Here’s a book review of an oldie-but-goodie. Liar’s Poker by Michael Lewis is a non-fiction account of the author’s experiences as a 24-year old the 1980s who started working as a bond salesman for Salomon Brothers, one of the most powerful investment banks at the time (now folded into Citigroup).
Half of the book is an insider’s view of the fast-paced and testosterone-driven world of trading and sales on Wall Street. Lewis explains terms like “Big Swinging Dick” and how he made of dollars of profits for the company, sometimes by necessarily screwing a few customers over. Don’t ever forget their priorities! Here is a quote from a 2008 Portfolio article where Lewis takes a look back:
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.
The other half explains how some of the most powerful securities in the world were created – namely high-yield “junk” bonds (which exploded in the late 1980s) and mortgage-backed securities (which took longer, and exploded in the late 2000s). They saw an opportunity:
From the early 1930s legislators had created a portfolio of incentives for Americans to borrow money to buy their homes. The most obvious of these was the tax deductibility of mortgage interest payments. The next most obvious was the savings and-loan industry.
The savings and loan industry made the majority of home loans to average Americans and received layers of government support and protection. The breaks given savings and loans, such as deposit insurance and tax loopholes, indirectly lowered the interest cost on mortgages, by lowering the cost of funds to the savings and loans. The savings and loan lobbyists in Washington invoked democracy, the flag, and apple pie when shepherding one of these breaks through Congress. They stood for homeownership, they’d say, and homeownership was the American way. To stand up in Congress and speak against homeownership would have been as politically astute as to campaign against motherhood. Nudged by a friendly public policy, savings and loans grew, and the volume of outstanding mortgages loans swelled from $55 billion in 1950 to $700 billion in 1976. In January 1980 that figure became $1.2 trillion, and the mortgage market surpassed the combined United States stock markets as the largest capital market in the world.
Following the money, in 1986 Salomon Brothers created the first mortgage derivative. Soon after, they figured out how to take BBB-rate bonds with a unknown maturity and perform financial voodoo to create top AAA-rated bonds with more predictable maturities. (A good explanation of collateralized debt obligations (CDOs) and tranches is in the video Crisis of Credit Visualized.)
Lewis also learned the trader mentality:
Many of the trades that [mentor] Alexander suggested followed one of two patterns. First, when all investors were doing the same thing, he would actively seek to do the opposite. The word stockbrokers use for this approach is contrarian. Everyone wants to be one, but no one is, for the sad reason that most investors are scared of looking foolish. Investors do not fear losing money as much as they fear solitude, by which I mean taking risks that others avoid. When they are caught losing money alone, they have no excuse for their mistake, and most investors, like most people, need excuses. They are, strangely enough, happy to stand on the edge of a precipice as long as they are joined by a few thousand others. But when a market is widely regarded to be in a bad way, even if the problems are illusory, many investors get out.
All in all, this book was a very fun read. It reminded me of somewhat of Ugly Americans by Ben Mezrich, but Liar’s Poker had a much more authentic and feel of historical significance to it.