Michael Lewis on Fixing Wall Street

On a sunny day last week at Fool HQ, best-selling author Michael Lewis recounted his experience selling bonds at the former brokerage firm Salomon Brothers:

"When I became the salesperson, I was in an unpleasant situation that kept me up at night. I found the people evaluating me inside Salomon Brothers to be uncooperative and unhelpful if I wasn’t trying to screw the customer on behalf of the trader. Nobody has really explained to me why a single financial firm should be allowed to trade for its own book in securities that it’s advising customers to buy and sell. It creates a naturally poisoned relationship, and worse, it creates an incentive for a Wall Street firm to design securities that will explode, because they can take the other side."

Lewis’s experience took place in the 1980s, but the flawed incentive system and structure he describes continue to rule Wall Street to this day, as anyone who witnessed the recent crash can surely attest.

Lewis made a splash in the financial world with his first best-selling book, Liar’s Poker, which exposed the greed, corruption and excesses on Wall Street. Since then, he has written several more best-sellers, including Moneyball and The Blind Side. Unless you’ve been living under a rock, you know Sandra Bullock won a Best Actress Oscar for her role in the movie version of The Blind Side this year. And Moneyball is being made into a movie starring Brad Pitt due out next year.

Lewis’s latest book, The Big Short: Inside the Doomsday Machine, tells the story of the few who saw the subprime mortgage crisis coming and bet against it, or shorted it, to become millionaires. They saw the problems AIG (NYSE: AIG  ) and Citigroup (NYSE: C  ) did not.

Though Lewis admits he’s been receiving angry messages on his Bloomberg terminal since the release of his new book, he also says he has a lot of friends who work on Wall Street and that he doesn’t know of any who disagree with him. “Inside the financial world, there is a [mind-set of] ‘please stop us before we kill again,’” Lewis said. He recounted Morgan Stanley (NYSE: MS  ) Chairman John Mack’s quote: “Regulators have to be much more involved. We cannot control ourselves.”

Lewis added, “So I don’t think Wall Street is uniformly opposed to reform or opposed to a negative interpretation of what’s happened over the last few years. I think they have a hard time ignoring it.”

If Lewis were God ...
Lewis said he thinks we should separate entities like Charles Schwab (NYSE: SCHW  ) , which offer advice on different levels, from entities like hedge funds that trade their own book. “People who are making the bets don’t have direct contact with the end investor,” he said.

 The Volcker rule, which works toward that goal, is a good idea in Lewis’ view, but is only one example of position-taking by firms. (The rule channels a lighter Glass-Steagall-like separation of commercial banking operations from investment banking operations by -- among other stipulations -- proposing a ban on proprietary trading from commercial bank operations.) “True, it would probably result in some minor increase in inefficiency,” Lewis said, “because there’s an extra step between the investor and the trader of the securities. But I think it would be more than compensated for by the added level of trust in the marketplace.”

Indeed, if Lewis had it his way, everything that could be traded on Wall Street would be traded through clearinghouses or on exchanges: “So there would be no such thing as me at Goldman Sachs (NYSE: GS  ) being able to call you at Morgan Stanley and make a $5 billion bet on subprime mortgage bonds that basically isn’t on the books that investors can’t evaluate -- or that, if Morgan Stanley goes down, no one knows whether it’s there or not,” he said. “It creates all this uncertainty for the market. So all trading would be as out in the open as it could be.”

Lewis said he would “insist” that the proprietary-like trading be done in a partnership structure, rather than in a public corporation. “No partnership would ever be sitting on $50 billion of AAA-rated CDOs backed by subprime mortgages,” he said. “The attitude toward risk-taking in a partnership is just different. It’s not that partnerships can’t do stupid things, but it’s much less likely.” This speaks to one of the great themes in this era of finance: how badly the smart money failed to live up to its name. “The Wall Street firms became the dumb money, and that’s shocking,” he said.

Back on earth ...
In reality, though, the plan for reshaping our financial system is taking the possible form of Sen. Chris Dodd’s proposed bill. Lewis said he’s worried the Dodd bill will politicize the Fed, giving the central bank more duties that are political in nature. “The more you politicize the Fed, the less likely the money supply is going to be an apolitical decision, and there could be enormous populist pressures to inflate away the deficit. I’m sure we’re going to do it,” he said. It’s just a question of how we do it.”

For example, Lewis favors establishing a separate agency for consumer protection, rather than adding a unit to the Fed. “The mind-set of the Fed is not conducive to thinking about the little guy,” he said.

Whatever shape reform takes, Lewis said, “no one is going to get very far in standing up and defending the existing structure. So I think it’s possible that something really good might happen between now and November.”

That’s what Michael Lewis thinks. Tell us what you think in the comment box below.

Interested in more from Michael Lewis? Follow the links below.

Fool contributor Jennifer Schonberger owns does not own shares in any of the companies mentioned in this article. You can follow her on Twitter. Charles Schwab is a Motley Fool Stock Advisor pick. The Motley Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 23, 2010, at 2:32 PM, Ironbob wrote:

    This article is how do you say it---idiotic. Wall Street runs on greed and excess and the corruption is skin deep. It was designed that way. Anyone who thinks or says different is living in a polyanna world. So sorry Michael, you may be able to fool some of the people some of the time but you won't fool me any of the time.

    Sorry but Moneyball was a joke, not even near reality of the situation for Billy Beane and Co. and I suspect this is no different. You want to place blame for the financial crisis? Place it right smack dab on the head of American citizens and the lapdog Democrats who wrapped themselves up in the flag of "civl rights" and forced financial institutions to make loans to deadbeats while bankrupting the country.

  • Report this Comment On September 17, 2010, at 8:16 AM, MarkEvans24 wrote:

    So if Lewis is right, and the Fed turns on inflation, what should we be doing now to come out ahead? Have lots of well chosen, manageable, debt? Have no cash? Have lots of international investments? Non-dollar denominated investments (I don't know what those are)?

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