Liar's Poker by Michael Lewis: Summary & Notes

Rating: 9/10

Available at: Amazon

Related: Flash Boys, The Big Short


An excellent book, both wildly entertaining and explaining the complexities of various financial markets with remarkable clarity.

This is considered a classic in the world of money, and for good reason.

It’s also an great book to read before reading (or watching) The Big Short, as it sets the stage for the financial crisis of 2008.


  • The biggest myth about bond traders is that they make their money by taking big risks. Some do, but most do it by taking a commission when brokering a trade between two parties.
  • In any market, as in poker, there is always a fool.
  • The shift in monetary policy in 1979 to fixing the money supply, and letting interest rates fluctuate, is what kicked off the bond market.
  • Bond prices move inversely with interest rates, so allowing interest rates to fluctuate wildly meant bond prices swung wildly too.
  • The other factor during the 1980s was borrowing: American governments, consumers, and corporations borrowed money at a faster clip in the 1980s than ever before, so the volume of bonds exploded.
  • Ask any trader and they’ll tell you their best work cuts against the conventional wisdom.
  • Rule of thumb about information in the markets: “Those who say don’t know, and those who know don’t say.”
  • Traders placed bets in the markets on behalf of Salomon Brothers. Traders required market savvy. The very best traders were also superb salesmen, because they had to persuade a salesman to persuade his customers to buy bond X or sell bond Y.
  • Salesmen were the trader’s mouthpiece to the outside world (institutional investors). Salesmen required interpersonal skills. The very best salesmen were superb traders and found their customers handing them their portfolios to manage.
  • Traders ruled the shop: their bonus was determined by the profits on their trading books, and the salesman’s bonus was determined by this. The trader held all the control.
  • Good bond traders had fast brains and enormous stamina. They watched the markets twelve and sometimes sixteen hours a day—and not just the market in bonds. They watched dozens of financial and commodity markets: stocks, oil, natural gas, currencies, and anything else that might in some way influence the bond market.
  • Small mortgage lenders, known as “thrifts” started losing money once the interest rates were raised in 1979. So Congress passed a tax break that gave them relief, but required them to sell their loans to Wall Street. Losses on these loans could be amortized over their life, and also offset against any taxes paid in the last 10 years.
  • Thrifts continued to buy loans on top of their old loss-making loans, hoping the new would offset the old. It was irresponsible and only made it so that the next thrift crisis would be larger.
  • Ranieri & Co. intended to transform the "whole loans" into bonds as soon as possible by taking them for stamping to the U.S. government. Then they could sell the bonds to Salomon's institutional investors as, in effect, U.S. government bonds. For that purpose, partly as the result of Ranieri's persistent lobbying, two new facilities had sprung up in the federal government alongside Ginnie Mae. They guaranteed the mortgages that did not qualify for the Ginnie Mae stamp. The Federal Home Loan Mortgage Corporation (called Freddie Mac) and the Federal National Mortgage Association (called Fannie Mae) between them, by giving their guarantees, were able to transform most home mortgages into government-backed bonds. The thrifts paid a fee to have their mortgages guaranteed.
  • The shakier the loans, the larger the fee a thrift had to pay to get its mortgages stamped by one of the agencies. Once they were stamped, however, nobody cared about the quality of the loans. Defaulting homeowners became the government's problem.
  • The Salomon trading floor was unique. It had minimal supervision, minimal controls, and no position limits. A trader could buy or sell as many bonds as he thought appropriate without asking. The trading floor was, in other words, a CEO's nightmare.
  • Many of the best trades followed two patterns: when all investors were doing one thing, do the opposite. And when there was a major dislocation (stock market crash, natural disaster, etc.), look past the initial focus of investor interest and seek secondary and tertiary effects.
  • Having a second source of income in a young career is helpful because it leaves you fearless.
  • Often, behavior of investors is not rational. Some like risk, others hate risk, and you can often profit from creating a way to “sell” risk back and forth.
  • The same can be said of junk bonds: often they were cheap, even factoring in the additional risk, compared to blue-chip bonds. The reason? Investors didn’t want to seem imprudent. Note this is similar to some of The Big Short investors where their thesis is people don’t want to think about bad things.
  • Michael Milken reassessed corporate America and noticed two things. First, many large and seemingly reliable companies borrowed money from banks at low rates of interest. Their creditworthiness had one way to go: down. It was a stupid trade: tiny upside, huge downside.
  • Second, two sorts of companies could not persuade risk-averse commercial bankers and money managers to lend them anything: small new companies and large old companies with problems. Money managers relied on debt-rating agencies to tell them what was safe, rather than actually analyzing the business.
  • Another advantage? It is illegal to trade on inside information in stocks. But it isn’t illegal in bonds, and junk bonds often behaved like stocks. Milken could trade junk bonds on inside information.
  • The belief in the meaning of making dollars crumbles once you see something like investment banking, where the money is completely out of proportion with the contribution to society.

Detailed Notes


““Wall Street," reads the sinister old gag, "is a street with a river at one end and a graveyard at the other.”

This is striking, but incomplete. It omits the kindergarten in the middle.” —Frederick Schwed, Jr., Where Are the Customers' Yachts?

Chapter One: Liar’s Poker

The Game: In Liar's Poker a group of people—as few as two, as many as ten—form a circle. Each player holds a dollar bill close to his chest. The game is similar in spirit to the card game known as I Doubt It. Each player attempts to fool the others about the serial numbers printed on the face of his dollar bill. One trader begins by making "a bid."

He says, for example, "Three sixes." He means that all told the serial numbers of the dollar bills held by every player, including himself, contain at least three sixes.

Once the first bid has been made, the game moves clockwise in the circle.

Let's say the bid is three sixes. The player to the left of the bidder can do one of two things. He can bid higher (there are two sorts of higher bids: the same quantity of a higher number [three sevens, eights, or nines] and more of any number [four fives, for instance]). Or he can"challenge"—that is like saying, "I doubt it."

The bidding escalates until all the other players agree to challenge a single player's bid. Then, and only then, do the players reveal their serial numbers and determine who is bluffing whom. In the midst of all this, the mind of a good player spins with probabilities.

What is the statistical likelihood of there being three sixes within a batch of, say, forty randomly generated serial numbers? For a great player, however, the math is the easy part of the game.

The hard part is reading the faces of the other players. The complexity arises when all players know how to bluff and double-bluff.

Chapter Two: Never Mention Money

At Princeton, in my senior year, for the first time in the history of th«e school, economics became the single most popular area of concentration. And the more people studied economics, the more an economiics degree became a requirement for a job on Wall Street.

There was a good reason for this. Ecomomics satisfied the two most basic needs of investment bankers. Firstt investment bankers wanted practical people, willing to subordinate their educations to their careers. Economics, which was becoming an everr more abstruse science, producing mathematical treatises with no obwious use, seemed almost designed as a sifting device. The way it was itaught did not exactly fire the imagination. I mean, few people would claim they actually liked studying economics; there was not a trace off self-indulgence in the act. Studying economics was more a ritual satcrifice. I can't prove this, of course. It is bald assertion, based on what ^economists call casual empiricism. I watched. I saw friends steadily drained of life. I often asked otherwise intelligent members of the prebanking set why they studied economics, and they explained that it was the most practical course of study, even while they spent their time drawing funny little graphs. They were right, of course, and that was even more maddening. Economics was practical. It got people jobs. And it did this because it demonstrated that they were among the most fervent believers in the primacy of economic life.

The only inexplicable aspect of the process was that economic theory (which is, after all, what economics students were supposed to know) served almost no function in an investment bank. The bankers used economics as a sort of standardized test of general intelligence.

Chapter Three: Learning to Love our Corporate Culture

The biggest myth about bond traders, and therefore the greatest misunderstanding about the unprecedented prosperity on Wall Street in the 1980s, are that they make their money by taking large risks. A few do. And all traders take small risks. But most traders act simply as toll takers. The source of their fortune has been nicely summarized by Kurt Vonnegut (who, oddly, was describing lawyers): "There is a magic moment, during which a man has surrendered a treasure, and daring which the man who is about to receive it has not yet done so. An alert lawyer [read bond trader] will make that moment his own, possessing the treasure for a magic microsecond, taking a little of it, passing it on."

In other words, Salomon carved a tiny fraction out of each financial transaction. This adds up. The Salomon salesman sells $50 million worth of new IBM bonds to pension fund X. The Salomon trader, who provides the salesman with the bonds, takes for himself an eighth (of a percentage point), or $62,500. He may, if he wishes, take more. In the bond market, unlike in the stock market, commissions are not openly stated.

Now the fun begins. Once the trader knows the location of the IBM bonds and the temperament of their owner, he doesn't have to be outstandingly clever to make the bonds (the treasure) move again. He can generate his own magic microseconds. He can, for example, pressure one of his salesmen to persuade insurance company Y that the IBM bonds are worth more than pension fund X paid for them initially. Whether it is true is irrelevant. The trader buys the bonds from X and sells them to Y and takes out another eighth, and the pension fund is happy to make a small profit in such a short time.

In this process, it helps if neither of the parties on either side of the middleman knows the value of the treasure. The men on the trading floor may not have been to school, but they have Ph.D.'s in man's ignorance. In any market, as in any poker game, there is a fool.

One of the benevolent hands doing the stuffing belonged to the Federal Reserve. That is ironic, since no one disapproved of the excesses of Wall Street in the 1980s so much as the chairman of the Fed, Paul Volcker. At a rare Saturday press conference, on October 6, 1979, Volcker announced that the money supply would cease to fluctuate with the business cycle; money supply would be fixed, and interest rates would float. The event, I think, marks the beginning of the golden age of the bond man. Had Volcker never pushed through his radical charge in policy, the world would be many bond traders and one memoir the poorer. For in practice, the shift in the focus of monetary policy meant that interest rates would swing wildly.

Bond prices move inversely, lockstep, to rates of interest. Allowing interest rates to swing wildly meant allowing bond prices to swing wildly. Before Volcker's speech, bonds had been conservative investments, into which investors put their savings when they didn't fancy a gamble in the stock market. After Volcker's speech, bonds became objects of speculation, a means of creating wealth rather than merely storing it. Overnight the bond market was transformed from a backwater into a casino. Turnover boomer at Salomon. Many more people were hired to handle the new business, on starting salaries of forty-eight grand.

Once Volcker had set interest rates free, the other hand stuffing the turkey went to work: America's borrowers. American governments, consumers, and corporations borrowed money at a faster clip during the 1980s than ever before; this meant the volume of bonds exploded (another way to look at this is that investors were lending money more freely than ever before).

The combined indebtedness of the three groups in 1977 was $323 billion, much of which wasn't bonds but loans made by commercial banks. By 1985 the three groups had borrowed $7 trillion. What is more, thanks to financial entrepreneurs at places like Salomon and the shakiness of commercial banks, a much greater percentage of the debt was cast in the form of bonds than before.

So not only were bond prices more volatile, but the number of bonds to trade increased. Nothing changed within Salomon Brothers that made the traders more able.

Now, however, trades exploded in both size and frequency. A Salomon salesman who had in the past moved five million dollars' worth of merchandise through the traders' books each week was now moving three hundred million dollars through each day. He, the trader, and the firm began to get rich. And they decided for reasons best known to themselves to invest some of their winnings in buying people like me.

Ask any astute trader and he'll tell you that his best work cuts against the conventional wisdom. Good traders tend to do the unexpected. We, as a group, were painfully predictable.

And why Salomon let it happen, I still don't understand. The firm's management created the training program, filled it to the brim, then walked away. In the ensuing anarchy the bad drove out the good, the big drove out the small, and the brawn drove out the brains. There was a single trait common to denizens of the back row, though I doubt it ever occurred to anyone: They sensed that they needed to shed whatever refinements of personality and intellect they had brought with them to Salomon Brothers.

This wasn't a conscious act, more a reflex. They were the victims of the myth, especially popular at Salomon Brothers, that a trader is a savage, and a great trader a great savage. This wasn't exactly correct. The trading floor held evidence to that effect. But it also held evidence to the contrary. People believed whatever they wanted to.

Chapter Four: Adult Education

When asked the key to his success, he said, "In the land of the blind the one-eyed man is king." Best of all, he gave us a rule of thumb about information in the markets that I later found useful: "Those who say don't know, and those who know don't say."

A trader placed bets in the markets on tbehalf of Salomon Brothers. A salesman was the trader's mouthpiece t(» most of the outside world. The salesmen spoke with institutional investors such as pension funds, insurance companies, and savings and loams. The minimum skills required for the two jobs were quite differemt. Traders required market savvy. Salesmen required interpersonal skillls. But the very best traders were also superb salesmen, for they had to persuade a salesman to persuade his customers to buy bond X or selll bond Y. And the very best salesmen were superb traders and found custtomers virtually giving their portfolios over to them to manage.

The difference between a trader and a salesman was more than a matter of mere function. The traders ruled tthe shop, and it wasn't hard to see why. A salesman's year-end bonus was determined by traders. A trader's bonus was determined by the profits on his trading books. A salesman had no purchase on a trader, wlhile a trader had complete control over a salesman. Not surprisingly, yciung salesmen dashed around the place looking cowed and frightened, while young traders smoked cigars. That the tyranny of the trader was. institutionalized shouldn't surprise anyone. Traders were the people closest to the money. The firm's top executives were traders.

Good bond traders had fast brains andl enormous stamina. They watched the markets twelve and sometimess sixteen hours a day—and not just the market in bonds. They watcheed dozens of financial and commodity markets: stocks, oil, natural gass, currencies, and anything else that might in some way influence the bcond market. They sat down in their chairs at 7:00A.M. and stayed put umtil dark. Few of them cared to talk about their jobs; they were as reticent as veterans of an unpopular war. They valued profits.

And money. Especially money, and all the things that money could buy, and all the Ikudos that attached to the person with the most of it.

Sangfroid and the Human Piranha turned out to be two of my favorite people on the forty-first floor. There was no bullshit about them. They were brutal, but they were also honest and, I think, fair. The problems on 41 were caused by people who were tough but unfair, otherwise known, under the breath of many a trainee, as flaming assholes. You survived the Human Piranha and Sir Sangfroid by simply knowing what you were about.

Chapter Five: A Brotherhood of Hoods

He belonged to the Lions or Rotary Club and also to a less formal group known within the thrift industry as the 3-6-3 Club: He borrowed money at 3 percent, lent money at 6 percent, and arrived on the golf course by three in the afternoon.

Chapter Six: The Fat Men and Their Marvelous Money Machine


What was going on? From the moment the Federal Reserve lifted interest rates in October 1979, thrifts hemorrhaged money. The entire structure of home lending was on the verge of collapse. There was a time when it seemed that if nothing were done, all thrifts would go bankrupt. So on September 30, 1981, Congress passed a nifty tax break* for its beloved thrift industry. It provided massive relief for thrifts. To take advantage of it, however, the thrifts had to sell their mortgage loans. They did. And it led to hundreds of billions of dollars in turnover on Wall Street.

Wall Street hadn't suggested the tax breaks, and indeed, Ranieri's traders hadn't known about the legislation until after it happened. Still, it amounted to a massive subsidy to Wall Street from Congress. Long live motherhood and home ownership! The United States Congress had just rescued Ranieri & Co. The only fully staffed mortgage department on Wall Street was no longer awkward and expensive; it was a thriving monopoly.

The tax break allowed thrifts to sell all their mortgage loans and put their cash to work for higher returns, often by purchasing the cheap loans disgorged by other thrifts. The thrifts were simply swapping portfolios of loans. The huge losses on the sale (the thrifts were selling loans for sixty-five cents on the dollar they had originally made at par, or a hundred cents on the dollar) could now be hidden. A new accounting standard allowed the thrifts to amortize the losses over the life of the loans. For example, the loss the thrift would show on its books in the first year from the sale of a thirty-year loan that had fallen 35 percent in value was a little over 1 percent: 35 / 30.

But what was even better is that the loss could be offset against any taxes the thrift had paid over the previous ten years. Shown losses, the Internal Revenue Service (IRS) returned old tax dollars to the thrifts. For the thrifts, the name of the game was to generate lots of losses to show to the IRS; that was now easy. All they had to do to claw back old taxes was sell off their bad loans; that's why thrifts were dying to sell their mortgages.

It was all a great mistake. The market wasn't exploding because of the megatrends that Bob Dall had listed in his memo to Gutfreund (growth in housing, movement from Rust Belt to Sun Belt, etc.) although those later became factors. The market took off because of a simple tax break. It was as if Steven Jobs had bought office space, built an assembly line, hired two hundred thousand salesmen, and written brochures before he had anything to sell. Then someone else creates the personal computer, and seeing this, Jobs leaps into action, calling his previously useless infrastructure Apple Computer.

Bond traders tend to treat each day of trading as if it were their last. This short-term outlook enables them to exploit the weakness of their customers without worrying about the long-term effects on customer relations. They get away with whatever they can. A desperate seller is in a weak position.

He's less concerned about how much he is paid than when he is paid. Thrift presidents were desperate. They arrived at the Salomon Brothers mortgage trading desk hat in hand. If they were going to be so obvious about their weakness, they might as well have written a check to Salomon Brothers.

The situation was aggravated by the ignorance of the thrifts. The 3-6-3 Club members had not been stress-tested for the bond market; they didn't know how to play Liar's Poker.

They didn't know the mentality of the people they were up against. They didn't know the value of what they were selling. In some cases, they didn'teven know the terms (years to maturity, rates of interest) of their own loans. The only thing the thrift managers knew was how much they wanted to sell. The truly incredible thing about them, noted by all the Salomon traders, was that no matter how roughly they were treated, they kept coming back for more. They were like ducks I once saw on a corporate hunt that were trained to fly repeatedly over the same field of hunters until shot dead.

You didn't have to be Charles Darwin to see that this breed was doomed.

Many thrifts layered a billion dollars of brand-new loans on top of their existing, disastrous hundred million dollars of old loss-making loans, in a hope that the new would offset the old. Each new purchase of mortgage bonds (which was identical to making a loan) was like the last act of a desperate man. The strategy was wildly irresponsible, for the fundamental problem (borrowing short term and lending long term) hadn't been remedied. The hypergrowth only meant that the next thrift crisis would be larger. But the thrift managers were not thinking that far in advance. They were simply trying to keep the door to the shop open. That explains why thrifts continued to buy mortgage bonds even as they sold their loans.

Ranieri & Co. intended to transform the "whole loans" into bonds as soon as possible by taking them for stamping to the U.S. government. Then they could sell the bonds to Salomon's institutional investors as, in effect, U.S. government bonds. For that purpose, partly as the result of Ranieri's persistent lobbying, two new facilities had sprung up in the federal government alongside Ginnie Mae. They guaranteed the mortgages that did not qualify for the Ginnie Mae stamp. The Federal Home Loan Mortgage Corporation (called Freddie Mac) and the Federal National Mortgage Association (called Fannie Mae) between them, by giving their guarantees, were able to transform most home mortgages into government-backed bonds. The thrifts paid a fee to have their mortgages guaranteed.

The shakier the loans, the larger the fee a thrift had to pay to get its mortgages stamped by one of the agencies. Once they were stamped, however, nobody cared about the quality of the loans. Defaulting homeowners became the government's problem. The principle underlying the programs was that these agencies could better assess and charge for credit quality than individual investors.

The wonderfully spontaneous mortgage department was the place to be if your philosophy of life was: Ready, fire, aim. The payoff to the swashbuckling traders, by the standards of the time, was shockingly large.

In 1982, coming off two and a half lean years, Lewie Ranieri's mortgage department made $150 million. In 1984 a mortgage trader named Steve Baum shattered a Salomon Brothers record, by making $100 million in a single year trading whole loans. Although there are no official numbers, it was widely accepted at Salomon that Ranieri's traders made $200 million in 1983, $175million in 1984, and $275 million in 1985.

Lewie Ranieri was the right man at the right place at the right time. "Lewie was willing to take positions in things he didn't fully understand. He had a trader's instinct that he trusted. That was important," says one of his senior traders. "The attitude at Salomon was always, 'If you believe in it, go with it, but if it doesn't work, you're fucked.' And Lewie responded to this. At other places management says, 'Well, gee, fellas, do we really want to bet the ranch on this deal?' Lewie was not only willing to bet the ranch. He was willing to hire people and let them bet the ranch, too. His attitude was:

'Sure, what the fuck, it's only a ranch.' In other shops, he'd have had to write a two-hundred-page memo for a committee that wanted to be sure that what he was doing was safe. He would have had to prove he knew what he was doing. He could never have done that. He knew what he was doing, but he could never have proved it. Had Lewie been assigned to look at the mortgage market at other firms, it wouldn't have gone anywhere."

The Salomon trading floor was unique. It had minimal supervision, minimal controls, and no position limits. A trader could buy or sell as many bonds as he thought appropriate without asking. The trading floor was, in other words, a CEO's nightmare. "If Salomon's trading floor was a business school case study," says mortgage trader Wolf Nadool-man, "the guy pretending to be the CEO would say, 'That is shocking!' But you know what? He'd be wrong. Sometimes you lose some dough, but sometimes you make a fortune. Salomon was right."

Salomon's loose management style had its downside. Salomon Brothers was the only major firm on Wall Street in the early 1980s with no systernjor allocating costs. As unbelievable as it seems, no measure was taken of the bottom line; people were judged by the sum total of the revenues on their trading books irrespective of what those cost to generate. When the firm was a partnership (1910-1981) and managers had their own money in the till, loose controls sufficed. Now, however, the money didn't belong to them but to the shareholders. And what worked for a partnership proved disastrous in a publicly owned corporation.

Instead of focusing on profits, trading managers focused on revenues. They were rewarded for indiscriminate growth. Gross revenues meant raw power.

Various Salomon mortgage traders estimate that between 50 and 90 percent of their profits derived from simply taking the other side of thrifts' trades. Why, you might wonder, did thrift presidents tolerate Salomon's huge profit margins? Well, for a start, they didn't know any better. Salomon's margins were invisible. And since there was no competition on Wall Street, there was no one to inform them that they were making Salomon Brothers rich. What was happening—and is still happening—is that the guy who sponsored the float in the town parade, the 3-6-3 Club member and golfing man, had become America's biggest bond trader. He was also America's worst bond trader. He was the market's fool.

Ranieri & Co. had been forced by the glut into owning billions of dollars of mortgage bonds. Because of conditions of supply and demand in their market, they had no choice but to bet on the bond market going up. They watched with glee, therefore, the biggest bond market rally in the history of Wall Street. They had Kaufman to thank at first. When Henry said it was going up, it went up. But then the Federal Reserve allowed interest rates to fall. Policy in Washington, as anticipated by Kaufman, had taken a second fortunate turn for Ranieri and his band of traders. "We're talking off to the races, bond futures up sixteen points in a week, unreal," recalls Wolf Nadoolman. The mortgage department was the envy of the firm.

Yet there were other, more intriguing ways Ranieri made money.

Ranieri's traders found that their counterparts at other firms could be easily duped.

Salomon's was the only mortgage trading desk without direct phone lines to other Wall Street investment banks, preferring instead to work through intermediaries, called interbroker dealers. "We dominated the street," says Andy Stone. "You'd buy bonds at twelve, even when they were trading at ten, to control the flow. The [Salomon Brothers] research department would then produce a piece saying the bonds you had just bought at twelve were really worth twenty. Or we'd buy six billion more of the things at twelve.

The rest of the Street would see them trading up on the screens and figure, 'Hey, retail buying, better buy, too,' and take us out of our position.

Translation: Salomon could dictate the rules of the mortgage bond trading game as it went along.

One trick the new young traders exploited was the tendency of borrowers to prepay their loans when they should not. In a nice example of Wall Street benefiting from confusion in Washington, Steve Roth and Scott Brittenham made tens of millions of dollars trading federal project loans—the loans made to the builders of housing projects, guaranteed by the federal government. By 1981 the federal government was running a deficit. It embarked on a program of asset sales. One group of assets it sold were loans that it had made to the developers of low-cost housing in the 1960s and 1970s.

The loans had been made at below market rates in the first place, as a form of subsidy. On the open market, because of their low coupons, they were worth far less than par (one hundred cents on the dollar); a typical loan was worth about sixty cents on the dollar. So, for example, a thirty-year hundred-million-dollar loan, paying the lender 4 percent a year in interest (when he could earn, say, 13 percent in U.S. treasuries), might be worth sixty million dollars.

On the occasion of the government sale of a loan a tiny announcement appeared in the Wall Street Journal. It seemed only two people read it: Roth and Brittenham.

Brittenham now says, "We dominated the market for years. When I came on board in 1981, we were really the only people buying them." The market was more of a game than most. The trick was to determine beforehand which of the government project loans was likely to prepay, for when it did, there was an enormous windfall to the owner of the loan, the lender. This arose because project loans traded below a hundred cents on the dollar.

When Roth and Brittenham bought loans at sixty cents on the dollar that prepaid immediately, they realized a fast forty cents on the dollar profit. To win the money, you had to know how to identify situations in which the lender would get his money back prematurely. These, it turned out, were of two sorts.

The first were the financially distressed. Where there was distress, there was always opportunity. "It was great if you could find a government housing project that was about to default on its mortgage," says Brittenham.

It was great because the government guaranteed the loan and, in the event of a default, paid off the loan in full. The windfall could be in the millions of dollars.

The other kind of project likely to prepay its mortgage was the cushy upmarket property. Brittenham recalls, "You'd look for a nice property—not a slum—something with a nice pool, tennis court, microwave ovens. When you found it, you'd say to yourself, That's a likely conversion. ' " To convert, the occupants bought out the owner-developer, who would, in turn, repay the loan to the government. Once the government had received its money, it repaid Roth and Brittenham a hundred cents on the dollar for a piece of paper they had just bought at sixty. The thought of two young M.B.A.'s from Wall Street roaming the nation's housing projects in search of swimming pools and bankrupt tenants seems ridiculous until you have done it and made ten million dollars.

The wonder is that the people in Washington who sold the loans did not do the same.

But they didn't understand the value of the loans. Instead they trusted the market to pay them the right price. The market, however, was inefficient.

Even larger windfalls came from exploiting the inefficient behavior of the American homeowner. In deciding when to pay off his debts, the homeowner wasn't much craftier than the federal government. All across the country citizens with 4, 6, and 8 percent home mortgages were irrationally insisting on paying down their home loans when the prevailing mortgage rate was 16 percent; even in the age of leverage there were still many people who simply didn't like the idea of being in hock. This created a situation identical to the federal project loan bonanza. The home loans underpinned mortgage bonds. The bonds were priced below their face value. The trick was to buy them below face value just before the homeowners repaid their loans. The mortgage trader who could predict the behavior of the homeowners made huge profits. Any prepayments were profits to the owner of the mortgage bond. He had bought the bond at sixty; now he was being paid off at a hundred.

A young Salomon Brothers trader named Howie Rubin began to calculate the probability of homeowners' prepaying their mortgages. He discovered that the probability varied according to where they lived, the length of time their loans had been outstanding, and the sizes of their loans. He used historical data collected by Lew Ranieri's research department. The researchers were meant to be used like scientific advisers at an arms talk.

More often, however, they were treated like the water boys on the football team. But the best traders knew how to use the researchers well. The American homeowner became, to Rubin and the research department, a sort of laboratory rat. The researchers charted how previously sedentary homeowners jumped and started in response to the shock of changes in the rate of interest. Once a researcher was satisfied that one group of homeowners was more likely than another to behave irrationally, and pay off low-interest-rate mortgages, he would inform Rubin, who then bought their mortgages. The homeowners, of course, never knew that their behavior was so closely monitored by Wall Street.

One trader remembers that "Lewie would say he thought the market was going up, and buy a hundred million [dollars' worth of] bonds. The market would start to go down. So Lewie would buy two billion more bonds, and of course, the market would then go up. After he had driven the market up, Lewie would turn to me and say, 'See, I told you it was going to go up.'

Rubin found the prepayment game he played with discount mortgage securities similar to counting cards. "Blackjack is the only nonin-dependent outcome game in the casino. What happens in the past affects what will happen in the future. There are actually times when you have a statistical advantage, and that is when you make the big bets," he says. At Salomon he had the advantage of superior information about the past behavior of homeowners, and only when he had this edge did he make the bets. What's more, he says, the trading floor at Salomon Brothers felt like a Las Vegas casino. You made your bets, handled risk, in the midst of a thousand distractions. To feign indifference before the blackjack dealer in the casino while he memorized every card that was dealt, Rubin engaged a neighbor in conversation and drank gin and tonics. At Salomon Brothers he traded bonds while being hollered at by six salesmen, eating a morning cheeseburger, and watching Ranieri hold a Bic lighter under the balls of a fellow trader.In his first year out of the training program, 1983, Rubin made $25 million.

Chapter Seven: The Salomon Diet


"I have this theory," says Andy Stone, seated in his office at Pruden-tial-Bache Securities. "Wall Street makes its best producers into managers. The reward for being a good producer is to be made a manager. The best producers are cutthroat, competitive, and often neurotic and paranoid. You turn those people into managers, and they go after each other. They no longer have the outlet for their instincts that producing gave them.

They usually aren't well suited to be managers. Half of them get thrown out because they are bad. Another quarter get muscled out because of politics.

The guys left behind are just the most ruthless of the bunch. That's why there are cycles on Wall Street—why Salomon Brothers is getting crunched now—because the ruthless people are bad for the business but can only be washed out by proven failure."

Ranieri had accomplished what he set out to do: put the mortgage department on equal footing with corporate and government bonds. The U.S. mortgage market is now the largest credit market in the world and may one day be the single largest bond market in the world. Ranieri's creation signaled a shift in the focus of Wall Street. Wall Street, historically, had dealt with only one side of the balance sheet: liabilities. Mortgages are assets. If home mortgages could be packaged and sold, so could credit card receivables, car loans, and any other kind of loan you can imagine.

Chapter Eight: From Geek to Man

He let us cut office meetings and work our own hours. He led by example, by arriving at work each morning an hour after the rest of the sales force had made its first phone calls. This, I think, was an inspired gesture. His was the most profitable unit in the office, year in and year out, and I am sure it was because its members were left with room to think for themselves.

The young man directly across from me, a member of my unit whom I'd spend the next two years gazing upon in wonderment, leaned over and whispered, "Wanna know a lay-up? Short the stock of Salomon Brothers." A lay-up, it should be said, was jargon for agamble that was sure to succeed.

To sell short, or to short, is to sell a security that you don't own, hoping that it will decline in price and you can buy it back later at a lower price. To short our own stock would be to bet on its taking a nose dive.

Thinking, as yet, was a feat beyond my reach. I had no base, no grounding.

My only hope was to watch the salesmen around rne and gather what advice I could. Learning what to do meant learning an attitude: how to sound on the telephone, how to deal with traders, and, most important, how to spot the difference between a financial opportunity and a rip-off.

What bothered Dash was that Salomon Brothers had actually spent money to make these things. A book and a bowl? Who gave a shit, he said, about a book and a bowl? He'd rather have the money. What's more, he added, the people who worked at Salomon in the old days would never have done such a thing; they, too, would rather have had the money. The book and the bowl violated what Dash considered to be the Salomon ethic. And that's why he told me to short the stock.*

Still, I relied heavily on Dash and on the other members of our unit, a woman and two men. We sat at a single desk, divided artificially to accommodate five. We had a hundred telephone lines; each line was a channel through which money, tasteless jokes, and rumors flowed. If you ever care to see how all the world's most awful jokes spread, spend a day on a bond trading desk. When the Challenger space shuttle disintegrated, six people called me from six points on the globe to explain that NASA stands for "Need Another Seven Astronauts."

The attraction of options and futures, our specialty item, was that they offered both liquidity and fantastic leverage.

“Uuuuuhhhhhhhhh," he continued, in a slightly different key. He began to hyperventilate into the phone.

And you want to know how I felt? I should have felt guilty, of course, but guilt was not the first identifiable sensation to emerge from my exploding brain. Relief was. I had told him the news. He was shouting and moaning.

And that was it. That was all he could do. Shout and moan. That was the beauty of being a middleman, which I did not appreciate until that moment.

The customer suffered. I didn't. He wasn't going to kill me.

He wasn't even going to sue me. I wasn't going to lose my job. On the contrary, I was a minor hero at Salomon for dumping a sixty-thousand-dollar loss into someone else's pocket.

And I couldn't help remembering a snide remark made by a seasoned trader to one of my fellow trainees while we were in the classroom. The trainee had tried to impress the trader and failed. The trader had said, "You are proof that some people are born to be customers." Born to be customers, the back row had thought it was the funniest thing they had heard all day.

He disapproved of workdays longer than eight hours because, he said, "you then arrive at the office in the morning with the same thoughts you left with late the night before."

On the heels of a few drinks, this sounded wise enough to note on a napkin.

Many of the trades that 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.

The second pattern to Alexander's thought was that in the event of a major dislocation, such as a stock market crash, a natural disaster, the breakdown of OPEC's production agreements, he would look away from the initial focus of investor interest and seek secondary and tertiary effects.

Remember Chernobyl? When news broke that the Soviet nuclear reactor had exploded, Alexander called. Only minutes before, confirmation of the disaster had blipped across our Quotron machines, yet Alexander had already bought the equivalent of two supertankers of crude oil. The focus of investor attention was on the New York Stock Exchange, he said. In particular it was on any company involved in nuclear power. The stocks of those companies were plummeting. Never mind that, he said. He had just purchased, on behalf of his clients, oil futures. Instantly in his mind less supply of nuclear power equaled more demand for oil, and he was right. His investors made a large killing.

Mine made a small killing. Minutes after I had persuaded a few clients to buy some oil, Alexander called back.

"Buy potatoes," he said. "Gotta hop. "Then he hung up.

Of course. A cloud of fallout would threaten European food and water supplies, including the potato crop, placing a premium on uncon-taminated American substitutes.

Perhaps a few folks other than potato farmers think of the price of potatoes in America minutes after the explosion of a nuclear reactor in Russian, but I have never met them.

But Chernobyl and oil are a comparatively straightforward example. There was a game we played called What if? All sorts of complications can be introduced into What if? Imagine, for example, you are an institutional investor managing several billion dollars. What if there is a massive earthquake in Tokyo? Tokyo is reduced to rubble.

Investors in Japan panic. They are selling yen and trying to get their money out of the Japanese stock market. What do you do?

Well, along the lines of pattern number one, what Alexander would do is put money into Japan on the assumption that since everyone was trying to get out, there must be some bargains. He would buy precisely those securities in Japan that appeared the least desirable to others. First, the stocks of Japanese insurance companies. The world would probably assume that ordinary insurance companies had a great deal of exposure, when in fact, the risk resides mainly with Western insurers and with a special Japanese earthquake insurance company that's been socking away premiums for decades. The shares of ordinary insurers would be cheap.

Then Alexander would buy a couple of hundred million dollars' worth of Japanese government bonds. With the economy in temporary disrepair, the government would lower interest rates to encourage rebuilding and simply order the banks to lend at those rates. Japanese banks would comply as usual with their government's request. Lower interest rates would mean higher bond prices.

Also, the short-term panic could well be overshadowed by the long-term repatriation of Japanese capital. Japanese companies have massive sums invested in Europe and America. Eventually they would withdraw those investments, turn inward, lick their wounds, repair their factories, and bolster their stock. What would that mean?

Well, to Alexander, it would suggest buying yen. The Japanese would buy yen, selling their dollars, francs, marks, and pounds to do so. The yen would appreciate not just because the Japanese were buying it but because foreign speculators would eventually see the Japanese buying it and rush to join them. If the yen collapsed immediately after the quake, it would only further encourage Alexander, who sought always to do the unexpected, that his idea was a good one. On the other hand, if the yen rose, he might sell it.

Dash was Dash. Alexander was Alexander. I was a fraud, a composite of traits I felt rightfully belonged to these two. In my defense I can say only that I was a very good fraud. Also, that I had one useful quality possessed by neither of my teachers: a detachment from the business and the firm. It comes, I suppose, from getting your job at a fund raiser at St. James's Palace or perhaps from having another source of income (I was a journalist at nights and on weekends while I was at Salomon Brothers). Anyway, it is extremely helpful in a young career because it leaves you fearless. I had the same advantage of recklessness as a driver in a traffic jam with a rent-a-car.The worst anyone could do to my rent-a-career was take it away, and though I did not actively court that fate, the thought of losing my job didn't trouble me as much as it troubled lifers such as, say, Dash Riprock. That is not to say I did not care; I cared immensely. I thrived on praise more than most and thus sought to please. But I was willing to take greater risks than if I had felt deeply proprietary about niy career. I was, for instance, willing to disobey my superiors, and that caused them to sit up and take notice far more quickly than if I had been a good soldier.

Salomon would make a lot of money. My customer would make a little money (which, for a customer, was grand). And I would be a hero. If there was a single lesson I took away from Salomon Brothers, it is that rarely do all parties win. The nature of the game is zero sum. A dollar out of my customer's pocket was a dollar in ours, and vice versa.

Chapter Nine: The Art of War

Pride of authorship is superseded by pride of profits. If Salomon Brothers creates a new kind of bond or stock, within twenty-four hours Morgan Stanley, Goldman Sachs, and the rest will have figured out how it worked and will be trying to make one just like it. I understand this as part of the game. I recall that one of the first investment bankers I met taught me a poem.

God gave you eyes, plagiarize.

A handy ditty when competing with other firms. What I was about to learn, however, is that the poem was equally handy when competing within Salomon Brothers.

In view of the high percentage of times they end up apologizing for, or modifying, their remarks, it is a wonder they don't stifle themselves.) But there was no such news. I told Alexander that several Arabs had sold massive holdings of gold, for which they received dollars. They were selling those dollars for marks and thereby driving the dollar lower.

I spent much of my working life inventing logical lies like this. Most of the time when markets move, no one has any idea why. A man who can tell a good story can make a good living as a broker. It was the job of people like me to make up reasons, to spin a plausible yarn. And it's amazing what people will believe. Heavy selling out of the Middle East was an old standby. Since no one ever had any clue what the Arabs were doing with their money or why, no story involving Arabs could ever be refuted. So if you didn't know why the dollar was falling, you shouted out something about Arabs.

My client loved risk. Risk, I had learned, was a commodity in itself. Risk could be canned and sold like tomatoes. Different investors place different prices on risk. If you are able, as it were, to buy risk from one investor cheaply and sell it to another investor dearly, you can make money without taking any risk yourself. And this is what we did.

My client wanted to take a big risk by wagering a large sum of money on German bonds rising. He was therefore the "buyer" of risk. Alexander and I created a security, called a warrant or a call option, which was a means of transferring risk from one party to another. In buying our warrant, risk-averse investors from around the world (meaning most investors) would be, in effect, selling us risk. Many of these investors would not know they wanted to sell risk on the German bond market until we suggested it to them with our new warrant, just as most people didn't know they wanted to plug their ears all day and listen to Pink Floyd until Sony produced the Walkman. Part of our job was to fill needs that investors never knew they had. We'd rely on Salomon's sales force to generate demand for our new product, which, because it was unique, was pretty sure to succeed.

The difference between what we paid cautious investors for the risk and what we sold it to my customer for would be our profits. We estimated these would come to about seven hundred thousand dollars.

The idea was a dream. Salomon Brothers, which sat in the middle of this transfer of risk, would take no risk whatsoever. Seven hundred thousand risk-free dollars was a refreshing sight for Salomon management. But even more important, as far as Salomon was concerned, was the novelty of our deal. A warrant on German interest rates was new.

The publicity of being the first investment bank ever to issue them was the sort of thing that drives investment bankers mad with desire.

Book: Clausewitz's On War

Chapter Ten: How Can We Make You Happier?

We had the temperament and wisdom of a Lebanese taxi driver: We had our foot slammed down either on the accelerator or on the brake; we knew no moderation and had no judgment.

Junk bonds are bonds issued by corporations deemed by the two chief credit-rating agencies, Moody's and Standard & Poor's, to be unlikely to repay their debts. "Junk" is an arbitrary but important distinction. The spectrum of creditworthiness that has IBM at one end and a Beirut cotton trading firm on the other has a break somewhere in the middle. At some point the bonds of a company cease to be investments and become wild gambles.

Junk bonds are easily the most controversial financial tool of the 1980s; they have been much in the news.

But they are not, it should be emphasized, new. Companies, like people, have always borrowed money to buy things they haven't had the cash to afford. They also borrow money because, in America at least, it is the most efficient way to finance an enterprise; interest payments on debt are tax-deductible. And shaky enterprises have always wanted to borrow money. At times, as when the turn of the century robber barons built their empires on mountains of paper, lenders have been surprisingly indulgent. But never as indulgent as today. What is new, therefore, is the size of the junk bond market, the array of rickety companies deeply in hock, and the number of investors willing to risk their principal (and perhaps also their principles) by lending to these companies.

Michael Milken at Drexel created that market, by persuading investors that junk bonds were a smart bet, in much the same fashion that Lewie Ranieri persuaded investors mortgage bonds were a smart bet. Throughout the late 1970s and early 1980s Milken crisscrossed the nation and pounded on dinner tables until people began to listen to him.

Mortgages and junk made it easier to borrow money for people and companies previously thought unworthy of the funds. Or, to put it the other way around, the new bonds made it possible for the first time for investors to lend money directly to homeowners and shaky companies. And the more investors lent, the more others owed. The consequent leverage is the most distinctive feature of our financial era.

In her book The Predators' Ball, Connie Bruck traced the rise of Drexel's junk bond department (Milken reportedly tried to pay the author not to publish). The story she tells begins in 1970, when Michael Milken studied bonds at the University of Pennsylvania's Wharton School of Finance. He was blessed with an unconventional mind, which overcame his conventional middle-class upbringing (his father had been an accountant).

At Wharton he examined fallen angels, the bonds of one-time blue-chip corporations now in trouble. At the time fallen angels were the only junk bonds around. Milken noticed that they were cheap compared with the bonds of blue-chip corporations even considering the additional risk they carried. The owner of a portfolio of fallen angels, by Milken's analysis, almost always outperformed the owner of a portfolio of blue-chip bonds.

There was a reason: Investors shunned fallen angels out of a fear of seeming imprudent. It is a remarkably simple observation. Like Alexander, Milken noticed that investors were constrained by appearances and, as a result, had left a window of opportunity open for a trader who was not.Thus the herd instinct, the basis for so much human behavior, laid the foundation for a revolution in the world of money.

Here the similarity ends. For unlike Ranieri, Michael Milken took complete control of his firm. He moved his junk bond operation from New York to Beverly Hills and eventually paid himself $550 million a year, 180 times what Ranieri made at his peak.

When Milken opened his Wilshire Boulevard office (which he owns), he let it be known who was in charge by putting his name on the door instead of Drexel's. And he created a working environment that was different from Salomon Brothers in one crucial respect: Success was measured strictly by how many deals you brought in, rather than by how many people worked for you, whether you had a seat on the board of directors, and how many gossip columns you appeared in.

It is always hard to say what it is about a man that makes him suited to overturn the conventions by which the rest of the world has been living for ages. In Milken's case, it is especially difficult because he's almost neurotically private and offers no helpful insights into his character to would-be biographers, other than the business he does. My view is that he combined two qualities that were, at the time of his ascendancy, regarded as mutually exclusive. They certainly did not coexist within Salomon Brothers in the early 1980s. Milken possessed both raw bond-trading skills and patience with ideas. He had an attention span.

Michael Milken, who began in a job not dissimilar to Dash's, was building a business, rather than making an endless series of trades. He was willing to look up from the blips on his trading screen and think clear and complete thoughts years into the future. Would a certain microchip company survive for twenty years to meet its semiannual interest payments? Would the U.S.steel industry survive in any form? Fred Joseph, who became CEO of Drexel, listened to Milken on the subject of corporations and thought he "understood credit better than anyone in the country." As a by-product, Milken came to understand companies.

Thinking like a bond trader, Milken completely reassessed corporate America. He made two observations. First, many large and seemingly reliable companies borrowed money from banks at low rates of interest.

Their creditworthiness had but one way to go: down. Why be in the business of lending money to them? It didn't make sense. It was a stupid trade: tiny upside, huge downside. Many companies that had once been models of corporate vitality subsequently went bust. There was no such thing as a riskless loan.

Even corporate giants are felled when their industries collapse under them.

Witness the entire U.S. steel industry.

Second, two sorts of companies could not persuade risk-averse commercial bankers and money managers to lend them so much as the time of day: small new companies and large old companies with problems. Money managers relied on the debt-rating agencies to tell them what was safe (or, rather, to sanction their investments so they did not appear imprudent). But the rating services, like the commercial banks, relied almost exclusively on the past-corporate balance sheets and track records-in rendering their opinions. The outcome of the analysis was determined by the procedure rather than by the analyst. This was a poor way to evaluate any enterprise, be it new and small, or old, large and shaky. A better method was to make subjective judgments about the character of management and the fate of their industry. Lending money to a company such as MCI, which funded most of its growth with junk bonds, could be a brilliant risk-if one could foresee the future of competitive long-distance phone services and the quality of MCI's management. Lending money to Chrysler at extortionate rates of interest could also be a smart bet, as long as the company had enough cash flow to pay that interest.

Milken often spoke to students at business schools. On these occasions he liked, for dramatic effect, to demonstrate how hard it actually is to put a large company into bankruptcy. The forces interested in keeping a large company afloat, he argued, are far greater than those that wish to see it perish. He'd present the students with the following hypothetical situation.

First, he'd say, let's locate our major factory in an earthquake zone.

Then let's infuriate our unions by paying the executives large sums of money while cutting wages. Third, let's select a company on the brink of bankruptcy to supply us with an essential irreplaceable component in our production line. And fourth, just in case our government is tempted to bail us out when we get into trouble, let's bribe a few indiscreet foreign officials.That, Milken would conclude, is precisely what Lockheed had done in the late 1970s. Milken had purchased Lockheed bonds when the company looked to be heading for liquidation and had made a small fortune when it was saved in spite of itself, just as Alexander had bought Farm Credit bonds when all seemed lost but wasn't.

What Milken was saying was that the entire American credit-rating system was flawed. It focused on the past when it should have focused on the future, and it was burdened by a phony sense of prudence. Milken plugged the hole in the system. He ignored large Fortune 100 companies in favor of ones with no credit standing. To compensate the lender for the higher risk, their junk bonds bear a higher rate of interest, sometimes 4 or 5 or 6 percent higher, than the bonds of blue-chip companies. They also tend to pay the lender a big fat fee if the borrower makes enough money to repay his loans prematurely. So when the company makes money, its junk soars, in anticipation of the windfall. And when the company loses money, its junk sinks, in anticipation of default. In short, junk bonds behave much more like equity, or shares, than old-fashioned corporate bonds.

Therein lies one of the'surprisingly well-kept secrets of Milken's market.

Drexel's research department, because of its close relationship with companies, was privy to raw inside corporate data that somehow never found its way to Salomon Brothers. When Milken trades junk bonds, he has inside information. Now it is quite illegal to trade in stocks on inside information, as former Drexel client Ivan Boesky has ably demonstrated.

But there is no such law regarding bonds (who, when the law was written, ever imagined that one day there would be so many bonds that behaved like stock?).

Not surprisingly, the line between debt and equity, so sharply drawn in the mind of a Salomon bond trader (Equities in Dallas!), becomes blurred in the mind of a Drexel bond trader. Debt ownership in a shaky enterprise means control, for when a company fails to meet its interest payments, a bondholder can foreclose and liquidate the company.

Having attracted tens of billions of dollars to his new speculative market, Michael Milken, by 1985, was faced with more money than places to put it.

It must have been awkward for him. He simply could not find enough worthy small-growth companies and old fallen angels to absorb the cash.

He needed to create junk bonds to satisfy the demand for them. His original premise-that junk bonds are cheap because lenders are too chicken to buy them-was shot to hell. Demand now exceeded natural supply. Huge pools of funds across America were dedicated to the unbridled pursuit of risk.

Milken and his Drexel colleagues fell upon the solution: They'd use junk bonds to finance raids on undervalued corporations, by simply pledging the assets of the corporations as collateral to the junk bond buyers. (The mechanics are identical to the purchase of a house, when the property is pledged against a mortgage.) A take-over of a large corporation could generate billions of dollars' worth of junk bonds, for not only would new junk be issued, but the increased leverage transformed the outstanding bonds of a former blue-chip corporation to junk. To raid corporations, however, Milken needed a few hit men.

The new and exciting job of invading corporate boardrooms appealed mainly to men of modest experience in business and a great deal of interest in becoming rich. Milken funded the dreams of every corporate raider of note: Ronald Perelman, Boone Pickens, Carl Icahn, Mar-vin Davis, Irwin Jacobs, Sir James Goldsmith, Nelson Peltz, Samuel Heyman, Saul Steinberg, and Asher Edelman. "If you don't inherit it, you have to borrow it," says one. Most sold junk bonds through Drexel to raise money to storm such hitherto unassailable fortresses as Revlon, Phillips Petroleum, Unocal, TWA, Disney, AFC, Crown Zellerbach, National Can, and Union Carbide.

Managers running public companies with cheap assets began to consider buying the companies from their shareholders for themselves (what is known in Europe as management buyout, or MBO, and in America as a leveraged buyout, or LBO). They put themselves in play. Then, finally, Wall Street investment bankers became involved in what Milken had been quietly doing all along: taking big stakes in the companies for themselves.

The assets were cheap. Why let other people make the money? So the take-over advisory business was all of a sudden shot through with the same conflict of interest I faced every day selling bonds: If it was a good deal, the bankers kept it for themselves; if it was a bad deal, they'd try to sell it to their customers.

There was, in other words, plenty of work to go around. Mergers and acquisitions departments mushroomed across Wall Street in the mid-1980s, just as bond trading departments had mushroomed a few years before.

There was a deep financial connection between the two: Both drew heavily on the willingness of investors to speculate in bonds.

Both also drew on the willingness of people to borrow more than they could easily repay.Both, in short, depended on a whole new attitude toward debt. "Every company has got people sitting around who do nothing for what they get paid," says Joe Perella. "If they take on a lot of debt, it forces them to cut fat." The take-over specialists did for debt what Ivan Boesky did for greed.

Debt is good, they said. Debt works.

There was a deep behavioral connection between bond trading and take-overs as well: Both were driven by a new pushy financial entrepre-neurship that smelled fishy to many who had made their living on Wall Street in the past. There are those who would have you think that a great deal of thought and wisdom is invested in each take-over. Not so.

Wall Street's take-over salesmen are not so different from Wall Street's bond salesmen.

They spend far more time plotting strategy than they do wondering whether they should do the deals. They basically assume that anything that enables them to get rich must also be good for the world. The embodiment of the take-over market is a high-strung, hy-perambitious twenty-six-year-old, employed by a large American investment bank, smiling and dialing for companies.

And the process by which a take-over occurs is frighteningly simple-in view of its effects on community, workers, shareholders, and management.

A paper manufacturer in Oregon appears cheap to the twenty-six-year-old playing with his computer late one night in New York or London. He writes his calculations on a telex, which he send to any party remotely interested in paper, in Oregon, or in buying cheap companies. Like the organizer of a debutante party, the twenty-six-year-old keeps a file on his desk of who is keen on whom. But he isn't particularly discriminating in issuing invitations. Anyone can buy because anyone can borrow using junk bonds.

The papermaker in Oregon is now a target.

The next day the papermaker reads about himself in the "Heard on the Street" column of the Wall Street Journal. His stock price is convulsing like a hanged man because arbitrageurs like Ivan Boesky have begun to buy his company's shares in hopes of making a quick buck by selling out to the raider. The papermaker panics and hires an investment banker to defend him, perhaps even the same twenty-six-year-old responsible for his misery.

Five other twenty-six-year-olds at five hitherto unoccupied investment banks read the rumors and begin to scourge the landscape for a buyer of the paper company. Once a buyer is found, the company is officially "in play."

At the same time the army of young overachievers check their computers to see if other paper companies in America might not also be cheap. Before long the entire paper industry is up for grabs.

The money to be made from defending and attacking large companies makes bond trading look like a pauper's game. Drexel has netted fees in excess of $100 million for single take-overs. Wasserstein and Perella, in 1987, generated $385 million in fees for their employer, First Boston.

If there is one thing I learned on Wall Street, it's that when an investment banker starts talking about principles, he is usually also defending his interests and that he rarely stakes out the moral high ground unless he believes there is gold under his campsite.

The question of the day on 41 was: How come he makes a billion dollars and I don't?

This question drives us right to the center of what has happened in financial America over the past few years. For Milken, not Salomon Brothers, had made the biggest trade of the era. That trade was, of course, the buying and selling of corporate America. Salomon had missed the grand shift in its own business from trading bonds to trading entire industries.

Chapter Eleven: When Bad Things Happen to Rich People

The men who made the decision were practicing their favorite anatomical trick of thinking with their balls. In other words, they weren't thinking at all but trading. Bill Simon used to shout at his young traders, "If you guys weren't trading bonds, you'd be driving a truck. Don't try to get intellectual in the marketplace. Just trade." When a trader is long and wrong he cuts and runs. He drops his position, cuts his losses, and moves on.

Monday, October 12, 1987: Day One

Neither municipal bonds nor money markets were profitable. Does that mean we should have dropped them completely? The firm could, at little expense, have kept a small staff in both markets. That would have appeased the customers who had come to depend on us in these areas and were now furious with us. And it would have enabled us to profit in the event that either of the two markets recovered. Why dump whole businesses? Why not, at the very least, sift through the people and keep the best for other jobs? A star municipal bond salesman could easily become a star government bond salesman. Salomon Brothers was the nation's leading underwriter of municipal bonds and among the leaders of the money markets; the people employed by these departments were by no means losers. *

Friday, October 16, 1987: Day Five

Early on Alexander taught me the importance of a strong exterior. "I learned awhile ago that there was no point to showing weakness," he said. "When you arrive at six-thirty A.M., having had no sleep the night before, and having lost your best friend in a car accident, and some Big Swinging Dick walks over to your desk, slaps you on the back, and says, 'How the hell are you?' you don't say, T'm really tired and really upset.' You say, T'm great, how the hell are you?' "

Saturday, October 17,1987: Day Six


Monday, October 19, 1987: Day Seven

The prevailing reasoning in the bond market went like this: Stock prices were lower; therefore, people were less wealthy; therefore, people would consume less; therefore, the economy would slow down; therefore, inflation would fall (maybe there'd even be depression and deflation); therefore, interest rates would fall; therefore, bond prices should rise. So they did.

The world of money was in upheaval. Funds were rushing out of the stock market and into safe havens. The conventional safe haven for money is gold, but this was not a conventional moment. The price of gold was falling fast. Two creative theories made their happy way around the trading floor, both explaining the fall in gold.

The first was that investors were being forced to sell their gold to meet margin calls in the stock market. The second was that in the depression that followed the crash, investors would have no need to fear inflation, and since for many gold was protection against inflation, it was less in demand.

Whatever the case, money was pouring not into gold but into the money markets-i.e., short-term deposits. Had we had a money market department, we could have made a killing presiding over this movement, but we did not and could not. The decline in business after the crash occurred mainly in the equity markets. And which was the one and only department not to cut a single employee?

Equities. So the area most direly overstaffed was the one that had made no cuts.

A quick calculation showed that Salomon's share price implied a value for the company less than its liquidation value. (If we had been a take-over play three weeks before at thirty bucks a share, we were a bargain now at eighteen. A false rumor spread that Lewie Ranieri had raised money and was returning to buy Salomon Brothers).

After checking with our legal department to make sure I wasn't following Boesky's footsteps, I followed Gutfreund's and bought a bunch of Salomon shares with the bonus I was busy lobbying for. Many, many others on our trading floor were doing the same.

Gutfreund would later say that it bespoke of a faith in the firm when employees bought Salomon shares and that he personally found it encouraging. Perhaps. But I for one wasn't making a statement of faith when I made my purchase. My investment was raw self-interest, coupled with a certain abstract pleasure in having found a smart bet. Within a few months Salomon shares had bounced back, from a low of sixteen dollars to twenty-six dollars.

December 17, 1987: Bonus Day

A strange and glorious day. The firm, for the first time in its history, broke the compensation bands. It was lucky for me. My bonus was meant to fall within the band, which would have limited it to about $140,000. Instead, it paid me $225,000 (275 with benefits, but who's counting?), which is more than it has ever paid any employee two years out of the training program, or so I have been told. I am now the highest-paid member of my training class.But that means less than it did. More than half my class has either quit or been fired.It is now clear that given time, and only time, the firm would make me a rich man.Doing the same level of business, I would be paid 350 or so next year, 450the year after that, and 525 the year after that. And so on, with lesser increases but higher totals each year until I did or did not become a managing director.

But it was sad, and a bit ridiculous, to break the bands and pay selected employees more than ever before in the worst year in the recent history of the firm. The firm cleared $142 million, an abysmal return on $3.5 billion in capital. The numbers looked even worse when you considered that the firm for most of the year had been twice the size of three years before. Why was it paying me now?

I had an idea. When the head of sales presented me with my bonus, he tried to ensure that I appreciated what a monumental gift was being made to me (and he told me not to tell anyone). The clue to the large sum was in his eyes: panic. Salomon Brothers, in a sense, made a trade by putting a price on the services of an employee, and now, having lost a great number of people, it was less composed than usual as it traded. One thing is for sure: It did not pay me a premium because it thought it was the right and proper thing to do. A few good men at the top of the Brothers did what was right and proper, including, I am proud to say, my rabbis, but most did oTily what was necessary. It paid me more because it thought that would compel me to stay, seal my loyalty.

What loyalty I had was already sealed. I felt loyal to a handful of individuals: Dash; Alexander; my jungle guide; my rabbis. But how can you speak of loyalty to the firm when the firm is an amalgam of small and large deceptions and riven with strife and discontent? You can't. And why even try? But now it was abundantly clear that the money game rewarded disloyalty. The people who hopped from firm to firm and, in the process, secured large pay guarantees did much better financially than people who stayed in one place.


I left Salomon Brothers in the beginning of 1988, but not for any of the obvious reasons. I didn't think the firm was doomed. I didn't think that Wall Street would collapse. I wasn't even suffering from growing disillusionment (it grew to a point, still bearable, then stopped). Although there were many perfectly plausible reasons to jump ship, I left, I think, more because I didn't need to stay any longer. My father's generation grew up with certain beliefs.

One of those beliefs is that the amount of money one earns is a rough guide to one's contribution to the welfare and prosperity of our society. I grew up unusually close to my father. Each evening I would plop into a chair near him, sweaty from a game of baseball in the front yard, and listen to him explain why such and such was true and such and such was not. One thing that was almost always true was that people who made a lot of money were neat. Horatio Alger and all that. It took watching his son being paid 225 grand at the age of twenty-seven, after two years on the job, to shake his faith in money. He has only recently recovered from the shock.

I haven't. When you sit, as I did, at the center of what has been possibly the most absurd money game ever and benefit out of all proportion to your value to society (as much as I'd like to think I got only what I deserved, I don't), when hundreds of equally undeserving people around you are all raking it in faster than they can count it, what happens to the money belief?

Well, that depends. For some, good fortune simply reinforces the belief.

They take the funny money seriously, as evidence that they are worthy citizens of the Republic. It becomes their guiding assumption-for it couldn't possibly be clearly thought out-that a talent for making money come out of a telephone is a reflection of merit on a grander scale. It is tempting to believe that people who think this way eventually suffer their comeuppance.

They don't. They just get richer. I'm sure most of them die fat and happy.

For me, however, the belief in the meaning of making dollars crumbled; the proposition that the more money you earn, the better the life you are leading was refuted by too much hard evidence to the contrary. And without that belief, I lost the need to make huge sums of money. The funny thing is that I was largely unaware how heavily influenced I was by the money belief until it had vanished.

It is a small piece of education, but still the most useful thing I picked up at Salomon Brothers. Almost everything else I learned I left behind. I became fairly handy with a few hundred million dollars, but I'm still lost when I have to decide what to do with a few thousand. I learned humility briefly in the training program but forgot it as soon as I was given a chance. And I learned that people can be corrupted by organizations, but since I remain willing to join organizations and even to be corrupted by them (mildly, please), I'm not sure what practical benefit will come from this lesson. All in all, it seems, I didn't learn much of practical value.

Perhaps the best was yet to come and I left too soon. But having lost my need to stay at Salomon Brothers, I discovered a need to leave. My job became nothing more than showing up every morning to do what I had already done, the reward for which was simply more of the same. I disliked the lack of adventure. You might say that I left the trading floor of Salomon Brothers in search of risk, which was as stupid a financial decision as I hope I'll ever make. In the markets you don't take risk without being paid hard cash at the same time. Even in the job market it's a handy rule, and I have broken it.

I am now both poorer and more exposed than I would have been had I remained on the trading floor.

So, on the face of it, my decision to leave was an almost suicidal trade, the sort of thing a customer might do if he fell into the hands of a geek salesman at Salomon. I believe I walked away from the clearest shot I'll ever have at being a millionaire. Sure, Salomon Brothers had fallen on hard times, but there was still plenty of gravy on the tray for a good middleman; that is the nature of the game. And if Salomon turns itself around, the money will flow even more freely. As it happens, I still own shares in Salomon Brothers because I believe it will eventually recover. The strength of the firm lies in the raw instincts of people like John Meriwether, the Liar's Poker champion of the world.

People with those instincts, including Meriwether and his boys, are still trading bonds for Salomon. Anyway, business at Salomon simply couldn't get much worse. The captains have done their level best to sink the ship, and the ship insists on floating. In leaving, I was sure I was making the beginner's mistake of selling at the bottom, which I could only partially offset by buying a few shares in the company as I walked out the door. If I made a bad trade, it's because I wasn't making a trade. I was given pause, however, after I had decided to vamoose, to think that maybe what I was doing wasn't so foolish after all.

Alexander insisted at our farewell dinner that I was making a great move.

The best decisions he has made in his life, he said, were completely unexpected, the ones that cut against convention. Then he went even farther. He said that every decision he has forced himself to make because it was unexpected has been a good one. It was refreshing to hear a case for unpredictability in this age of careful career planning. It would be nice if it were true.

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