So when did it first start to go wrong for one-time Wall Street powerhouses like Goldman Sachs (NYSE: GS ) , Merrill Lynch (NYSE: MER ) , and Morgan Stanley (NYSE: MS ) ? Is the stock market still the place to be for long-term investors, or is Warren Buffett's optimism misplaced? And would we be in this mess if women were calling the shots on Wall Street? In this second of three installments, I ask Liar's Poker author Michael Lewis, editor of a new anthology, Panic: The Story of Modern Financial Insanity.
For the full audio version of the interview, click here.
Mac Greer: Michael, I know your employer at one point, Salomon Brothers, was the first Wall Street firm to go public. And when Salomon Brothers goes public and other big Wall Street firms go public, the game changes?
Michael Lewis: Dramatically, because all of a sudden what happens is the employees keep a large chunk of the upside of any risky bets and none of the downside. Before they had the downside and the upside and the firms, as partnerships, took much less risk and never would take risks, single risks that would sink the whole firm because essentially all the partners' wealth was tied up in these places. Once the firms are corporations, well then the game becomes shoot the moon and just disguise the fact that you are shooting the moon because if you are right; let's say you are faced with a bet that has got a 60% chance of working out and a 40% chance of failing. A pretty good bet, right?
Greer: I like it, yeah.
Lewis: You like that bet and if they let you bet as much as you want on it and you get to keep the winnings, you would probably just bet as much as you could on it.
Lewis: But there is still a 40% chance that it is going to fail and if it fails, the firm goes down. This was starting when I was at Salomon Brothers. John Meriwether's traders, who went on to become Long Term Capital Management and so on, were increasingly allowed to make bets, that if they had gone wrong, could have sunk the firm and they were smarter than everybody else and for a long time, they did really, really well, but it was still risky. There were still catastrophic risks being run and these firms; what happened in the minds of Wall Street people is really interesting, I think, because I think part of this story is how the normal levels of pay changed so that when I got to Wall Street, if you made a million bucks in a year, you were really happy. You were big time. Million, two million, that was pretty great.
That became chump change. The levels of compensation became just extraordinary where people were making $10, $20, $30, $40, $50, $60, $70, $80 million inside these firms. If you back away from it and ask, "How do you make that kind of money as a financial person?" Well, it is very unlikely you are making it by adding that kind of value, by you actually being that valuable. You make it by taking huge risks and the risks paying off. I think people thinking that it was normal to get paid that much helps them get their minds around taking that much risk.
Greer: In terms of taking that sort of risk, is that unique to the male persuasion? Would this whole thing have unfolded differently if women were calling the shots on Wall Street?
Lewis: Yeah, that is a really good question. It was some academic research that ... was trying to analyze performance in the stock market, according to sex, and found that the most success. If you took a single woman, did better than a married woman and a married woman did better than a married man and a single man did worst of all. The presence of women was a good thing for an investment portfolio.
I don't think men are worse than women, but they are different and they are; I do think that if you waved a wand over Wall Street and it put women in the seats of genuine power through all of this, you never would have had the risk-taking.
Greer: And it sounds like ideally we want Henry Paulson to be a single woman.
Lewis: (Laughing.) Maybe he is ... wearing an incredible wig.
Greer: (Laughing.) That is your next book. I want to talk a little more about your experience at Salomon Brothers. I believe you wrote Liar's Poker back in 1989 and reflecting back on that experience at Salomon Brothers, you had this to say. You said, "To this day, the willingness of a Wall Street investment bank to pay me hundreds of thousands of dollars to dispense investment advice to grown-ups remains a mystery to me. I was 24 years old with no experience of or particular interest in guessing which stocks and bonds would rise and which would fall. The essential function of Wall Street is to allocate capital to decide who should get it and who should not. Believe me when I tell you that I hadn't the first clue."
Now are you being a bit tough on yourself and to what extent can we basically just say that about everyone on Wall Street now?
Lewis: Well I am being completely honest. I think I described myself as an intelligent observer would have described me. The piece you are referring to is the piece that is in the current issue of Portfolio magazine, where I basically, as the author if Liar's Poker, wander back on to the Street and figure out what the hell happened here. I think that there are really smart people on Wall Street, and there are people who are suited to the job. Warren Buffett is suited to the job. But there are a lot more people doing finance than should be doing finance. The system has evolved to reward all kinds of quixotic personalities and talents that have nothing to do with actually making shrewd decisions about capital allocation.
Greer: Any thoughts on Warren Buffett's recent call that U.S. stocks are a good place to be for the next 10 years?
Lewis: Well, you really don't, and I have done it before, want to take on Warren Buffett. It is sort of a game that doesn't pay. Let me tell you what I have done. I have actually just started buying S&P index funds, just now, just in the last week or so. I had been on the sidelines for a long time, so I got a huge amount of cash and those. And I am going to average down if I have to average down, so I guess I agree with him, but I don't really know. I wouldn't want anybody to take my advice and he doesn't know, he just thinks. He doesn't know how bad it could get because how bad it gets depends in large part on investor psychology, and that is essentially unpredictable.
I think that in the long run; the problem with Warren Buffett is that in the short run he is dead. In the long run, we are all dead. If you are an older person, if you are talking to a 75-year-old person saying, "Should you get in the stock market with your retirement funds right now?" I would say it is insane. You don't know what it is going to do. God, it could go to 4,000; it could go anywhere. We are in the middle of a panic, but if you are a middle-aged person or a young person, it makes complete sense. I don't feel at all uncomfortable having my children's college funds in the stock market because they are 9 and 6 and 2 years old.