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Good Reading -- April 2010

Happy Friday.


  1. "No Credit" -- a favorable profile of Tim Geithner and his policies aimed at forestalling financial Armageddon. Love him or hate him, least it's at least refreshing to read about a human being in Washington willing to consider difficult but important decisions apart from the vapid, short-term political implications.

  2. "Keeping America's Edge" -- this article ran last year, but I just read it and I think it is truly exceptional and has several worthwhile arguments and ideas.

  3. "What if Women Ran Wall Street? Testosterone and Risk" -- very interesting, and, in my experience, very true.


  1. "At Lehman, Watchdogs Saw it All" and "Insider Warned of Lehman Accounting" and Matthew Lee's memo to senior management -- need more evidence that the SEC, and pretty much the entire financial regulatory system, is a couple joke? Here's more. And more and more and more. Oh, and by the way, this guy Lee at Lehman who tried to blow the whistle on this nonsense? He was fired, er, downsized, because of it. Still hacked off about Lehman? Be sure to read David Einhorn's May 2008 speech (attached) which includes his analysis of Lehman's blatant accounting fraud and remember that it was (a) five months before Lehman collapsed, and (b) roundly criticized by almost every as another reckless attack by the short sellers. Oh, and here's more off-balance sheet, undisclosed debt. [*Cough*Enron*Cough] And none of this goes into R3, a sham of an outfit Lehman set up in summer 2008 to house toxic waste off the books.

  2. Need still more SEC incomptence, also related to Einhorn but concerning an entirely different fraudulent company? Try this and this.

  3. "Lehman Chief Warns of More Big Bank Failures" -- sorry, last one.

  4. "The End-Times Investor" -- some interesting thoughts from James Chanos (OK, I lied -- be sure to notice his comment about identifying a $150 billion - billion with a "b" - hole in Lehman's balance sheet.

  5. Interview with Michael Lewis. I do not agree with everything Lewis says or writes, although he generally makes a lot of good points with minimal garbage mixed in. His new book was just released and I plan to read it, but this interview pretty much tells the bigger story.

  6. "Now What?" -- more excellent commentary from Atul Gawande, this time on the recently passed health care reform legislation.

At Lehman, Watchdogs Saw It All


Almost two years ago to the day, a team of officials from the Securities and Exchange Commission and the Federal Reserve Bank of New York quietly moved into the headquarters of Lehman Brothers. They were provided desks, phones, computers — and access to all of Lehman’s books and records. At any given moment, there were as many as a dozen government officials buzzing around Lehman’s offices.

These officials, whose work was kept under wraps at the time, were assigned by Timothy Geithner, then president of the New York Fed, and Christopher Cox, then the S.E.C. chairman, to monitor Lehman in light of the near collapse of Bear Stearns.

Similar teams from the S.E.C. and the Fed moved into the offices of Goldman Sachs, Morgan Stanley, Merrill Lynch and others.

There were plenty of reasons to send in these SWAT teams. With investors on edge about the veracity of valuations on Wall Street — and with hedge fund managers like David Einhorn publicly questioning Lehman’s numbers — the government examiners rifled through Lehman’s accounts. They also interviewed executives about various decisions, and previewed the quarterly earnings reports.

Yet now, two years later, we learn through a 2,200-page report from Lehman’s bankruptcy examiner, Anton R. Valukas, that the firm was taking a creative approach with its valuations and accounting.

One crucial move was to shift assets off its books at the end of each quarter in exchange for cash through a clever accounting maneuver, called Repo 105, to make its leverage levels look lower than they were. Then they would bring the assets back onto its balance sheet days after issuing its earnings report.

And where was the government while all this “materially misleading” accounting was going on? In the vernacular of teenage instant messaging, let’s just say they had a vantage point as good as POS (parent over shoulder).

The new mystery is why it took this long for anyone to raise a red flag. “Even though Lehman dressed up its accounts for the great unwashed public, it did not try to fool the authorities,” Yves Smith, the author of “ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism,” wrote on her blog last week. “Its game-playing was in full view.”

Indeed, it now appears that the federal government itself either didn’t appreciate the significance of what it saw (we’ve seen that movie before with regulators waving off tips about Bernard L. Madoff). Or perhaps they did appreciate the significance and blessed the now-suspect accounting anyway.

Oddly, when the bankruptcy examiner asked Matthew Eichner of the S.E.C., who was involved with supervising firms like Lehman, whether the agency focused on leverage levels, he answered that “knowledge of the volumes of Repo 105 transactions would not have signaled to them ‘that something was terribly wrong,’ ” according to the examiner’s report.

There’s a lot riding on the government’s oversight of these accounting shenanigans. If Lehman Brothers executives are sued civilly or prosecuted criminally, they may actually have a powerful defense: a raft of government officials from the S.E.C. and Fed vetted virtually everything they did.

On top of that, Lehman’s outside auditor, Ernst & Young, and a law firm, Linklaters, signed off on the transactions.

The problems at Lehman raise even larger questions about the vigilance of the S.E.C. and Fed in overseeing the other Wall Street banks as well.

“I’m concerned that the revelations about Lehman Brothers are just the tip of the iceberg,” Senator Ted Kaufman wrote in a speech he was preparing to give Tuesday on the Senate floor. “We have no reason to believe that the conduct detailed last week is somehow isolated or unique. Indeed, this sort of behavior is hardly novel.”

Here’s how Repo 105 worked in simple terms: At the end of each quarter, to reduce its all-important leverage levels, Lehman would “sell” assets (typically highly liquid government securities) to another firm in exchange for cash, which it would use to pay down its debt. The assets were typically worth 105 percent of the cash Lehman received. Several days later, after reporting its earnings, it would buy the assets back. Normally, this would be considered a loan, or repurchase agreement, but instead it was booked as a sale.

Huge piles of cash were moving in and out. According to the examiner’s report, “Lehman reduced its net balance sheet at quarter-end through its Repo 105 practice by approximately $38.6 billion in fourth quarter 2007, $49.1 billion in first quarter 2008, and $50.38 billion in second quarter 2008.”

Perhaps tellingly, there is no evidence that Lehman kept two sets of books or somehow tried to hide what it was doing from regulators. The bankruptcy examiner spent over a year searching through virtually every e-mail message at the firm and didn’t say he found any evidence of a cover-up.

That may explain why so few at the firm seemed to think that what they were doing was wrong, based on the e-mail traffic reviewed by the examiner. They talked openly about Repo 105. And while some apparently felt queasy about it, they also repeatedly said that it was legal (there are no e-mail messages from Richard Fuld Jr. or any senior executive directing another executive to use Repo 105 to mask earnings).

Lehman’s shell game didn’t come to light until June 2008, when a lower-level executive named Matthew Lee sent a letter to management raising a host of questions about the firm’s practices. (By the way, the S.E.C. and Fed were still working inside the building at this point.)

What the examiner didn’t report, however, was that Mr. Lee started raising questions about Repo 105 only when it became clear that he was being replaced in his role, according to people briefed on the matter. Indeed, Mr. Lee’s original letter to management did not mention the use of Repo 105.

Whatever the case, in an age calling for more accountability on Wall Street, it seems we could use some in Washington too.

Insider Warned About Lehman Accounting


Inside Lehman Brothers Holdings Inc., some executives quietly fretted about the firm's accounting as the company headed to the brink in September 2008.

Matthew Lee did something about it.

In May 2008, the former Lehman senior vice president wrote a letter to senior management warning that the company may have been masking the true risks on its balance sheet.

Now, the little-known Lehman executive once in charge of "global balance sheet and legal entity accounting" is at the center of allegations that Lehman manipulated its numbers and misled investors.

His warnings, revealed for the first time in a report by a U.S. bankruptcy-court examiner, show that Lehman's auditors knew of potential accounting irregularities and allegedly failed to raise the issue with Lehman's board.

"I had a premonition that this day was coming," said Mr. Lee late Thursday, from the front stoop of a two-story brownstone in Brooklyn, N.Y.

Mr. Lee said he had yet to read the 2,200-page examiner's report, which is being devoured by readers online.

"I am a hard-copy kind of guy," he said in a phone interview on Friday.

Mr. Lee was raised in Scotland and attended the University of Edinburgh. He referees weekend soccer matches in Brooklyn.

A person close to Mr. Lee said the fallout from his warnings has been difficult for the 14-year Lehman veteran. Mr. Lee declined to say where he has been working since Lehman's collapse. Ironically, he worked at Ernst & Young before joining Lehman in 1994.

"I have no animosity toward anyone at Lehman Brothers. I just want the truth to come out," said the tall, brown-haired 56-year-old.

Mr. Lee said he was refraining from comment on details from the report until all Lehman litigation has been settled, which he realized could take years. "I have a lot to say, but unfortunately it is going to have to wait," he said.

At the time Mr. Lee voiced his concerns in May 2008, Lehman was under siege from investors who questioned whether the securities firm was accurately valuing its risky assets.

"We are also dealing with a whistle-blower letter, that is on its face pretty ugly and will take us a significant amount of time to get through," William Schlich, a former lead partner on Ernst & Young's Lehman team, wrote in a June 5, 2008, email to a colleague, which is included in the examiner's report.

While saying he was confident he could clear up Mr. Lee's concerns, Mr. Schlich wrote that the letter and off-balance sheet accounting issues were "adding stress to everyone." Mr. Schlich didn't return a request for comment.

In a statement, Ernst & Young said: "Lehman conducted an investigation of the allegations in the employee's May 2008 letter. In July 2008, Lehman's management reported to the Audit Committee and concluded the allegations were unfounded and there were no material issues identified. We never concluded our review of the matter, because Lehman went into bankruptcy before we completed our audit."

Mr. Lee's letter contained several allegations, according to the examiner's report. Among them: That Lehman had "tens of billion of dollars of unsubstantiated balances, which may or may not be 'bad' or non-performing assets or real liabilities."

He also alleged that Lehman was failing to value tens of billion of dollars of illiquid inventory in a "fully realistic or reasonable way."

Mr. Lee was worried that Lehman had failed to bolster its accounting systems and personnel to keep up with the firm's rapid growth.

Specifically, he was concerned about "potential misstatements of material facts" coming from Lehman's India office.

A month after receiving Mr. Lee's letter, Lehman board members directed Ernst & Young to interview Mr. Lee and investigate his concerns, according to the examiner's report.

In a June 12, 2008 interview with Ernst & Young, Mr. Lee raised the issue that Lehman was moving as much as $50 billion off its balance sheet, using a practice the firm called "Repo 105," the report says.

The accounting device was used by Lehman to temporarily park assets off its books at the end of a quarter to make it look as if the firm had less debt, the report concludes, something investors and credit raters would tend to look favorably on.

Lehman "had way more leverage than people thought; it was just out of [the public's] sight," Mr. Lee told the examiner in July 2009, according to the report.

Internally, the issue appeared to fall on deaf ears.

Mr. Lee said when Repo 105 was raised at monthly staff meetings the response was usually that Lehman officials were "quite keen on reducing the balance sheet," according to the examiner's report.

In a meeting the day after they interviewed Mr. Lee, Ernst & Young auditors didn't mention his allegations about Repo 105 to Lehman's board "even though the Chairman of the Audit Committee had clearly stated that he wanted every allegation made by Lee—whether in Lee's May 16 letter or during the course of the investigation—to be investigated,'' the report states.


May 18, 2008



Mr. Martin Kelly, Controller

Mr. Gerard Reilly, Head of Capital Markets Product Control

Ms. Erin Callan, Chief Financial Officer

Mr. Christopher O’Meara, Chief Risk Officer

Lehman Brothers Holdings, Inc. and subsidiaries

745 7th Avenue

New York, N.Y. 10019

Gentlemen and Madam:

I have been employed by Lehman Brothers Holdings, Inc. and subsidiaries (the “Firm”) since May 1994, currently in the position of Senior Vice President in charge of the Firm’s consolidated and unconsolidated balance sheets of over one thousand legal entities worldwide. During my tenure with the Firm I have been a loyal and dedicated employee and always have acted in the Firm’s best interests.

I have become aware of certain conduct and practices, however, that I feel compelled to bring to your attention, as required by the Firm’s Code of Ethics, as Amended February 17, 2004 (the “Code”) and which requires me, as a Firm employee, to bring to the attention of management conduct and actions on the part of the Firm that I consider to possibly constitute unethical or unlawful conduct. I therefore bring the following to your attention, as required by the Code, “to help maintain a culture of honesty and accountability”. (Code, first paragraph).

The second to last section of the Code is captioned “FULL, FAIR, ACCURATE, TIMELY AND UNDERSTANDABLE DISCLOSURE”. That section provides, in relevant part, as follows:

“It is crucial that all books of account, financial statements and records of the Firm reflect the underlying transactions and any disposition of assets in a full, fair, accurate and timely manner. All employees…must endeavor to ensure that information in documents that Lehman Brothers files with or submits to the SEC, or otherwise disclosed to the public, is presented in a full, fair, accurate, timely and understandable manner. Additionally, each individual involved in the preparation of the Firm’s financial statements must prepare those statements in accordance with Generally Accepted Accounting Principles, consistently applied, and any other applicable accounting standards and rules so that the financial statements present fairly, in all material respects, the financial position, results of operations and cash flows of the Firm.

Furthermore, it is critically important that financial statements and related disclosures be free of material errors. Employees and directors are prohibited from knowingly making or causing others to make a materially misleading, incomplete or false statement to an accountant or an attorney in connection with an audit or any filing with any governmental or regulatory entity. In that connection, no individual, or any person acting under his or her direction, shall directly or indirectly take any action to coerce, manipulate, mislead or fraudulently influence any of the Firm’s internal auditors or independent auditors if he or she knows (or should know) that his or her actions, if successful, could result in rendering the Firm’s financial statements materially misleading”

In the course of performing my duties for the Firm, I have reason to believe that certain conduct on the part of senior management of the Firm may be in violation of the Code. The following is a summary of the conduct I believe may violate the Code and which I feel compelled, by the terms of the Code, to bring to your attention.

1. Senior Firm management manages its balance sheet assets on a daily basis. On the last day of each month, the books and records of the Firm contain approximately five (5) billion dollars of net assets in excess of what is managed on the last day of the month. I believe this pattern indicates that the Firm’s senior management is not in sufficient control of its assets to be able to establish that its financial statements are presented to the public and governmental agencies in a “full, fair accurate and timely manner”. In my opinion, respectfully submitted, I believe the result is that at the end of each month, there could be approximately five (5) billion dollars of assets subject to a potential write-off. I believe it will take a significant investment of personnel and better control systems to adequately identify and quantify these discrepancies but, at the minimum, I believe the manner in which the Firm is reporting these assets is potentially misleading to the public and various governmental agencies. If so, I believe the Firm may be in violation of the Code.

2. The Firm has an established practice of substantiating each balance sheet account for each of its worldwide legal entities on a quarterly basis. While substantiation is somewhat subjective, it appears to me that the Code as well as Generally Accepted Accounting Principles require the Firm to support the net dollar amount in an account balance in a meaningful way supporting the Firm’s stated policy of “full, fair, accurate and timely manner” valuation. The Firm has tens of billions of dollars of unsubstantiated balances, which may or may not be “bad” or non-performing assets or real liabilities. In any event, the Firm’s senior management may not be in a position to know whether all of these accounts are, in fact, described in a “full, fair, accurate and timely” manner, as required by the Code. I believe the Firm needs to make an additional investment in personnel and systems to adequately address this fundamental flaw.

3. The Firm has tens of billions of dollar of inventory that it probably cannot buy or sell in any recognized market, at the currently recorded current market values, particularly when dealing in assets of this nature in the volume and size as the positions the Firm holds. I do not believe the manner in which the Firm values that inventory is fully realistic or reasonable, and ignores the concentration in these assets and their volume size given the current state of the market’s overall liquidity.

4. I do not believe the Firm has invested sufficiently in the required and reasonably necessary financial systems and personnel to cope with this increased balance sheet, specifically in light of the increased number of accounts, dollar equivalent balances and global entities, which have been created by or absorbed within the Firm as a result of the Firm’s rapid growth since the Firm became a publicly traded company in 1994.

5. Based upon my experience and the years I have worked for the Firm, I do not believe there is sufficient knowledgeable management in place in the Mumbai, India Finance functions and department. There is a very real possibility of a potential misstatement of material facts being efficiently distributed by that office.

6. Finally, based upon my personal observations over the past years, certain senior level internal audit personnel do not have the professional expertise to properly exercise the audit functions they are entrusted to manage, all of which have become increasingly complex as the Firm has undergone rapid growth in the international marketplace.

I provide these observations to you with the knowledge that all of us at the Firm are entrusted to observe and respect the Code. I would be happy to discuss any details regarding the foregoing with senior management but I felt compelled, both morally and legally, to bring these issues to your attention. These are, indeed, turbulent times in the economic world and demand, more than ever, our adherence and respect of the Code so that the Firm may continue to enjoy the investing public’s trust and confidence in us.

Very truly yours,


cc: Erwin J. Shustak, Esq.

Lehman chief warns of more big bank failures

Lehman Head Bryan Marsal has warned that Wall Street had not learned its lesson in the credit crisis and that another megabank bankruptcy is likely. Marsal made the remarks while in Berlin for a bankruptcy conference in an interview with German business daily Handelsblatt, which I have translated below. A link to the full German text is provided at the bottom of this post. His comments serve as a reminder that the megabanks are still too large and complex, and, therefore pose a risk to the entire global banking system.

Text of the interview

Handelsblatt: you are handling the largest bankruptcy in human history. Can anything like this happen again?

Bryan Marsal: It is even likely that a case like Lehman’s will repeat itself – in any event, as long as nothing fundamental changes in financial regulation and in financial institutions. Wall Street has not really learned a lot from the situation. There is still too much leverage in the market, and credit default swaps remain completely unregulated. Even with regulators and in the companies little has been done after the global catastrophe.

HB: But financial regulators around the world are now pulling in the reins …

Marsal: Oh, really? That’s just for show. The regulators are overworked and underpaid. Someone who earns $80,000 a year cannot seriously compete with someone who gets $400,000 for finding ways to get around the system. And so far no one from the regulators at the SEC, at the FDIC or our government has asked how the Lehman collapse could have been avoided and what countermeasures could be taken to prevent a recurrence.

HB: So David loses to Goliath?

Marsal: I wouldn’t put it that way. In Canada, for example, you have to put up at least 25 percent equity to finance your own home. The banks finance no more than three quarters of the money. If we had such a rule in the U.S., there would never have been the massive mortgage-speculation in the years from 2005 to 2007.

HB: What should have been done?

Marsal: You see, Lehman was not too big to go bust, rather too complex. An orderly bankruptcy with the assistance of the U.S. government would have saved investors losses in the order of 75 to 100 billion U.S. dollars. A similar global meltdown could be prevented only if there were global regulations for companies that are also as complex and global as Lehman was. Lehman saw itself as an American institution, but worked in 40 states and had more than 900 subsidiaries. Consequently, we have to deal with 80 different types of insolvency proceedings in 20 different jurisdictions. There is simply a lack of an overarching coordination of the regulatory bodies in the international financial markets. Banks are growing globally, but die locally, that’s the problem.

HB: And no one anticipated this?

Marsal: The Treasury Department miscalculated. Nobody there had counted on the global consequences of the Lehman collapse, and therefore no one had taken a well-prepared liquidation of the company into consideration.

HB: What do you mean?

Marsal: Banks in trouble cannot be saved in the sense of a ongoing concern (?) forecast. We thus need some kind of global emergency parachute. If banks want to grow beyond national borders, regulators need to agree in advance on a single procedure in the event of bankruptcy. In the absence of such agreement between individual states, banks should not receive any authorization for cross-border expansion.;2550742;0

The End-Times Investor

By Bess Levin

March 23, 2010

There are lots of people who search for signs of the end of the world. The homeless guy on the corner. Glenn Beck. The most highly paid one we know of is Kynikos Associates founder Jim Chanos, whose batting average as an investing Cassandra is pretty high (and with the exception of a few disgruntled CEOs of the companies he’s targeted, no one’s ever called him a crazy). He was among the first to call out Enron, WorldCom and the housing/credit bubble that nearly brought the world to its knees. Fellow hedge fund manager Bill Ackman recently said that if he were Treasury secretary, he’d hold a weekly meeting with Mr. Chanos to hear what could go wrong in the markets. No need.

The Observer: Did anything surprise you about the Lehman Brothers report? Or did it just validate everything you thought?

Mr. Chanos: Except for the shameful New York Fed/Lehman “stress test” disclosures, nothing in it surprised me. We had concerns about Lehman well before 2008. People thought they were tough, no-nonsense guys. But we were saying, actually, they’re incredibly aggressive risk takers with a wide berth for what they consider the truth. We’ve known for a while that the hole in their balance sheet was around $150 billion. To put that in perspective, the hole in Enron’s balance sheet was roughly $65 billion. We can quibble on a billion here, a billion there, but $150 billion? I have to think that fraud was involved. It wasn’t just bad business judgment.

So do you think there will be any perp walks? And why haven’t there been any yet?

I would be stunned if there weren’t at least indictments at Lehman and some of the other large institutions that have failed. I don’t know why there haven’t been any yet, but it’s amazing that it’s taken them this long. We’ve known about Lehman’s books since late 2008, but we just needed it confirmed by someone who wasn’t a short seller, since we’re not to be trusted. [laughs] We’ve known something was wrong with their books since the collapse.

Fuld apparently loved the report and has been telling people it vindicated him. He can sleep easy now, which must be nice.

I’d say that reaction is not inconsistent with the way he ran his firm.

You were very supportive of Obama during the election, and showed that support in the best possible way, i.e., through cash. How do you think the administration has been doing?

You know, I agree with the White House that they were dealt an awfully bad hand and number one, we have to understand that. Number two, the economy does appear to be getting better and the markets certainly have righted themselves. I do not agree with some of the financial rescue decisions that the administration made, which were simply follows-on of the previous administration. And I think that’s still politically hurting this White House. The real problem isn’t the White House; it’s Congress. It’s just completely broken down. On the financial regulatory front we still need to see what happens in the near future. We’ve got the House bill, we’ve got the Senate bill, and I think there’s some good steps in both, and some steps that need to be changed. However, it still amazes me that the banking industry continues to have the clout in Congress that it does, after all that’s happened. I’m stunned by the amount of power they still wield down in Washington.

What do you think the passing of the health care bill will mean for the economy?

I don’t think health care is out of the woods yet long term, because it’s still increasing as a percent of the economy, and that’s the real problem. In fact, if you look at the two areas of our economy where the government has very large and growing exposure, it’s residential real estate and health care. And both at the end of the day are fairly nonproductive, long term, for our economy. Putting more and more money into housing and keeping us healthy in our golden years doesn’t necessarily make us a more productive society. We should be devoting more of that money to technology and education.

Lewis Faults ‘Short-Term Greedy,’ Cites Goldman: Interview

2010-03-15 04:00:01.12 GMT

Interview by Erik Schatzker

March 15 (Bloomberg) -- Michael Lewis made a name for himself on Wall Street by writing about it. His 1989 book, "Liar’s Poker," exposed the inner workings of Salomon Brothers, a firm then at the peak of its power, and described his improbable run as a bond salesman there.

Lewis has since written about Silicon Valley, in "The New New Thing," baseball, in "Moneyball," and football, in "The Blind Side." His newest book, "The Big Short" (W.W. Norton & Co., 266 pages, $27.95), chronicles how a small handful of investors anticipated the subprime-mortgage collapse and positioned themselves to make fantastic profits.

Lewis says "The Big Short" is "the end of my story that I wrote 20 years ago" because it documents the damage wreaked by securities first developed at Salomon Brothers in the 1980s. He attributes the economic crisis of 2008 to the emergence of a "short-term greedy" culture on Wall Street, the growing complexity of financial instruments and traders’ efforts to profit at the customer’s expense.

If there’s one group to blame, Lewis says it’s the "people who designed synthetic CDOs at Goldman Sachs."

I interviewed Lewis on March 9 in Berkeley, California.

Portions of the interview will air on Bloomberg Television at

9 p.m. New York time today.

SCHATZKER: Was "The Big Short" a natural evolution from your days a Salomon Brothers and "Liar’s Poker?"

LEWIS: It was. I didn’t think one day something would happen that would bring me back to Wall Street to write what is essentially a sequel. But that’s what happened.

I really thought that. I thought in the first place that "Liar’s Poker" was describing a world that was ending, not that a world was beginning. And what it was describing, it turns out, is a period in finance that went on for another 25 years or 20 years.

And what we’re reckoning with now is an event that really has its seeds in the early ‘80s, and is not something that just happened three or four years ago. So there was that connection.

It was just, it was like the things I was describing in "Liar’s Poker" ended up having all these effects. And I felt like I really should go back and see what on earth happened.

That was the first thing that pulled me in.

SCHATZKER: Did you get the feeling over time that, because the world that you thought would end hadn’t ended, maybe someday you would have to revisit it?

LEWIS: No, I just assumed it would never end. I really did assume that if the mere fact of me being paid hundreds of thousands of dollars to give financial advice did not end the financial world, then nothing would. That, that was a shocking enough event that if that didn’t stop this thing from happening, nothing would.

As I watched, I became more detached from the financial services industry as time went on after "Liar’s Poker." Book comes out, it’s a big hit, for a number of years I’m asked to write about Wall Street one way or another.

But my connection to the place diminished with time. And I really thought I just drifted away, and I was off doing other things. Some of my writing, like "Moneyball," was informed by the Wall Street experience, but I didn’t think there was any reason I was going to be coming back.

When the financial crisis starts to break, and the losses in the subprime mortgage market are starting to look really big in late 2007, I started to get really interested again.

And there were several layers to the interest. But I can remember the first thing that grabbed me was I was shocked that these big firms, that used to essentially be the smart money at the poker table, had become the dumb money. And I was really curious how that had happened.

I was curious. I watched them change over the years and adapt to the world in ways that enabled people to continue to get paid large sums of money. And the outrageous behavior that I described in "Liar’s Poker," that didn’t exist. Places got much more corporate, much more sanitized, all in the service of preserving paychecks.

So the short answer to the question is I really didn’t think there was going to be something else to write that would really intrigue me in the way this has. And I really didn’t think I’d ever feel that kind of personal connection to the event again. But I felt a very personal connection to this one.

I felt like this is the end of my story that I wrote 20 years ago. I’ve really got to go finish the job.

SCHATZKER: Calamity for the rest of us, serendipity for you.

LEWIS: Well, yes. I also thought one of the points of "Liar’s Poker" was it was a very bad sign for Wall Street that I was on it. Me and people like me probably don’t belong there, but we drifted in because of what’s happened in the world of finance. And when I saw some of the names of the people who were then associated with this catastrophe, there were people inside Citigroup who I’d worked with at Salomon Brothers.

I really did have the thought: If I’d hung around on Wall Street, I might have helped create this catastrophe. This is just the kind of catastrophe I would have created. And so I felt that kind of personal connection to it too. It was the logical conclusion of me being on Wall Street.

SCHATZKER: The characters in the book itself are wonderfully eccentric and certainly unusual. Does that help explain why they found this incredible trade that most everybody else missed?

LEWIS: This is one of the great mysteries of the last few years in finance. There emerges on the scene this really, really smart trade, buying credit default swaps on subprime mortgage bonds. You’re buying insurance on subprime mortgage bonds.

Limited downside: You’re paying a couple of percent premium a year for a bet that, maybe it’s not sure to pay out, but the odds are better than 50-to-1 that they will. It’s a really obvious, smart bet.

And many thousands of investors could have made this bet.

Not individual investors, for the most part, but a lot of institutional investors could have made this bet. In the end, only about a dozen make it in a huge way. A lot of people dabble in it, but only about a dozen make it in a huge way. I got to know most of the people who did, to do this book. I did a kind of casting search.

Most of them are outsiders, are people who are kind of on the fringe, certainly on the fringe of the credit markets.

They’re not people who are bond market people. They were, for the most part, stock market people, crawfished into it because they could see that the stocks that they were trying to understand were going to be driven by this event that was going on in the subprime mortgage market.

So they had to understand the subprime mortgage market. And then the more they came to understand it, the more appalled they were about how that market worked. And the more appalled they became, the more they began to think about really how to bet against it.

So they were outsiders to the market that they were betting on. And in addition, they were, in many cases, personally curious people, not clubbable members of the group. And I think that was a key to the success. I think that the fact that they didn’t feel compelled in any way, on any level, to think like other people gave them an advantage.

SCHATZKER: But as you point out, much of what they saw could have, could have been obvious to others.

LEWIS: We’ve lived through a period of mass financial delusion. And there was a handful of people who were wandering around sane in an insane world.

One of the reasons I wrote the book is that I wanted to know why that was in very particular ways and not generally what was true about all these people. But why, if there are only a dozen of you who are right and millions who are wrong, what is it about the dozen of you that were right that enabled you to be right?

I think the answer is more than one thing. You can’t just say it’s because they’re oddballs, because there are a lot of oddballs who were wrong too. Being an oddball doesn’t enable you to get rich in the financial markets. It just happened to be a trait of many of these people.

But in the case of Michael Burry, a man who has Asperger’s Syndrome and doesn’t know it, even though he’s a former medical doctor, he’s misdiagnosed himself, but he’s diagnosing the financial markets correctly. The Asperger’s is critical to his success, because the Asperger’s did two things that helped him.

One was it made him very uncomfortable in social situations, so he avoided them entirely. So he wasn’t bombarded by the same propaganda as everybody else, because he just shut out the world.

The second was in lieu of getting his information socially, he got his information through documents, and through data. And he sought out data. He lived in a room with data. And if you were a person who didn’t listen to what anyone said and you just looked at the structure and composition of subprime mortgage bonds and read subprime mortgage bond prospectuses, you had a completely different view of the world than everybody else.

Nobody but someone with Asperger’s would read a subprime mortgage bond prospectus. And he had a feeling that he was the only one who read the things, except for the lawyers who drafted them. So I think his intense focus on data really helped.

In the case of one of my other main characters, Charlie Ledley and Jamie Mai of a tiny little firm called Cornwall Capital, they had a view that the financial markets made a systematic intellectual error. And it’s the Black Swan error.

It’s underestimating the likelihood of unlikely events. That yes, an event, some catastrophe, some event is unlikely, but it’s not as unlikely as your pricing these way out of the money options.

They had spent several years scouring the world for way out of the money options to buy on currencies, commodities, stocks, bonds, everything. And it’s with their filtering everything through that prism, they’re thinking "I’m just looking for cheap options, cheap. I want to make bets on double zero on the roulette table where the odds are actually better than 32-to-1."

So they did that without often knowing that much about the underlying things that they were betting on. They just knew that the odds were better than the markets were saying.

And they stumble into this market called the subprime mortgage market, the bond market, and they see you can buy credit default swaps for 2 percent. And that’s your downside.

And they think the odds of these things going bad are much more likely than the 50 to 1 against the price of the option implies.

And they start to build a position.

And then they start to learn about it. And the more they learn about it, they think this is not only more likely than the market thinks it is, it’s likely to happen, this catastrophe.

And they become obsessed with it. So that’s another way you can come to it, through that.

The third person, my third character, who had a point of view that was very particular, was Steve Eisman, with FrontPoint Partners. And Eisman happened to actually know a lot about on- the-ground behavior between subprime mortgage lenders and borrowers because he had been essentially the world’s foremost expert on the subject of subprime mortgage originators back in the ‘90s. And he knew how bad the behavior had been then.

So when the market is reborn in 2002, 2003, he’s very alert to the possibility that this could end badly. In addition, and his wife actually is very interesting on this subject, they’d had a tragedy in their lives. His first son had been killed as a baby. His wife said when that happened, Steve went from being someone who was a joyous cynic to being actually a pessimist about the world.

He was always looking for something bad that actually could happen that people didn’t think was possible. So he was predisposed to...

SCHATZKER: Finding the downside.

LEWIS: Finding the downside. And so in each case, I learned something about investing from this book, because I’ve always thought of it as antiseptic event, and a purely intellectual event. And it was pretty clear to me in each case these characters had an emotional, some psychological dimension to them that enabled them to get where they are.

SCHATZKER: You note early on in the book that John Paulson made more money than anyone had ever made so quickly on Wall Street. So why not make him more a part of this story?

LEWIS: I spent time with him. And he was very friendly. I could have made him part of the story very easily.

But I had a purpose for this story. And the purpose was I wanted to explain to the reader what on earth had happened. And to do that, it helped that the characters themselves had to learn about these markets, that they didn’t understand these markets to begin with.

So the reader could learn with them. John Paulson happened to be oddly positioned inside the financial markets in that he was one of the few people who made his living shorting bonds and looking for bonds to short.

His motives were, to me, less interesting. He’s much more a purely economic animal. And so he didn’t have a great distance to travel to get to the trade.

And in addition I’m writing a story. And the story is driven by these characters. And it’s got to be true. I can’t make it up. I don’t want to exaggerate what this thing means to a character.

The people who I was interested in were the people who had laid it all on the line, where they started out thinking, "A nice little trade," and they’d end up, essentially, that if this didn’t work out, their careers were over. And Paulson had very cleverly but, from the character, the logical point of view, less interestingly structured his financial life so that he was going to win either way.

When he went to investors and said, "Give me your money so I can short the subprime mortgage bond market," he didn’t say this is a bet we want to make because we’re all going to get rich. He said your whole portfolio is premised on this not happening, this catastrophe not happening. Give me a tiny bit of your money and put it in this as an insurance policy. And if it works out, it will be a hedge. And if it doesn’t work out, the rest of your portfolio is fine.

So there wasn’t a lot at stake there. He made a lot of money when it worked out. But he wasn’t set up to be in a lot of trouble if it failed. And I was particularly interested in the people who were set up to be in a lot of trouble if it failed.

SCHATZKER: How on earth did you find the guys at Cornwall Capital?

LEWIS: No one’s ever heard of them. And they were very reluctant to talk to me. It was agonizing getting them to let me do what I do. I have to be in their lives. I have to live with them. And to get them to let me do that was not easy for them.

And I’m eternally grateful that they did.

I wandered around the hedge fund world for a year on a casting search, finding everybody who made this trade in a big way. And I was in an office of, I can’t name him, a very well known hedge fund manager. I was rattling off the names of the people I knew who had done the trade, who had made a bunch of money.

And he said there’s one you left off. And I said who? And he said there’s this crazy guy I went to business school with who’s over there. And I think he had $100,000 in a Schwab account. Two years ago he was going on about how the subprime mortgage bond market was going to collapse, and he’d bet on it.

And sure enough, he did, and he got rich. And his name’s Charlie Ledley. Go talk to him.

I went over to see Charlie. And it took about an hour before I realized that I wanted to write about him. He’s so interesting. He wasn’t a money person. He was more interested in public policy than he is in money. He worked in the Clinton campaign. He really was. His passion is education reform.

But he’s intellectual and curious. And he had landed in this job working with a friend as a small investor. And it started with $100,000 in a Schwab account. They had this theory about how financial markets made mistakes. And this mistake, this particular mistake, underestimating the likelihood of unlikely events, became the premise of their portfolio.

He’d educated himself about the subprime mortgage bond market. And he was very funny on the subject, and I thought, "He’s perfect." He’s perfect because he can be a proxy for the reader who knows absolutely nothing, because he started out knowing absolutely nothing, and yet he figured it out.

SCHATZKER: You identify some of the people on Wall Street who figured out the subprime bubble early. Greg Lippmann from Deutsche Bank, Gene Park at AIG Financial Products. Why no central character from Goldman Sachs, because it was Goldman that created the synthetic CDO in the first place?

LEWIS: Goldman is in the book in a big way. I suppose if they would have let me speak honestly to Jonathan Egol, the trader there, or Andy Davilman, the salesman who bought credit default swaps from AIG, I might have developed them further as characters. But Goldman, the last thing they want is someone like me writing about Goldman Sachs. They’re very careful about what they’ll divulge.

But I didn’t need it. I knew what had happened. And so absent total cooperation, where you actually get to know the people in a really intimate way, there was no intermediate place I was going to go with Goldman Sachs that was going to be useful to me. I needed to know what they’d done and I needed to be able to describe it.

The people inside the Wall Street firms who were more interesting to me were the people who had first seen the opportunity. And there weren’t many. Greg Lippmann is the exception. Goldman Sachs was shrewd in finding AIG to be the turkey at the table, and shrewd in getting them to insure subprime mortgage bonds.

But Goldman Sachs was not set up when they were doing that to make money if the subprime mortgage bond market collapsed. If the subprime mortgage bond market had done what it was supposed to do and collapsed maybe a year or a year-and-a-half earlier than it did, Goldman would have been buried. They were long.

They were the dumb money, too. So they weren’t that interesting for that reason. The one guy who was really interesting as smart money inside a Wall Street firm was Greg Lippmann. Lippmann was a Deutsche Bank asset-backed trader who was at war with his own firm, because the whole rest of the firm was long in the market. And he’s saying this is going to be a disaster. And Lippmann was the proselytizer of the trade.

SCHATZKER: The evangelist.

LEWIS: He was. All the people who did the trade, almost everybody, you can trace it back one way or another to Lippmann running around trying to get people to short the subprime mortgage market. So he was really interesting. And he is a character in the book.

And then the other, broadly speaking, character on Wall Street who was interesting to me was who in a big way was the dumb money on the other side?

SCHATZKER: Howie Hubler.

LEWIS: Howie Hubler. And I looked around and I said you’re spoiled for choice, because all these firms lost a lot of money.

All these firms had traders who were long and wrong. And the numbers at some of the other firms were more spectacular:

Merrill Lynch lost $50 billion. Citigroup lost I don’t know how many tens of billions of dollars.

But no where else on Wall Street was there a single trader, I don’t think, making a directional bet on the subprime mortgage market who lost as much as Howie Hubler did at Morgan Stanley.

He lost $9.4 billion.

I don’t think anybody’s ever done that on Wall Street. And this guy had done it. And he was basically anonymous. It was amazing to me. This is another example of the way things that used to be scandalous became innocent. When I was at Salomon Brothers, we had a Howie, Howie Rubin, who went from Salomon Brothers to Merrill Lynch and lost a few hundred million dollars and ended up on the front page of the Wall Street Journal and became radioactive for awhile. And it was only $300 million.

Howie Hubler loses almost $10 billion, and...

SCHATZKER: Nobody notices.

LEWIS: Nobody knows who he is or what he did. Morgan Stanley comes out, John Mack the CEO comes out and issues an elaborate apology of how embarrassed he is, how much money they’ve lost, and attributes it to this small group of traders.

But he doesn’t explain what happened.

So there was a story to be told. And I figured if I could get that story, I was getting in a way the other side of the smart people, the other side of the bet, the thinking that was on the other side of my protagonists’ profits.

SCHATZKER: What should we make of a guy like Greg Lippmann?

He effectively creates the market for shorting subprime CDOs.

Does that make him a good guy or a bad guy?

LEWIS: I think it makes him a neutral guy. There’s more than one question here, it’s so complicated. The question what we should make of Greg Lippmann is a wonderful question because even the people who do the trade that he’s selling to them don’t know what to make of him. He is the cipher to them. They think he’s an unreliable narrator. And they completely mistrust the market he comes from.

The bond market is the Wild West. What goes on in the bond market would never be allowed to go on in the stock market.

Investors in the bond market know that if Goldman Sachs and Deutsche Bank come to you and want to sell you something, you don’t want to buy it.

That Greg Lippmann is running around selling the single greatest trade in the history of the bond market and nobody believes him tells you something about the bond market. He can’t get the message across, because of where he comes from.

Now, he does also succeed in eventually creating the short side of the market, which in theory should be a great thing.

Because in theory what it should do is subdue the market. It should make the market more rational. It’s introducing the negative information into the market that the market needs to function to price things accurately.

In practice, the activity he generates is too small in relation to the size of the market to move the market at all.

And the demand side of the market is so separate; the buyers are so separate from the shorters they don’t talk. Whatever information the people who are short the market have does not inform the decisions of the people who are buying the market.

So it doesn’t have the positive effect you would like.

Instead, it has a very negative effect. And the negative effect is every time he gets someone to buy a credit default swap on a subprime mortgage bond...

SCHATZKER: Somebody else has to go long.

LEWIS: Someone else has to go long. And every time he gets someone to short, he replicates the market. The market replicates not just subprime mortgage loans, but the absolute worst subprime mortgage loans, because the people who were shorting the market are selecting the absolute worst ones to short.

This is one of the bizarre things about what happened in the free markets in the United States of America in 2005, 2006, 2007. The only people who were doing serious credit analysis on the loans that were being made to subprime mortgage borrowers were the people who were doing it to short the bonds, to bet against them, not the people who were making the loans themselves.

So when the losses happened, when the market finally does, in fact, crater, the effect of Greg Lippmann -- not just Greg Lippmann, but the market he’s in the middle of -- is to increase the number of losses because they’ve replicated all these bad loans.

It isn’t so much the raw size of this market that Lippmann sits in the middle of, because that’s only a few hundred, $400 billion, whatever it is. It’s a lot of money, but it’s not as big as the $3 trillion in subprime and Alt-A loans that have been made in the previous three years.

The problem is it’s totally hidden. Nobody knows. People can tell you who owns the subprime mortgage loans. They can’t tell you who’s on the other side of the credit default swaps. No one knows which firms are on the wrong side of this bet. These are private transactions between consenting adults. And no one knows how much of it there is.

This creates uncertainty. If you want to know why the panic happened in 2008, it was because no one knew who had what losses. And the reason no one knew who had what losses is there were all these private transactions of enormous size, enormous indeterminate size, that were undisclosed.

And so the effect of Greg Lippmann in the world is very ambiguous. On the one hand, he was a voice, truth and honesty in the market. He was doing exactly what he should be doing, making the smart bet. If everyone thought like him, this whole problem never would have happened. So it’s hard to say he’s the villain, certainly not the villain.

SCHATZKER: Hard to call him a hero at the same time.

LEWIS: That’s a little hard, too. He’s an ambiguous character. If he had been outside the Wall Street firm, if he’d been in a hedge fund doing what he was doing, I think I would have a less ambiguous feeling about him. I would think he’s not part of the engine of the problem.

Deutsche Bank was part of the problem, not part of the solution. And the mystery of him, the great mystery, is he was so right, he was so smart about it, and yet he was so unpersuasive, even to the people in his firm. Deutsche Bank lost, I don’t know, $12 billion, $15 billion in the subprime mortgage market. And they had the single most persuasive salesman against that market in their shop. Why didn’t they listen?

SCHATZKER: It seems as though there is a parallel of sorts between what happened back in 2007 and 2008 and what we’re seeing happen this very moment with Greece and the EU.

LEWIS: The parallel gets even more elaborate, because Goldman Sachs appears to advise the Greek government on how to disguise its level of indebtedness. So it feels as if Wall Street went into entire countries and persuaded them to take out subprime mortgage loans, in effect, or help them, enable them, in taking out a subprime mortgage loan.

So yes, we’re living through this period where we’re reckoning with the real consequences of financial engineering, and financial engineering gone wrong. The very small-bore version of this was the financial engineering that enabled some poor schmuck in Chico, California, who had no income, to buy a

$1 million house. And the big version of this is Greece.

SCHATZKER: And it may be soon to be Italy...

LEWIS: And Ireland and Iceland.

SCHATZKER: How did Wall Street become so dangerous?

LEWIS: I think the seeds of this catastrophe go back to the ’80s. The source of a lot of the problems are people’s incentives being screwed up. It’s not right, or it’s certainly not satisfying to say Wall Street’s just greed, got too greedy, and that was the problem. Wall Street’s always greedy. People who go to work on Wall Street are greedy. That’s why they go to Wall Street. They don’t go to Wall Street because they have a calling in finance. A handful of people do. But for the most part, people go there because that’s where the money is, and they want money.

You’re not going to change that. What changes are the rules that channel the greed or the system that channels the greed.

And so the greed came to be channeled in very short-term ways.

So people became very short-term greedy, greedy for the next quarter, greedy for the next bonus, rather than greedy for a long and lucrative career.

What caused that? Firms ceasing to be partnerships is the beginning of it. A Wall Street firm that is investing its own money, the people inside it, it’s their money that’s at stake, are going to behave very differently from people who are a public corporation who are using shareholders’ money.

No partnership would have ever allowed itself to own billions of dollars of AAA-rated CDOs backed by subprime. It just wouldn’t have happened, because they would have scrutinized it in a different way. Nobody will say that on Wall Street or say that’s true. They’ll say, "We’ve behaved just as we would as if it was our own money." But they don’t. Nor would you expect them to. It’s amazing how powerful incentives are.

Two, the business got intellectualized in the 1980s. The proximate cause of the intellectualization was the Black-Scholes option pricing model. But just generally, it got more complicated. And so as it got more complicated, it got harder and harder for normal people to understand it, and easier and easier for smart people to persuade dumb people to do things they shouldn’t do, and easier and easier for smart traders to disguise what they were doing from their bosses because it’s so complicated.

That was absolutely necessary. One of the signature traits of this crisis is that the people on the top of the firms clearly didn’t know what their firms were doing. They were buffaloed by people underneath them. They all feel betrayed by their employees when they’re speaking privately about them. But this is why they could be: because the businesses got too complicated for the people who ran them.

Finally, and this is a really, really big one, and related to the other two: the relationship between Wall Street and its customers. The legitimate business of Wall Street is to allocate capital. The traditional businesses on Wall Street, the traditional capital allocation businesses, have gotten less and less profitable. All these new markets, this financial innovation, is a response, in part, to Wall Street’s need for profits.

Profits dried up in old-fashioned stock brokering because you can now go onto the Internet and buy a stock and pay a tiny commission rather than call your guy at Merrill Lynch and pay a fat one.

If you look at how firms make their money, especially if you’ve been inside one of them, you realize that increasingly, especially in the bond markets, where more of the profits are than in the stock markets, Wall Street has come to increasingly trade against its customers rather than on their behalf, acting not as an intermediary, but as essentially a big proprietary trading fund that is using its customers to get itself out of the positions it doesn’t want to be in, to take the stupid side of the smart trade they want to do.

There is a poisonous interface between these big firms and the customers in the bond market. And everybody now takes it for granted. It shocked me when I saw it in 1986 and 1987, but it’s now just normal. It’s thought to be normal.

The minute you’re starting to think, "The way I make money is exploiting the idiocy of my customers," is the minute you start creating securities that are designed to explode, that you could be on the other side of.

The minute you’re thinking less like a handmaiden to productive enterprise and a useful allocator of capital, you’re becoming the jerk in the zero sum game. And they become the jerks in the zero sum game. So you back away from it all and you say, "look at what these people did." And the shocking thing is what they did was legal. And you say how do you change the rules, what do you do here?

One of the things you obviously do is you have to destroy this notion that it’s okay to trade against your customers.

Maybe what you say is you can be a firm like Schwab that has customers, but you don’t trade in anything for yourself. Or you can be a hedge fund. But you can’t be both.

Because the minute you start trading against the customers is the minute you start designing things that aren’t good for the customers. And the minute you start designing things that aren’t good for the customers, you start designing CDOs, subprime mortgage bonds. You start to misallocate capital.

You’re trying to misallocate capital.

And that’s crazy. It’s insane. But it is the normal on Wall Street. And so breaking it up, changing it is going to be a violent act, because it’s become so assumed. It’s so deeply embedded as the assumption of how the business is.

SCHATZKER: Did you learn anything about Wall Street that you didn’t know before?

LEWIS: If I hadn’t learned a lot, I wouldn’t have been interested in doing it. But I learned first about investing. It was very interesting to me to see just how personal investing decisions can be, just how in the end, a lot of it comes back to who you are as a person. That you’re guided by all sorts of things that I wouldn’t have thought would have informed investment decisions. So just how human the financial markets were on the buy side was really interesting to me.

In the Wall Street firms -- I should have known it, but I didn’t know it -- I didn’t know quite how cynical they could become, just how detached from their original purpose they could get.

This surprised me, because the Salomon Brothers I left in

1989 was a fractious, violent body. Interesting place. But there was a personal attachment that people felt to the institution.

People were angry with me for writing the book, because they felt I had betrayed Salomon Brothers.

On the Wall Street that I walked back into to do "The Big Short" it wouldn’t occur to anyone that you could betray your Wall Street firm, because there isn’t that relationship. The relationship doesn’t exist anymore. Everybody is a free agent.

There’s no sense of loyalty to an institution or a cause greater than yourself or all that stuff.

So what I learned was just how purely financial and commercial the place had become. Essentially, it was denuded of was the partnership sentiment. There was a residue of the partnership sentiment that was still hovering around Salomon Brothers when I got there, because it had been a partnership not that long ago.

That has been completely replaced by this new antiseptic, raw financial relationship. It was curious to see that people could function in that environment and feel like that was a satisfying thing to be doing with their lives.

SCHATZKER: A lot of people would say there never, ever was a golden age of investment banking, even when the firms were privately held. Do you agree with that?

LEWIS: Well golden age might be a bit strong. But the incentives were organized much more properly. The right incentive now is the hedge fund incentive. There are things that are screwed up about it, but typically the person who runs the hedge fund has all his money in his own hedge fund. And that’s how it’s got to be. He’s on the hook for losses.

Goldman Sachs, in the ‘50s and ‘60s and the early ‘70s was run by a man named Gus Levy. I may have my dates slightly wrong, but that’s roughly when he was there. And Gus Levy used to give a speech about the importance of being long-term greedy. It wasn’t "don’t be greedy," it was "be long-term greedy."

That’s the problem now. The problem now is there’s no long- term greed, it’s all short-term greed. It’s not institution- building or career-building, it’s quick kills. I do think that aspect of the business, that approach to finance, is a healthier, more golden age-like approach than what we have now.

I’m not arguing that investment banks were ever perfect institutions. That’s silly. I’m just saying that there’s a smarter way of organizing.

SCHATZKER: Who’s the biggest villain in the subprime debacle?

LEWIS: You have a lot to choose from. You also have to make a distinction amongst the villains, within the hearts of the villains. You have to honestly ask yourself: Were they corrupt or stupid or deluded? Because nobody’s stupid. In a lot of cases, you wish they were corrupt and wish they’d done an illegal thing. In fact, they were just deluded.

There are obvious ones, like the ratings agencies. Moody’s and Standard & Poor’s should be ashamed of themselves. On the other hand, the more you get to know the people at Moody’s and Standard & Poor’s, the more you feel sorry for them, because they are pathetic in relation to the people who manipulated them.

They were manipulated by the people at Goldman Sachs and Morgan Stanley and Merrill Lynch. And they got paid one-tenth what those people got paid. And they all wished they’d worked there. Some part of them was currying favor with the big investment banks.

It feels a little bit like kicking the butler after the master does something bad. But they clearly were villains.

You asked me who the greatest villain was, so I don’t want to give you a long list of villains. If I had to put my finger on one person or one kind of person, one role player in this crisis who I would like to string up, or rather I’d like to have him have to answer questions honestly to the public, I think it would be the people who I know knew better.

I would like for the people who designed synthetic CDOs at Goldman Sachs and persuaded AIG to insure them, to essentially take all the risk in the subprime mortgage market in 2005, I would like for them to explain what they thought they were doing.

There was nothing illegal about what they did. It was just exploitative. It was just wrong. But they were smart enough, and their position in the society was elevated enough that you would have thought that they would have paused and said, "I have some responsibility here not to do this or to prevent this from happening." Not to actually make it happen.

There’s a very obvious status structure on Wall Street.

Ratings agencies aren’t even in it. But at the very top of the status structure is Goldman Sachs, certain traders at Goldman Sachs, and hedge funds. And when the people at the top set such a bad example, everything else, in a weird way, follows from it.

I’d like the genuine elites to explain why they did, why they behaved in the way they did. Because I think in the end, if you’re going to get back to a saner relationship between our financial system and the rest of the economy and the rest of the society, you have to have people at the very top of that structure who have some sense of social obligation. And they don’t right now.

It’s a question of how do you restore that. And you restore it with shame, with a sense of you should be ashamed that you did not behave in the way you should have behaved. How do we fix that, how do we get you to reframe your relationship to the rest of the society? That’s where I’d go. That’s who I’d like to see dragged in front of the public and have to explain themselves.

SCHATZKER: Does that make Goldman evil?

LEWIS: Evil’s too strong a word. I think the system is evil, and the system is capable, obviously capable and likely to do great wrong. And the rules in the system need to be changed.

And people are just badly incentivized. And they’re badly incentivized inside Goldman Sachs. And I’m sure individually they’re all bright, they’re all smart.

SCHATZKER: In some cases delightful.

LEWIS: Absolutely. Maybe not at the end of their careers, but certainly the beginning.

It’s not that these are bad people. And it’s a mistake to say what you need to do is get rid of some bad people and put some good people in. Because if you put the good people into the same system, they’ll become bad people. They’re badly incentivized.

SCHATZKER: So what happens if the rules of the game aren’t changed?

LEWIS: Well, the popular thing to say is it’s all going to happen again. But if it does all happen again, it’s going to happen in such a different way it’s going to require an elaborate explanation to show people how it all connects up. But it will all happen again.

The bigger problem is: What is Wall Street supposed to do?

It’s not a creator of wealth. It’s a handmaiden to creators of wealth. It occupies an essentially parasitic, but usefully parasitic relationship with the rest of the society. It’s totally out of control. It’s not making America a great place; it’s making America a worse place right now.

That’s the problem. Finance needs to occupy a healthier, more productive relationship with the rest of the society. It isn’t just an economic relationship; it’s got the social, cultural component to it. It is not healthy that our financial system has rules in it that enable the returns to individual traders that it enables.

And it leaves half the smartest kids from the best schools wanting to be, more than anything else in their lives, bond traders or investment bankers. It’s a waste of talent. The wrong economic signals are being sent by the system that’s in place. I think if the rules were changed in some obvious ways, the returns to the finance sector would decline and talent would find more useful avenues of endeavor.

SCHATZKER: Wall Street hasn’t disappeared. The firms that survived may be even stronger now than they were before. And a whole lot of the people, the traders, for example, who lost their jobs, are back employed by the firms that survived. So where is the justice?

LEWIS: It’s not over. We’re living through this big transition right now, I think. But Wall Street has changed dramatically. And Wall Street’s relationship to the rest of the world has changed dramatically. And the way people view Wall Street has changed dramatically.

These firms have gone from being unquestioned Masters of the Universe and an unquestioned upper class that everyone aspired to be in, to being essentially enemies of the people inside the last two years. They do have a lot of political influence, and there is natural resistance, an impediment to changing the rules of their road.

But there is also, on the other side of that, enormous anger and cynicism that is going to find a political expression.

You can’t expect democracy to move as quickly as finance.

Financial markets panic. They change very rapidly. Democracy moves very slowly. In 1929, the markets collapsed. It wasn’t until 1933 that Glass-Steagall was introduced. It took several years to have proper hearings in Congress.

The reason for that is that the engine for democratic change is elections, and elections don’t happen every day.

Essentially, the relationship between these firms and the rest of society has changed in a way that’s permanent, and that we are going to see changes in their political oversight. That is going to change their returns. That is going to change the prestige associated with working for them, all the rest. This comeuppance is going to be gradual.

SCHATZKER: Are you personally outraged?

LEWIS: Yes, because it’s outrageous. Absolutely. If the markets had been allowed to function, if the government had not stepped in to rescue these firms, they’d all be out of business, all of them. They’re all failed. There are different degrees of idiocy.

Maybe Goldman Sachs doesn’t fail because it has lots of subprime mortgage bonds on its books. It fails because it’s got credit default swaps with people who do. But nevertheless, it fails.

Because of the position they occupy in the financial system, they can’t be allowed to fail. I think that you can forgive; that step I can forgive. I completely understand. I can understand how the decisions made in the midst of the crisis were necessarily self-contradictory, ad hoc, hard to understand, in retrospect, all the rest.

But now we’re out of that. And what I find outrageous is that the people who were in positions of influence and power when the crisis occurred were by definition people who didn’t see it coming. They were, by definition, ignorant of what was going on right under their noses.

That there has been so little change in that regime is a little outrageous to me. I think it’s outrageous that, essentially, the U.S. government took the position, unlike the U.K. government, that these firms were so central to our way of life that not only could we not let them fail, but we can’t even suggest their creditors take a hit. Essentially, they’re failed institutions that we need to prop up, so we are going to gift them money until they get out of their problems, which they appear to be doing now.

So that’s what we’ve done. We’ve gifted them money. In the beginning, we gifted the money in very overt ways, direct investment in the firms or buying their securities at inflated prices or whatever. Those are obvious ways. But now they’re able to tap the Fed for money at zero percent, reinvest the money into agency bonds and take the spread as a gift.

It’s outrageous that they’re essentially being gifted out of their problems, and that their view is that their employees deserve a large chunk of the rewards of those gifts.

It’s outrageous. But on the other hand, it’s understandable, because they have a way of life that has existed for 30 years on Wall Street. It’s very hard to change people’s habits, especially if they don’t have to change. And they’ve proved that they don’t have to change.

I think that the end result of this, however, is just to stoke the political anger that is going to change the system. In the end, in a weird way, the behavior of the Wall Street firms currently is the best friend that reform has, because they’re not doing a very good job of disguising their interests in the rest of the world.

Now What?

by Atul Gawande April 5, 2010

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  • Keywords

  • Health-Care Reform;

  • American Medical Association (A.M.A.);

  • Medicare;

  • Health-Care Costs;

  • (Pres.) Lyndon Johnson;

  • “The Heart of Power”;

  • David Blumenthal

On July 30, 1965, President Lyndon Johnson signed Medicare into law. In public memory, what ensued was the smooth establishment of a popular program, but in fact Medicare faced a year of nearly crippling rearguard attacks. The American Medical Association had waged war to try to stop the program, and doctors weren’t about to abandon the fight against “socialized medicine” simply because it had passed into law. The Ohio Medical Association, with ten thousand physician members, declared that it would boycott Medicare, and a nationwide movement began. Race proved an even more explosive issue. Many hospitals, especially in the South, were segregated, and the law required them to integrate in order to receive Medicare dollars. Alabama’s Governor George Wallace was among those who encouraged resistance; just two months before coverage was to begin, half the hospitals in a dozen Southern states had still refused to meet Medicare certification.

Either boycott could have destroyed the program. Hundreds of thousands of elderly and black patients would have found their hospitals and doctors’ offices closed to them. But, as David Blumenthal and James A. Morone recount in “The Heart of Power,” their riveting history of health-care politics, Johnson recognized the threat and outmaneuvered his opponents. With the doctors, he cajoled and compromised, giving the A.M.A. a seat on an advisory council that oversaw the rules and regulations, and working with it on a series of thirty “improving” amendments to the legislation. With hospitals, however, the President brooked no compromise. He convened a battle council of top advisers; set Vice-President Hubert Humphrey phoning mayors to pressure resistant hospitals; and deployed hundreds of inspectors to make sure that participating hospitals integrated their wards. There was fury and acrimony. In the final weeks before Medicare’s start, though, the hospitals decided to abandon segregation rather than lose federal dollars. Only then was Medicare possible.

The health-reform bill that President Obama signed into law last week—the unmemorably named Patient Protection and Affordable Care Act—could prove as momentous as Medicare. Yet, because most of its provisions phase in more slowly than Medicare did, they are even more vulnerable to attack. The context, of course, is different. As Robert Blendon, of the Harvard School of Public Health, points out, the war against health reform in 2010 has not been an interest-group battle. The A.M.A. endorsed the legislation; hospital associations were supportive. Once the public option was dropped, most insurers favored the bill. The medical world will wage no civil resistance. This time, the threat comes from party politics. Conservatives are casting the November midterm elections as a vote on repealing the health-reform law. If they regain power, they are unlikely to repeal the whole thing. (No one is going to force children with preëxisting conditions back off their parents’ health plans.) Instead, they will try to strip out the critical but less straightforwardly appealing elements of reform—the requirement that larger employers provide health benefits and that uncovered individuals buy at least a basic policy; the subsidies to make sure that they can afford those policies; the significant new taxes on household incomes over two hundred and fifty thousand dollars—and thereby gut coverage for the uninsured.

Opponents may also exploit the administrative difficulties of creating state insurance exchanges. The states have four years to prepare, and creating an exchange is, in theory, no more complicated than what states do in providing health-benefit options to public employees. Massachusetts, which has achieved near-universal coverage this way, had its exchange working in six months. Still, with fourteen state attorneys general already suing to stop parts of the reform, some states may refuse to coöperate, forcing a showdown.

The major engine of opposition, however, remains the insistence that health-care reform is unaffordable. The best way to protect reform, in turn, is to prove the skeptics wrong. In 1965, health care consumed just six per cent of U.S. economic output; today, the figure is eighteen per cent. Nearly all the gains that wage earners made over the past three decades have gone to paying for health care. Its costs are curtailing all other investments in the economy, and, if they continue to rise as they have been doing—twice as fast as inflation—the reform’s subsidies, not to mention America’s prosperity, will indeed prove unsustainable.

But the reform package emerged with a clear recognition of what is driving costs up: a system that pays for the quantity of care rather than the value of it. This can’t continue. Recently, clinicians at Children’s Hospital Boston adopted a more systematic approach for managing inner-city children who suffer severe asthma attacks, by introducing a bundle of preventive measures. Insurance would cover just one: prescribing an inhaler. The hospital agreed to pay for the rest, which included nurses who would visit parents after discharge and make sure that they had their child’s medicine, knew how to administer it, and had a follow-up appointment with a pediatrician; home inspections for mold and pests; and vacuum cleaners for families without one (which is cheaper than medication). After a year, the hospital readmission rate for these patients dropped by more than eighty per cent, and costs plunged. But an empty hospital bed is a revenue loss, and asthma is Children’s Hospital’s leading source of admissions. Under the current system, this sensible program could threaten to bankrupt it. So far, neither the government nor the insurance companies have figured out a solution.

The most interesting, under-discussed, and potentially revolutionary aspect of the law is that it doesn’t pretend to have the answers. Instead, through a new Center for Medicare and Medicaid Innovation, it offers to free communities and local health systems from existing payment rules, and let them experiment with ways to deliver better care at lower costs. In large part, it entrusts the task of devising cost-saving health-care innovation to communities like Boise and Boston and Buffalo, rather than to the drug and device companies and the public and private insurers that have failed to do so. This is the way costs will come down—or not.

That’s the one truly scary thing about health reform: far from being a government takeover, it counts on local communities and clinicians for success. We are the ones to determine whether costs are controlled and health care improves—which is to say, whether reform survives and resistance is defeated. The voting is over, and the country has many other issues that clamor for attention. But, as L.B.J. would have recognized, the battle for health-care reform has only begun. ♦

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