Michael Lewis on Change for Wall Street

Jack Otter: As the fall out from 2008’s financial crisis continues, many people are still arguing about what went wrong. Author Michael Lewis answers that question with withering precision in his newest book The Big Short: Inside the Doomsday Machine. Hi Michael, thanks for being here. Michael Lewis: My pleasure. Thanks for having me. Jack Otter: So, a lot of books have come out but they’ve all been focusing on the big players everyone’s heard about, the Geithner’s, Bernanke’s and Paulson’s You write about some people I’d never heard about who actually saw that Wall Street was a house of cards and bet against the subprime market. Did all of Wall Street really missed this whole thing or did they just not want to understand what was going on? Michael Lewis: Well, both. They owe Wall Street and this whole thing and they didn’t want to understand what was going on which is why they missed it. I mean, I think the system largely rewarded people for cooperating and for not seeing the facts as they were and I think it’s generally true that anybody who was in a position of an authority when the crisis hit by definition and not seeing the problem as it grow. It interested me that they were these characters, oddballs, though they were who had not only seen it but they described it in some detail and laid pretty big bets in the market that the subprime mortgage bond market was going to collapse, the financial system was going to collapse. Jack Otter: Well, at this point, you still say that a lot of these financial firms would fail without government support. Michael Lewis: Even now. Jack Otter: Why do they still need taxpayer money? Michael Lewis: Because there are probably two layers to the answer. The first is -- and I don’t know the answer right now but certainly, even months after the bailout, there were enough of them had actual losses that were big enough that they were unsolved. I mean they had run, they are running very highly leverage debts, a dollar of capital for $30.00 of debts and the $30.00 of debts included big debts on the subprime mortgage bond market. Some of which had gone to zero and so, they were insolvent, some of them, not all of them. I mean the first answer is that -- the second is that -- I mean I think that a bank just generally to staying in business requires people to believe it’s going to be in business and so, there has to be a restoration of kind of a blind faith in these companies and I don’t think anybody has any blind faith in them right now. So, even if they weren’t insolvent right now, they might be run off, run out of business if they didn’t have the implicit government guarantee behind them. Jack Otter: And yet they still apparently have a lot of faith in themselves because they paid what? $20 billion in bonuses last year? Michael Lewis: Who’s counting right? They have interpreted what has been an enormous gift from the U.S. taxpayer that it takes many, many forums to themselves in order to keep them, in an order to restore their strength, they’ve interpreted that as a sign of their own success and it paid themselves accordingly. Jack Otter: So, you write that Wall Street is always going to be greedy but the problem we need to deal with is the system of incentives that channel that greed. Michael Lewis: Yes. Jack Otter: What do you mean by this? Michael Lewis: I mean greed is channeled to be a very short-term greed and it should be long-term greed that you can’t expect people who’ve got to work on Wall Street not to want to make money at the expense of lots of other things. All you can expect them to do is when they make money to also help the rest of us make money. You want their enterprise to be productive and not unproductive. So, what we have seen most notably in the last few years but even while before that is essentially a financial system that’s detached from their productive economy in which people are paid for doing actually very destructive things and because they’re paid to do them, they do them and they’re paid also for a very short-term performance. They’re judged on very short-term performance. So, it’s not surprising that they make decisions for the short-term that are expensive in the long-term. One such decision is for example selling lots of insurance on subprime mortgage bonds that might be catastrophic but in the very short-term, their premium is coming in, so it looks like you’re making money. It looks like free money until down the road, things go bad. Jack Otter: So, is there anything the Congress can do about that? The Senate is debating regulatory form right now, can incentives change? Michael Lewis: Oh, absolutely. Absolutely! I mean I think that if the strong version of the Whitehouse’s proposals gets through, it will probably change the structure of the financial industry. I mean what it’s going to do? I mean for example if you were to eliminate proprietary trading in the big Wall Street firms, you would dramatically reduce the volatility of earnings and so, you’d eliminate these big picks and the big trough. In eliminating the big picks, you dramatically suppress compensation. So, I think that it would be one measure of the success of the reforms as if what we’re left at in the end are less lucrative jobs inside big Wall Street firms and that would be a very good thing. Jack Otter: You know you hear people arguing about this on CNBC and the anti-regulation people always say, “Well, the vocal rule, the separation of proprietary trading, that wouldn’t really address the problem here”—these big bangs, what hurt them wasn’t the proprietary trading but your book pretty much puts the lie to that. Michael Lewis: That’s a lie. It’s just a lie. I mean, they all took on enormous risks that were disastrous. There are a couple of exceptions but just generally, they were all one way or another exposed to the thing because they are proprietary trading books. In general, it’s like this great question, “Why on earth are firms allowed to trade for their own account?” In securities, they’re advising customers to buy and sell. That conflict of interest creates a poisonous environment because the minute I, Goldman Sachs and Morgan Stanley can bet my own money on the things I’m trying to get you to buy, it creates an incentive for me to create explosive sort of combustible securities, things that are going to go bad. So, I can take the other side of them. And so, that’s what’s got to be wrong from the system. Jack Otter: You’ve written about this that Wall Street is increasingly trading against its customers. So, would this be the solution? Michael Lewis: This is a part of a solution. Consumer protection agency would help to rejiggering of the incentives and the supervision of the ratings agencies would help to and maybe we help them most of all is to insist that everything is traded in Wall Street, everything is traded on screens that everybody can see and through exchanges or clearing houses. So, that sense of the price which they’re supposed to trade is as open and transparent as possible. Jack Otter: And that’s the proposal to make derivatives more transparent. Michael Lewis: Yes. So, the proposals are all in the right direction. This question of how quickly they get done or whether they get done and this is going to turn entirely on popular sentiment. If people push their elected officials to make this happen, it will happen. Jack Otter: Did you learn anything researching this book that changed the way you handle your personal finances? Is there something that individual investors can learn? Michael Lewis: Well, I move my money out of Merrill Lynch and into Schwab. I used to have a Merrill Lynch account and I felt like I was forever defending myself against Merrill Lynch and because there was an agenda, sell the customer auction rate securities. In a lot of cases, customers were peddled equity in tranches of yes, of subprime mortgage bonds and you don’t want to be in a place where you don’t know why you’re being advised to do which you’re being advised to do. So, that’s an independent broker. There’s still a problem and there’s still a little bit of an incentive, not a little bit, an incentive to encourage turnover, trading is always -- and I think there’s a bias in the market for too much trading activity but it’s really reassuring to know that the person who I’m talking to doesn’t got a position he’s trying to unload on me. Jack Otter: Michael Lewis, thank you very much for being with us. Michael Lewis: Thanks for having me. Jack Otter: And thank you for watching.