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Lehman Brothers, he notes, certified it was in good health in June 2008 and issued stock, attracting investment, including from the New Jersey Teachers’ Pension and Annuity Fund. Secretly, Lehman was on an intravenous drip, poisoned by bad debt.
“My respect for their brains is too great to think Lehman’s top guys didn’t know they were conveying the cynical impression of health,” Mr. Lewis said.
He is no less suspicious of Goldman Sachs, which has alumni sprinkled across the upper reaches of government. In a tough spot, Goldman obtained extraordinary permission to make an overnight metamorphosis from investment bank to traditional bank holding company.
“Can I prove this was a wired deal? Absolutely not,” Mr. Lewis said. “Am I certain of it? Only 100 percent.”
As for the whirling, three-million-shares-per-second casino of Wall Street? He sees it as rigged. “I would not risk stocks under any circumstances,” he said, “because we don’t know when this thing is going to blow.”
Because everything essentially is.
“That,” Mr. Lewis said recently, “was when I realized that the trouble on Wall Street was systemic.”
A Lonely Redemption
By MICHAEL POWELL and DANNY HAKIM
September 15, 2012
ESSEX, N.Y. — Striding barefoot through the fields of his farm in the Adirondacks, S. B. Lewis, known as Sandy, is talking without pause, gesturing this way and that in a soft summer rain.
That Mr. Lewis is in a rage is not unusual. A few days earlier, he had watched as the computerized stock trading of Knight Capital ran amok.
“If Knight blows, six firms follow, and the whole corrupt thing goes up,” he said. “Predator banks and hedge funds run the market for their pleasure — there’s no rational structure, nothing!”
He is just warming up. News reports have revealed a world he knows intimately. Goldman Sachs pays vast fines to avoid prosecution for mortgage securities fraud. Barclays manipulates interest rates. The Senate exposes HSBC as a racketeering enterprise, laundering money for drug cartels. Banks are laden with bad assets.
And Wall Street, Washington, the press corps, everyone sits and stares like so many dumb cows.
“The complicity on Wall Street is sickness!” Mr. Lewis says. He fixes you with his laser stare. “If you think the big firms are being honest” — his tone slides streetwise — “well, sweetheart, go think something else!”
The temptation is to dismiss Mr. Lewis, 73, as a crank, except he once ruled as an eccentric genius of arbitrage, with a preternatural feel for the tectonic movements of the markets. He has railed for decades about venalities now on daily display. Rude truth is his currency.
He knows Wall Street’s heights. He helped hire Michael R. Bloomberg, and he invested the money of two former Securities and Exchange Commission chairmen, making a fortune in the 1980s. And he knows its depths, since he pleaded guilty to stock manipulation in 1989, and was barred from the Street.
President Bill Clinton pardoned him, and a federal court judge later said Mr. Lewis acted out of pure reforming impulse.
But he remains in self-imposed exile.
Mr. Lewis wants to flip over Wall Street’s paving stones and search for worms. He relies on his singular strength: he discerns patterns where most see random data. He forecast the financial meltdown of 2008 that vaporized Bear Stearns, Merrill Lynch and Lehman Brothers. In 2006, he warned a Bear Stearns executive: “Bear is toast. Get out now!”
Lehman Brothers, he notes, certified it was in good health in June 2008 and issued stock, attracting investment, including from the New Jersey Teachers’ Pension and Annuity Fund. Secretly, Lehman was on an intravenous drip, poisoned by bad debt.
“My respect for their brains is too great to think Lehman’s top guys didn’t know they were conveying the cynical impression of health,” Mr. Lewis said.
He is no less suspicious of Goldman Sachs, which has alumni sprinkled across the upper reaches of government. In a tough spot, Goldman obtained extraordinary permission to make an overnight metamorphosis from investment bank to traditional bank holding company.
“Can I prove this was a wired deal? Absolutely not,” Mr. Lewis said. “Am I certain of it? Only 100 percent.”
As for the whirling, three-million-shares-per-second casino of Wall Street? He sees it as rigged. “I would not risk stocks under any circumstances,” he said, “because we don’t know when this thing is going to blow.”
Nothing about Mr. Lewis is easy. He delights in sending scabrous, insulting, free-associative mass e-mails to journalists, financiers and members of Congress. Show annoyance, and he doubles down. “You know what I do with tension?” he said. “I ratchet it up!”
Not surprisingly, some dismiss him as a nut. As striking are those who pay careful heed.
“Sandy’s right; government created a banking oligopoly with no accountability,” said Peter Solomon, a friend of Mr. Lewis’s who runs an investment banking firm.
Arthur Aeder, a retired accounting executive, was twice fired by Mr. Lewis.
“Not many antagonize Goldman just for the hell of it,” Mr. Aeder said. “Most people think, ‘I have a family to feed.’ ”
Mr. Lewis is no less harsh on himself. After a visit, he handed us laptops containing every furious e-mail he had sent and received over 10 years.
“The Wall Street ethic broke decades ago,” he said by way of goodbye. “The stink is terrible.”
MR. LEWIS was born to Wall Street royalty — his father, Cy, was managing partner at Bear Stearns from 1949 to 1978.
His parents were characters out of a Fitzgerald novel: his father was Jewish, debonair and domineering; he desired power, wealth and a beautiful woman — wife or mistress, that mattered little. His mother, Diana Bonnor, a member of the Protestant establishment, was beautiful, brilliant and no less formidable. She cared about social justice and status and was profoundly uninterested in mothering.
“I never remember her at breakfast,” recalled Roger Lewis, Mr. Lewis’s younger brother. “High tea? Oh, yes. Cocktails? Yes! But breakfast? Never.”
Cy doted on Sandy while Diana screamed at the boy, striking him with a hair brush when he refused to read, he said. A willful child, the boy stopped speaking for days and sometimes retreated onto a window ledge, sitting high above Park Avenue.
Another brother, John, renounced wealth, bought clothes in thrift shops and became a well-known legal-aid lawyer. Roger got off to a fine start on Wall Street until the Grateful Dead moved into his town house before Woodstock. He ingested gobs of LSD, was arrested on charges of selling drugs and served time. “I broke all the bonds of polite behavior,” Roger said. “Prison was pretty fascinating.”
When Sandy Lewis was 10, his parents shipped him off to Chicago and Bruno Bettelheim’s Orthogenic School, an institution for emotionally disturbed children. The first day, he held his breath until he nearly passed out. But he credits the school with saving his life; Bettelheim became a second father.
“He had Bruno’s traits: he was arrogant, controlling, all powerful — and generous,” recalled George Kaiser, a former teacher at the school.
Mr. Lewis saw in Wall Street a three-dimensional chess game played at great velocity. “Brain not brawn, and the smartest wins, yes!” he said.
He came to conceive of the Street as a drainage system, every pipe connected to another. Inside information sluiced from brokerages to white-shoe law firms to investment houses.
He glimpsed this world when he returned to New York in 1964. He said he sat in the front of his father’s Cadillac limousine, listening as Cy and friends talked angrily about a partner who had impersonated a reporter for The New York Times and got a half-hour drop on a Supreme Court decision. The firm profited by trading ahead of the news.
Mr. Lewis said he confronted his father that night. Dad, you must fire that man. Cy shook his head: He is too valuable, Son.
“That,” Mr. Lewis said recently, “was when I realized that the trouble on Wall Street was systemic.”
He refused to sit at the Four Seasons trolling for inside tips and paying for call girls for clients.
He was fired by all the best firms: Salomon Brothers, White Weld, Dean Witter and Merrill Lynch. At Merrill, the chief executive officer at the time, Donald Regan, pursued a system to buy and sell stocks without using the exchange floor. Mr. Lewis came to see this creation as unfair to the public.
So Mr. Lewis, in speeches and work with the S.E.C., fought to make all sales transparent on the floor of the exchange. “In one of my periodic periods of unemployment, I walked down the street thinking, ‘O.K., now I’m going to sabotage Don Regan,’ ” he said. “I have six kids and I’m going to be eating worms.”
He worked briefly for Ivan F. Boesky, until he realized the arbitrage specialist was trolling for inside information. Mr. Lewis quit and Mr. Boesky was later imprisoned.
To find a place that would not fire him, in 1980 Mr. Lewis established S. B. Lewis and Company. The company’s returns were meteoric — over 50 percent annual returns after expenses. Former employees recall a brilliant arbitrageur who could, without warning, go to “Sandy World,” a mental planetoid with a population of one.
Mr. Lewis brokered the merger between Sandy Weill’s Shearson and James Robinson’s American Express.
“I told Robinson: ‘Weill’s got the brains; you’ve got great class. It’s perfect,’ ” Mr. Lewis recalled.
He had found success, a lovely wife and five boys and a girl, with a home in Short Hills, N.J. Except his volcanic pit never stopped rumbling.
IN November 1988, Rudolph W. Giuliani, the United States attorney, indicted Mr. Lewis on 22 charges, accusing him of manipulating the stock of a large insurer. Mr. Giuliani was a Savonarola in the canyons of mammon, and Mr. Lewis would fall beneath his sword.
Rivals shared laughs at Sandy the Moralist laid low. The trouble, however, took root not in venality but in his mania to police his industry. He had watched as insiders reaped profits by driving down prices before shares went public.
He laid a trap. He asked another securities firm to buy stock in the insurer to shore up the price. I’ll cover your losses and describe the payments as “investment banking services,” he told them.
Mr. Lewis hoped to deliver a delicious kick to the teeth of the insiders. He made not a dime; his firm was not involved in the offering.
Years later, a federal judge, William C. Conner, described Mr. Lewis’s action as “an act of market vigilantism in which Lewis in no way personally profited.” He was infuriated, the judge wrote, “by what he viewed as the unethical actions of arbitrageurs.”
“He was the Lone Ranger,” Mr. Solomon recalled, “and Giuliani treated him like a member of the corrupt club.”
Prosecutors threatened Mr. Lewis with 15 years if he went to trial. His wife, Barbara, urged him to cut a deal. He argued prison would be interesting. His bravado reinforced her fears.
Silver haired and trim, she looks at Mr. Lewis, still consumed: “I thought he would die. That was weak of me.”
He pleaded guilty to three charges, and the judge handed him three years’ probation and a $250,000 fine.
TELL us about Bill Clinton. Mr. Lewis cannot resist a smile; even by his standards, this is a weird tale.
In the summer of 1994, Mr. Lewis — in exile — got a phone call at his Maine home from his friend, Douglas S. Eakeley. Mr. Eakeley was also an old friend of Mr. Clinton’s.
I want you to go to a fund-raiser in Portland, Mr. Eakeley said, and talk with the president about his womanizing.
Is this, Mr. Lewis asked, an intervention?
As it happens, Mr. Lewis possesses a sixth sense for psychic pain. He can pick the addicted, the sick and the depressed out of a crowd. His fractured childhood and pathological candor give him an expert hand with the singed.
He rounded up Barbara and a friend, Dr. Stanley Evans, and drove to see Mr. Clinton at the Holiday Inn by the Bay.
Mr. Lewis introduced himself. “You’re Doug’s friend?” the president said, according to Mr. Lewis and Dr. Evans. “Wait, we’ll talk.”
The Secret Service escorted Mr. Lewis, his wife and the doctor into the kitchen, and the president followed.
“Sir,” Mr. Lewis recalled saying as he stared at Mr. Clinton. “Doug thought maybe I should spend a weekend with you. It would be the two of us only.”
Mr. Lewis said the president was taken aback. “What is this about?”
“Sir,” Mr. Lewis said, “this is about your most personal business. You probably won’t be too happy with me by Monday morning, but I think we can avoid a train wreck.”
The president’s face flushed. Dr. Evans realized his friend was confronting the president about his extramarital affairs. “I thought Sandy had lost his mind,” he said.
The weekend session never took place. Revelations of the president’s sexual dalliance with Monica Lewinsky came years later.
Mr. Eakeley is circumspect. “Sandy has incredible intuition and intellect, and I knew he could help if the president could stand it,” he said. “Sandy may have alarmed the president, but I don’t think he repelled him.”
Mr. Clinton’s office declined to comment.
So it goes for Mr. Lewis on his walk, decades long, through the wilderness. One night, he said, he yanked a truck driver out of a fiery wreck on the New Jersey Turnpike, only to discover that the driver had Mafia connections. He said a mob representative told him he could call in his i.o.u. anytime; Mr. Lewis declined, politely.
He became the de facto impresario of the Clinton Correctional Facility, a prison near his farm in the Adirondacks, arranging frequent performances. The prison has housed a who’s who of the criminal and homicidal, from Lucky Luciano to the serial killer Joel Rifkin.
Recently, Mr. Lewis brought in Helena Baillie, 30, an accomplished violinist who is akin to his surrogate daughter, to perform Bach’s “Chaconne” in the Church of St. Dismas, the Good Thief. Many prisoners were in tears.
Mr. Eakeley said Mr. Lewis might be better for his exile. One of Mr. Lewis’s sons, John, is not convinced. He sees a father become “walking id.”
“Giuliani,” he said, “obliterated some part of him.”
In 2000, Mr. Eakeley and former Attorney General Nicholas deB. Katzenbach worked pro bono and submitted a pardon application to Mr. Clinton. In January 2001, just before leaving office, the president signed it.
Six years later, Judge Conner overturned the S.E.C. order that barred Mr. Lewis from Wall Street. “Federal regulations now outlaw the very practice his actions were meant to thwart,” the judge noted.
No cloud of mellow descended. Mr. Lewis trailed the S.E.C. counsel out of the courthouse. “I will rip your guts out,” he bellowed. “Letter to follow!”A few days later, he looked at the mountains and experienced an epiphany: “I’ve gotten my redemption, and no one cares.”
THE phone rings and Mr. Lewis, in midsentence of a long disquisition, picks up the receiver. A North Country car dealer asks about the economy.
“Yes? Yes!” he listens for 30 seconds. “It’s going to get a lot worse. We’ll be burning scrap wood in our fireplaces before it’s over. Goodbye!”
Among residents of this rural land, Mr. Lewis has a reputation as a savant. He warned that the housing market was overheating years ago and sold several properties. He converted to cash before the 1987 stock crash.
Still, he could not complete the last act in his redemptive play. Financiers with White House connections solicited his advice during the 2008 crisis. But he was not invited into the circle of advisers who, to his mind, poorly served this young president.
As a Wall Street friend warned in an e-mail: “Sandy, you constantly kill yourself. You exhaust folks.”
Mr. Lewis considers his plight over a dinner with Barbara. His eyes are red, his voice a rasp. “I’m bright as hell, but I’m impossible to live with.” Barbara nods. “I am in a state of outrage all the time.” Barbara nods. “I bring this Orthogenic morality to everything on Wall Street, and it’s unsustainable.” Barbara, dry as gin, says, “No kidding.”Mr. Lewis sees a banking system in unstable remission.
Goldman answers to no one. China and Europe are wobbling, deflation is at the door, another crash is coming.
“The criminality is astounding,” he says. “You have a complete confusion between principal and principle.”
He is pacing again. “You don’t understand what it is to find someone on Wall Street who tells it like it is. You want to get real? Baby, let’s do the full root canal!”
And more and more. I mean, come onnnnn . . . they had to sell the shi(r)t to somebody!
The results are explosive. Hundreds of pages of internal Morgan Stanley documents, released publicly last week, shed much new light on what bankers knew at the height of the housing bubble and what they did with that secret knowledge.
January 23, 2013
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Financial Crisis Suit Suggests Bad Behavior at Morgan Stanley
By JESSE EISINGER, ProPublica
Morgan Stanley’s headquarters in New York. The financial firm is being sued by a Taiwanese bank over mortgage-backed securities it sold.
(Richard Drew/Associated Press)
On March 16, 2007, Morgan Stanley employees working on one of the toxic assets that helped blow up the world economy discussed what to name it. Among the team members’ suggestions: “Subprime Meltdown,” “Hitman,” “Nuclear Holocaust” and “Mike Tyson’s Punchout,” as well a simple yet direct reference to a bag of excrement.
Ha ha. Those hilarious investment bankers.
Then they gave it its real name and sold it to a Chinese bank.
We are never going to have a full understanding of what bad behavior bankers engaged in in the years leading up to the financial crisis. The Justice Department and the Securities and Exchange Commission have failed to hold big wrongdoers to account.
We are left with what scraps we can get from those private lawsuits lucky enough to get over the high hurdles for document discovery. A case brought in a New York State Supreme Court in Manhattan against Morgan Stanley by a Taiwanese bank, which bought a piece of the same deal the Chinese bank did, has cleared that bar.
The results are explosive. Hundreds of pages of internal Morgan Stanley documents, released publicly last week, shed much new light on what bankers knew at the height of the housing bubble and what they did with that secret knowledge.
The lawsuit concerns a $500 million collateralized debt obligation called Stack 2006-1, created in the first half of 2006. Collections of mortgage-backed securities, C.D.O.’s were at the heart of the financial crisis.
But the documents suggest a pattern of behavior larger than this one deal: people across the bank understood that the American housing market was in trouble. They took advantage of that knowledge to create and then bet against securities and then also to unload garbage investments on unsuspecting buyers.
Morgan Stanley doesn’t see the narrative as the plaintiffs do. The firm is fighting the lawsuit, contending that the buyers were sophisticated clients and could have known what was going on in the subprime market. The C.D.O. documents disclosed, albeit obliquely, that Morgan Stanley might bet against the securities, a strategy known as shorting. The firm did not pick the assets going into the deal (though it was able to veto any assets). And any shorting of the deal was part of a larger array of trades, both long and short.
Indeed, Morgan Stanley owned a big piece of Stack, in addition to its short bet.
Regarding the profane naming contest, Morgan Stanley said in a statement: “While the e-mail in question contains inappropriate language and reflects a poor attempt at humor, the Morgan Stanley employee who wrote it was responsible for documenting transactions. It was not his job or within his skill set to assess the state of the market or the credit quality of the transaction being discussed.”
Philip Blumberg, the Morgan Stanley lawyer who composed most of the names, meet the underside of a bus, courtesy of your employer.
Another Morgan Stanley employee sent an e-mail that same morning, suggesting that the deal be called “Hitman.” This might have been an attempt to manage up, because “Hitman” was the nickname of his boss, Jonathan Horowitz, who helped head the part of the group that oversaw mortgage-backed C.D.O.’s. Mr. Horowitz replied, “I like it.”
Both Mr. Blumberg and Mr. Horowitz, now at JPMorgan, declined to comment through representatives at their banks.
In February 2006, Morgan Stanley began putting together the Stack C.D.O. According to an internal presentation, Stack “represents attractive business for Morgan Stanley.”
Why? In addition to fees, another bullet point listed: “Ability to short up to $325MM of credits into the C.D.O.”
In other words, Morgan Stanley could — and did — sell assets to the Stack C.D.O., intending to profit if the securities backed by those assets declined. The bank put on a $170 million bet against Stack, even as it was selling it.
In the end, of the $500 million of assets backing the deal, $415 million ended up worthless.
“While investors and taxpayers all over the world continue to choke on Wall Street’s toxic subprime products, to this day not a single major Wall Street executive has been held accountable for misconduct relating to those products,” said Jason C. Davis, a lawyer at Robbins Geller who is representing the plaintiff in the lawsuit.
“They are generally untouchable, but we are pleased that the court in this case is ordering Morgan Stanley to turn over damning evidence, so that the jury will get to see what Morgan Stanley really knew about the troubled nature of its supposedly ‘higher-than-AAA’ quality product.”
Why might Morgan Stanley have bet against the deal? Did its traders develop a brilliant thesis by assessing the fundamentals of the housing market through careful analysis of the public data? The documents suggest something more troubling: bankers found out that the housing market was diseased from their colleagues down the hall.
Bankers were getting information from fellow employees conducting and receiving private assessments of the quality of the mortgages that the bank would purchase to back securities. These reports weren’t available to the public. It would be crucial information for trading in securities backed by those kinds of mortgages.
In one e-mail from Oct. 21, 2005, a Morgan Stanley employee warned a banker that the mortgages Morgan Stanley was buying from loan originators were troubled. “The real issue is that the loan requests do not make sense,” he wrote.
As an example, he cited “a borrower that makes $12K a month as an operation manger (sic) of an unknown company — after research on my part I reveal it is a tarot reading house. Compound these issues with the fact that we are seeing what I would call a lot of this type of profile.”
In another e-mail from March 17, 2006, another Morgan Stanley employee wrote about a “deteriorating appraisal quality that is very flagrant.”
Two of the employees who received those e-mails joined an internal hedge fund, headed by Howard Hubler, that was formed only the next month, in April 2006.
As recounted in Michael Lewis’s “The Big Short,” Mr. Hubler infamously bet against the subprime market on Morgan Stanley’s behalf, a fact that Morgan Stanley’s chief financial officer conceded in late 2007. Mr. Hubler’s group was supposed to be separate from the rest of Morgan Stanley, but the two bankers continued to receive similar information about the underlying market, according to a person briefed on the matter.
At no point did they receive material, nonpublic information, a Morgan Stanley spokesman says.
I struggle to see how the private assessments that the subprime market was imploding were immaterial.
Another of Morgan Stanley’s main defenses is that it couldn’t have thought the investment it sold to the Taiwanese was terrible because it, too, lost money on securities backed by subprime mortgages. As the Morgan Stanley spokesman put it, “This deal must be viewed in the context of a significant write-down for Morgan Stanley in 2007, when the firm recorded huge losses in its public securities filings related to other subprime C.D.O. positions.”
This is a common refrain offered by big banks like Citigroup, Merrill Lynch and Bear Stearns to absolve them of any responsibility.
But does losing money wipe away sin?
Yes, Mr. Hubler made his bets in what turned out to be a deeply disastrous way. As part of a complex array of trades, he bet against the middle slices of subprime mortgage C.D.O.’s. He bought the supposedly safe top parts. The income from the top slices helped offset the cost of betting against the middle slices.
But when the market collapsed, the top slices — called “super senior” because they were supposedly safer than Triple A — didn’t hold their value, losing billions for Mr. Hubler and Morgan Stanley. Mr. Hubler did not respond to requests for comment.
So Morgan Stanley lost a great deal of money.
But let’s review what the documents suggest is the big picture.
In the fall of 2005, bank employees shared nonpublic assessments of how the subprime market was a house of tarot cards.
In February 2006, the bank began creating Stack in part so that it could bet against it.
In April 2006, the bank created its own internal hedge fund, led by Mr. Hubler, who shorted the subprime market. Among the traders in this internal shop were people who helped create Stack and other deals like it, and at least two employees who had access to the private due diligence reports.
Mr. Hubler’s group had no investment position in Stack, according to the person briefed on the matter, but it sure looks as if the bank saw what was coming and tried to position itself for a subprime market collapse.
Finally, by early 2007, the bank appeared to realize that the subprime market was faring even worse than it expected. Even the supposedly safe pieces of C.D.O.’s that it owned, including its piece of Stack, were facing losses. So Morgan Stanley bankers set to scouring the world to peddle as a safe and sound investment what its own employees were internally deriding.
Morgan Stanley declined to comment on whether it made money on its Stack investments over all. But it looks to have turned out well for the bank. In Stack, it managed to fob off a nuclear bomb to the Taiwanese bank.
Unfortunately for Morgan Stanley, it had so many other pieces of C.D.O.’s, so many nuclear warheads, that it couldn’t find nearly enough suckers around the world to buy them all.
And so when the real collapse came, Morgan Stanley was left with billions of dollars in losses.
That hardly seems exculpatory.
(Jesse Eisinger is a reporter for ProPublica, an independent, nonprofit newsroom that produces investigative journalism in the public interest. Email: jesse@propublica.org. Twitter: @Eisingerj).
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