindered and laughing all the way out of these formerly ethical banks, having pickws Joe Public's pockets first out of their stock market portfolios, but twice for the tax stimuli recovery initiative of "Charlie McCarthy too", George Bush, and three times by states' recovery of losses and much more to come. They don't call it the 'Big Easy' for nothing. They never had to draw a gun...just GROPE, the Greatest Robbery of the People Ever.

[jeffinpa1234]

Rubber stamp regualtors, rating agencies paid by wall street, and a greed is good mentality..... makes for a good movie.

However now that real working class Americans are suffering because of it makes it a title that should be in the Horror Film section!

And all the while on Capital Hill they toil on a health care bill that is NOT supported by a majority of this country instead of getting real financial reforms in place and working to get Americans back to work!

Michael Lewis is right this is an elegant form of theft that continues to this day and is now finded by our tax payer $. Oh well no worry they will just increase our taxes to make tup the short fall for these misguided bailouts and continued bonus payments.

How do I get one of these jobs???? My bonus was cut to zero when the company I worked for experienced a sales slump. I want to work where the rewards for failure are paid in bonus $!!!

[KeithDrippingSprings]

Scoundrels and Thieves all. For you guys that want to blame the other party, which ever one that might be. You are doing just exactly what your elected officials want you to do. Blame anyone but the individuals at fault. Commerce, industry, journalist, have all lost their way. A dearth of ethics in public life is chipping away at the foundation of our society. If we disagree on the details that is one thing but when the corruption becomes so rampant that it can not even be denied then we have gone to far.

Every Congressman and Senator spends most of their day on the phone soliciting donations. They must collect from 2000 to 3000 dollars per day in order to get ready for their next election. Those who don't have to do that are the ones that have already sold their votes to corporations and special interest that can afford to keep supporting them without so much begging. Any person that can collect 3000 dollars making phone calls in a day has no earthly idea how it is to live on 30 or 40 thousand a year.

You have no more power to change the way you are governed than the Chinese or Russian citizens. You get to complain, you get to vote for either party (both of them are same) and you feel like you have some choices, but that is pretty much it. Your Legislators are going to do the bidding of those who sent them to Washington and it isn't the citizens. They are going to do the bidding of the people that paid their way to Washington and that ain't you.

[Uswiseguys]

You guys enjoying yourself? Doesn't take Einstein to figure out what the problem is. Two distinct political agendas and the free entries system colliding to make the perfect storm. One with a social agenda that says lets give loans to people who have no chance in hell of repaying them, another who decides to deregulate by in effect castrating virtually all regulations. Add the gasoline of the free enterprise system that says profits at any price and guess what you have? And all you guys can do is run around like a bunch of preschoolers calling each other names while Rome burns? Come on, grow up. While you all fart around guess who gets it in the shorts? Hint all the poor saps (as in taxpayers) that don't want a handout and don't stand to make a fortune by screwing everyone. 60 Minutes did a good job as far as they went, they just need to go a lot deeper and examine the real culprits in this mess, namely the people in both parties who are still in office and playing us all for chumps. Not hard to find them, they are in the Whitehouse, in the Senate and in the House in both parties with many still in power. Remember let us roll the dice Barney Frank who has pressed relentlessly for subprime loans? Or Mr. Get it Done Emanuel who helped ram through removing any regulations from derivatives under Clinton? They just happen to still be in power. The rest of them got rightfully tossed out on their ear. So what happens next, we forget what a bunch of clowns the Republicans are and toss out the clown Democrats and go around again? Could happen come November. You want to be scared look at the collusion with the Health Care bill. What a pathetic joke. We need real reform, not more political and corporate pandering and stupid games. It is just another huge rip off. Cut a deal with the big pharmaceutical/insurance companies and give some pabulum to the public and say you?re making history, what a joke. Now lets go a few years hence, no restriction for only signing up when you are sick, no cost controls and once what little regulations that are there are again castrated by the ?free enterprise? Republicans when they return to power because everyone is fed up the a bunch of arrogant incompetent Democrats. What a mess that will be. It is the same old crap in spades. Hello, wakeup. Come on 60 Minutes, find your balls and do some serious digging. The rest of you might be better off if you learned to play the fiddle or maybe, just maybe, woke up and smelled the coffee.

[curse914]

Both Parties still believe in infinite growth, do you? Without this bubble our economy would have been in an even faster decline years ago.

All the foundations of our 1950-60's single wage earner are gone. Yeah, voting out the Unfettered Capitalists would be a good start. But we have a socially excepted economic model that is nothing but a theory in practice that has some serious flaws beyond the proven failure of Laissez-Faire and insane "entitlements".

The extremes of the ideological spectrum actually propped up the really big myth of Infinite Growth and it is about to implode.

[DavidD_]

This is a great piece. It was nice to see a top expert make it clear that the blame for this resides squarely with the big investment banks. The big 5 (Lehman, Merrill, Bear, Goldman, and Morgan-Stanley) all went under or were bailed out in 2008. Since they were not depository banks, they were not subject to the Community Reinvestment Act or other government pressure. In fact, the SEC relaxed its oversight in 2004, letting these entities increase the bets they had made. The ratio of debt to equity in these firms jumped from around 20:1 to over 30:1 from 2003-2007. They gambled with borrowed money.

Now that the Fed has developed a series of innovative lending mechanisms, no entity is "too big to fail" anymore. Legitimate, non-parasitic organizations can get money from the Fed and don't need the investment banks. I think the government should shut these companies down as soon as feasible. The nerve of the leaders of these institutions astounds me. I cannot wait for the "perp walks" that are coming their way! Keep up the good work Michael and CBS!