A 'Justified' Outing For A Loose-Cannon Lawman

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How A Few Made Millions Betting Against The Market

TERRY GROSS, host:

This is FRESH AIR. I'm Terry Gross.

During the financial crisis of 2008, when investment banks collapsed and
the market crashed, a few people had made a fortune betting against the
system. These were people who knew that the bonds bundling subprime
mortgages were bad and would inevitably create a meltdown. These people
and how they managed to see what other investors didn’t are the subject
of the new book "The Big Short: Inside the Doomsday Machine" by my
guest, Michael Lewis.

His first book, "Liar's Poker," was about what he witnessed from 1985 to
'88, when he worked on Wall Street at Solomon Brothers. He says he
thought he was writing about a period when America had lost its
financial mind. He never imagined that the future reader might look back
on that and say: How quaint. How innocent. Lewis is also the author of
"Moneyball" and "The Blind Side," which was adapted into the hit film
starring Sandra Bullock.

Michael Lewis, welcome back to FRESH AIR. Why did you want to write
about the few people who managed to make a fortune on the collapse of
the financial system?

Mr. MICHAEL LEWIS (Author, "The Big Short: Inside the Doomsday
Machine"): There were several reasons, but the main was that, you know,
so much of what's been written and reported about the financial crisis
is through the eyes of people who clearly had no idea what was happening
when it was happening.

I mean, the treasury secretary and the chairman of the Federal Reserve
and the heads of the large investment banks, you know about all these
people one thing: They were clueless when the crisis was gathering
force.

And there were a handful of people who weren't clueless, who actually
saw what was happening while it was happening, who made a lot of noise
about it and who placed bets, essentially, on the collapse of the
financial system. And I thought that point of view was a very
interesting point of view.

Here you had this very strange situation in the financial markets, where
everybody had - was working with the same set of facts about subprime
mortgage lending, about how subprime mortgage loans were turned into
bonds and repackaged and turned into CDOs, and so on and so forth.

And the vast majority of the people in the markets took those facts and
painted one kind of picture with it. It was a very pleasant picture. And
a very small handful of people took the same facts and painted a
completely different kind of picture with it.

And what I really wondered, and what drove me to write a book about
these people, was: What is it about a person to enables them to paint
that picture? Why do these people look at the world differently?

GROSS: Let's talk about one of the characters who you write about in the
book, Michael Barry, who had been studying to be a doctor. I mean,
actually, he was a resident. And then while he was a resident, he was
keeping an investment blog, and so many people started to follow his
blog that he eventually decided to give up medicine and go full-time
into investing, and he actually started a hedge fund. Then he immersed
himself in the bond market, as opposed to choosing stocks. Why the bond
market?

Mr. LEWIS: Well, he found - after several years of choosing stocks,
which he'd done very successfully - that what was going on in the bond
market was going to overwhelm the stock market, because the bond market
was absorbing into it all these subprime mortgage loans that were being
made in America in incredible volumes.

And he realized that he couldn't, in good conscience, make investments
in these stocks without knowing what was going to happen to these
subprime mortgage loans, because they were going to affect his stocks.
And before long, he's essentially conceived a way to turn his portfolio
from a stock market portfolio into a portfolio that is devoted to
betting against the bond market and betting specifically against
subprime mortgage bonds.

GROSS: Now, I should mention here that Michael Barry has Asperger's
Syndrome, although he didn't know it at the time when he started his
hedge fund, and he thinks that helped him be very kind of obsessive in
reading the kind of reports that he needed to read. But how did he
figure out that these subprime mortgage bonds were bad?

Mr. LEWIS: It was interesting because there are a number of different
ways to get to that conclusion, but he does it really by studying the
prospectuses of subprime mortgage bonds. And as he put it, no one who
didn't have Asperger's Syndrome would read these things, they're so
tedious.

But he sees that the way that money is being lent to people is changing
rapidly and for the worse in 2003, 2004, early 2005. And in particular,
he sees that an awful lot of subprime mortgage loans are suddenly
interest-only and negatively amortizing, so that - which is to say that
the borrower not only does not have to repay principal, but if he can't
afford to repay the interest, it just rolls into a higher principal
balance.

And at that point, when there are pools of subprime mortgage loans that
are nothing but these, he thinks to himself the lending couldn't get any
worse, that this real estate bubble is being driven by people being lent
money to buy houses, and there's no - nothing worse the lenders could do
to get the money. So we're arriving at the end of the madness, and
that's the point when he can bet against pools of loans that are nothing
but interest-only, negatively-amortizing subprime mortgage loans that he
begins to bet against the subprime mortgage market.

GROSS: Now, when he wanted to start betting against the subprime
mortgage market, he didn't have a way of doing it, initially. He had to
find a way of doing it.

Mr. LEWIS: This is a curious thing, because the bond market is a - for
someone who doesn't know it and is an outsider like he was, it's a
strange, complicated, arcane thing. It's also the Wild West. I mean, the
stock market is regulated much more carefully than the bond market, and
bond market investors - it's much easier to get ripped off in the bond
market by Wall Street firms than it is to be ripped off in the stock
market.

And he's aware of that, and he's aware there's a lot he doesn't know.
And he starts to read complicated books about the bond market, and he
discovers that in one sphere of the bond market, the corporate bond
market, there is this instrument known as a credit-default swap, which
is essentially insurance. You can buy insurance on a corporate loan, in
effect, and this has existed for roughly a decade.

And he realizes, as the subprime mortgage bond market starts to
mushroom, that Wall Street's bound to invent a credit-default swap for
subprime mortgage bonds. They're bound to invent an insurance contract.
And if you could buy insurance on a subprime mortgage bond, you could
bet against it. If it went bad, the insurance would pay it off. And so
he begins to pester Wall Street firms to create this product
specifically so he can make this bet.

GROSS: So this is the guy who helped create, who urged the investment
banks to create credit-default swaps for subprime mortgage bonds.

Mr. LEWIS: He's the guy who urged them to create something that he could
use. There were some one-off contracts done before that between the
investment banks, but basically, they don't exist until he starts
pestering them.

So yes, he's ground zero. He's the patient number one. He is the person
who is the first investor to make this specific bet.

GROSS: And this is, what, in 2005?

Mr. LEWIS: Yes, it's March - kind of March to May, 2005. He actually is
able to persuade a couple of the investment banks to allow him to make
the bet before the contracts even exist. I think he makes the bet in
March of 2005, and finally he gets a contract in May.

GROSS: Now, Goldman Sachs is one of the banks that he convinced to do
these credit-default swaps for subprime mortgage bonds. Why was Goldman
Sachs willing to do it?

Mr. LEWIS: Well, this is where the story gets really interesting,
because Goldman Sachs had just - weeks before they do their trades with
Michael Barry where they're selling him insurance on subprime mortgage
bonds, Goldman Sachs had persuaded AIG, the insurance company, to sell
them huge dollops of insurance on subprime mortgage bonds in a slightly
form, but nevertheless, it's roughly the same thing.

And AIG had virtually unlimited appetite for this business, that they
were - in a matter of a few months, they sold to Goldman Sachs $20
billion of credit-default swaps on subprime mortgages. So Goldman Sachs
- very cheaply, very low prices, close to free.

And so Goldman Sachs was in the position of an intermediary, looking to
lay off the other side of that. And part of what Goldman Sachs did, I
think, is just take some of it on as a bet. They, too, wanted to be
betting against specific subprime mortgage bonds, but part of what they
did is they turned around and multiplied the price by 10 and sold them
on to Michael Barry.

And these transactions between AIG and Goldman Sachs are the very
beginning of this financial crisis - the narrow part of the financial
crisis, the subprime crisis. This is where, all of a sudden, there is
some big institution in the middle of the financial markets that's
willing to take huge amounts of subprime mortgage bond risk, and it's
AIG.

GROSS: So if Michael Barry basically had to convince Goldman Sachs to
create credit-default swaps for subprime mortgage bonds, how could it be
that AIG was already so invested in those kinds of swaps for subprime
mortgage bonds?

Mr. LEWIS: Well, it was all pretty much happening at the same time. I
mean, Goldman Sachs does its first trades with AIG in March of '05,
which is when Michael Barry is doing his first trades with Goldman Sachs
and Deutsche Bank. But I'm not convinced that Michael Barry pushing the
investment banks to create credit-default swaps on subprime mortgage
bonds was the only reason they did it.

They were already thinking along these lines. And when he calls them up
to do with these trades with them, they're already thinking, yeah, we'd
kind of like to do this, I think.

But there - can I start - because there's a slightly different answer,
too, and it's that AIG had been insuring corporate bonds for almost a
decade. And in corporate bonds, there's these pools of corporate loans.
And in 2004, 2005, Goldman Sachs starts to come to AIG with pools of
what they say are diversified consumer loans. They include some subprime
mortgages in it and other things.

And AIG says, yeah, this is roughly the same thing as we've always been
doing. We'll do that, too. And it's in March of 2005 when Goldman -
there's some conversation that is still a mystery. We don't know exactly
what happened, but Goldman Sachs effectively went to AIG with a pool of
something that was nothing but subprime mortgage loans, and they said:
Do you want to do this, too? And AIG said: Yup. We'll insure that. And
that, at that moment, there is a seller of insurance on subprime
mortgage loans, and Goldman Sachs can turn around and peddle that to
Michael Barry in the form of a credit-default swap.

GROSS: So when the financial system collapsed, how did Michael Barry get
paid off? Like, who - he bet against the subprime mortgage market, and
he won. The market collapsed. He won, but who had the money to pay him
when he won?

Mr. LEWIS: Well, he had done deals with Goldman Sachs and Deutsche Bank
and Morgan Stanley and Bank of America, and I think a few with Merrill
Lynch, too. And as the pools of loans that are underneath it, these
bonds, start to default, they actually have to send him daily
collateral. So he's getting paid daily as the bonds go bad. So Wall
Street firms had to pay him. They were on the other side of the bets.

Now, the question is: Were they ultimately on the other side of the
bets, or did they have someone that they had sold the bets on to who
they were collecting from? And for the most part, they had sold the bets
on, and AIG was on the other side of some of those.

GROSS: My guest is Michael Lewis, author of the new book "The Big
Short." We'll talk more after a break. This is FRESH AIR.

(Soundbite of music)

GROSS: My guest is Michael Lewis, who is, among other things, the author
of "The Blind Side," which was adapted into the movie, and his new book
is called "The Big Short: Inside the Doomsday Machine."

Let's talk about a couple of other people who made a killing when the
financial system collapsed in 2007, and this is Charlie Ledley and Jamie
Mai, two people who basically started a hedge fund in their garage and
called it Cornwall Capital. How did they get into this business?

Mr. LEWIS: They literally started with $100,000 in a Schwab account, and
they came into the subprime mortgage market in a completely different
way. They had a kind of theory about financial markets when they
started. They thought that Wall Street generally underestimated the
likelihood of really unlikely events, underestimated the likelihood of
various catastrophes.

They went looking, essentially, to make bets on unlikely things
happening. So they would buy options to buy stocks at prices far, far
away from where the stocks were currently trading. They did this with
currencies. They did it with commodities. They scoured the world,
essentially looking to make bets on extreme things happening.

And each bet cost them very little, because it was an unlikely event,
and if they were right it paid off in multiples. So they would be wrong
most of the time, but they were right enough that they were doing very,
very well, and they turned $100,000 into something like $15 million by
late 2006.

And then they stumble into the subprime mortgage market, and they see
that there's this bet that's very similar to the kind of bets they've
been making to be made here. For a couple of percent a year, they can
buy insurance on what seems to them to be very dicey pools of subprime
mortgage loans, and they start to learn about the subprime mortgage
market.

And they know nothing about the bond market at this point. It's
bewildering to them, yet they're able to piece together a very clear
picture of what's going on in a matter of months, to the point where
they become less interested in their bet than in sort of the social
implications of what they're learning.

They go to the FCC. They go to the New York Times and the Wall Street
Journal. They start screaming at the top of their lungs that, my God,
there's fraud in the system. But they make their bet, and they turn $15
million into $120 million with their bet.

But the thing that was, to me, so interesting about them was that all
these people who were in a handful who saw the disaster happening before
it happened, they all had something about them that enabled to see it.

I mean, this is a story of human perception as much as it is anything
else. And their attitude toward the financial markets was peculiar. It
was peculiar to be running around the world just looking for unlikely
things that might happen that the markets were underestimating.

And it told you something about Wall Street and about the way the
markets were functioning when they were dysfunctional. It told you that
there weren't enough people thinking this way. There weren't enough
people taking into account the real likelihood of extreme change in the
world, and they were.

GROSS: One of the things I found interesting about this duo was they
started betting against the financial institutions themselves. They
started betting against Bear Stearns and other financial institutions
around the country. What made them realize the financial institutions
themselves were vulnerable, not just the instruments that they sold?

Mr. LEWIS: Well, as they conduct their investigation of the subprime
mortgage market, they ask the question that's a very natural question to
ask: If these Wall Street firms are willing to sell me this really cheap
insurance on subprime mortgage bonds, who's on the other side? Who's
taking all this risk? If I'm right and this subprime mortgage market is
going to lead to a financial catastrophe, who's going to be affected?

And they pretty quickly figured out that the Wall Street firms
themselves were taking a lot of the risk. And even if they weren't, huge
amounts of their profits were coming out of the subprime mortgage
machine. So they were vulnerable that way, too.

And so they become concerned, because if they're buying insurance from
Bear Stearns, it's no good if, when the catastrophe happens, Bear
Stearns collapses, too, and they become afraid that Bear Stearns won't
be able to honor their contracts. So they turn around and they buy
insurance on Bear Stearns, too.

GROSS: And just months before Bear Stearns collapsed, they bought very
cheap insurance against the collapse of Bear Stearns. So when Bear
Stearns collapsed, they made a fortune.

Mr. LEWIS: Yes. They made more of a fortune from their bets against the
subprime mortgage bonds, but yes. You know, in a matter of a few years,
pursuing this strategy, they turned 100 grand into $120 million. So they
did very, very well.

You know, one of the aspects of this story, though, that is curious is
that none of these characters are natural - really natural short-sellers
in that most of them had some other purpose. They were people who wanted
to be investing in the stock markets. And it was interesting to see the
way they were affected by the realization that they could no longer have
such a positive and productive relationship with a larger financial
society when they were essentially set up just to bet against the
system.

And Charlie and Jamie are the leading examples of this. The effect of
getting rich this way almost kills their interest in the business. They
don't take actual pleasure in it. They're happy to be successful up to a
point, but they become disillusioned, really, in the process, and to
this day can't believe that the world doesn't understand what they
figured out in a matter of months.

GROSS: Wait, well, you write how Charlie Ledley, one of the co-founders
of Cornwall Capital, started getting, like, migraines and terrible
anxiety attacks during the collapse of the system, when he's making a
fortune. But it's physically hurting him at the same time.

Mr. LEWIS: All of the characters who made their fortunes betting against
the subprime mortgage market experience health problems: panic attacks,
heart problems. I mean, it's riveting. They're all changed by the
experience, and Charlie is no exception.

They were all stressed by it. They were stressed at being right. I mean,
you've got to wonder what would happen to them if they'd been wrong. And
I think they're so stressed because they realized that - I mean, this
wasn't a bet against a company. This was a bet against an entire
financial system, and it was a bet that arose from their insight that
the system had become rigged, that essentially Wall Street had become a
giant Ponzi scheme.

And they worried - Charlie in particularly worried - what it meant for
democracy. I mean, he worried that essentially the population was going
to wake up to the fact that Wall Street was rigged and there'd be riots.
They're still worried that because there's been very little in the way
of financial reform since the crisis, that we're living in a very
unstable world, and they found that naturally distressing.

GROSS: Michael Lewis will be back in the second half of the show. His
new book is called "The Big Short." I'm Terry Gross, and this is FRESH
AIR.

(Soundbite of music)

GROSS: This is FRESH AIR. I'm Terry Gross, back with Michael Lewis, the
author of "Liar's Poker,” "Moneyball" and "The Blind Side," which was
adapted into a hit film starring Sandra Bullock. His new book, "The Big
Short" is about a few of the investors who anticipated the meltdown of
the subprime mortgage market and made a fortune by shorting - by betting
against - the bonds that bundled subprime mortgage loans.

Did you come to see the people who bet against the financial system as
vultures or as just really, really the smartest guys around or some of
both? Because a lot of people see short sellers as vultures, people who
want to feed off of the death of something - the death of a bond, the
death of a company, the death of the financial system.

Mr. LEWIS: I didn’t see them as vultures. And I saw them, you know, I
didn’t have a view going into the story about who they were or why
they’d done what they’d done. So in the first place, I was surprised
that for the most part, they weren't what you think of as short sellers.
They didn’t have funds, the whole point of which was to short things.
They were by nature and experience, ordinary stock market investors,
that they were looking for stocks to bet on and the facts made it very
difficult for them to do that. So they kind of - the world forced them
into this position in a way.

They had a job to do, invest people's money - other people's money
shrewdly. And with the facts on the ground as they understood them, the
only way they could do that well was to make this bet against the
subprime mortgage market. So that they weren't what you think of as the
stereotypical short seller in the first place.

Having said that, there's then the question of, to what extent do they
contribute to this problem, to this crisis? And in their defense to
start with, one of the things they tried to do was tell the world what
was going on when it was going on and no one would listen. I mean...

GROSS: All of them tried to do that? All the people you write about?

Mr. LEWIS: They were all extremely noisy. They had various ways of being
noisy. But Jamie Mai and Charlie Ledley went to the SEC and tried to get
the SEC to investigate the ratings agencies and the Wall Street firms
that were creating subprime mortgage bonds and so on and so forth, and
the SEC didn’t want to have anything to do with them.

Michael Berry was writing very persuasive letters that were widely
circulated in the investment community about the madness of subprime
mortgage lending well before he started shorting subprime mortgage
bonds.

Steve Eisman, the third main character in the book, ran around Wall
Street being rude to as many people as possible who were involved in the
business, telling them that they were going to blow up their firms and
nobody would listen to him. So they ended up being ineffective
messengers but they tried.

If everybody had thought the way they thought and behaved the way they
behaved, the crisis never would've happened. So whatever you think of
short sellers, you have at least to admit that of all the people who
were involved in making financial decisions in the last few years, they
were the best. Now, having said all that, they do bear some
responsibility.

GROSS: What is the responsibility you think they bear for the collapse
of the financial system?

Mr. LEWIS: It's interesting. It's a responsibility that they themselves
did not perceive until pretty late in their game. But it's complicated,
so are you ready for it?

GROSS: Give it a shot.

Mr. LEWIS: All right, I'm going to give it shot. You just have to take
this on faith. But, when you buy - when you, Terry Gross, buy a credit
default swap, you’re buying insurance on a subprime mortgage bond. When
you buy that thing, you’re effectively replicating the bonds that are
being insured. So you’re doubling the risk in the system. It's like you
created a whole ‘nother pool of subprime mortgage loans simply by buying
that credit default swap.

And so, in betting against the market, these people increased the amount
of bad debts in the system. And they - in addition, they did it in such
a way, the credit default swap is a very - it's not an openly traded
thing. It's a deal between you and Goldman Sachs or you and Lehman
Brothers or you and Bear Sterns, and it's not articulated on Bear
Sterns’ or Lehman Brothers’ or Goldman Sachs' balance sheet.

So you could do, you know, a trillion dollars of credit default swaps
with Goldman Sachs and no one would know. The combination of adding to
the bad debts in the system and doing it in a way that is mysterious and
unaccounted for openly greatly increased the problems when they finally
became clear in 2008. They increase, A, the raw number of losses in the
system, but also when the panic hits Wall Street in the fall of 2008
nobody knows who has losses and how many. And that's the big problem is
nobody knows who has the losses and how many. Nobody knows who's going
to go down.

One of the big reasons are these deals - these credit default swap
deals. So they aren't completely blameless, the short sellers, but
they’re as close to blameless as anybody who was a part of that market.

GROSS: Well, isn't it true also that the way they made their fortune was
in a way by helping to collapse the financial institutions they made the
deals with? Because...

Mr. LEWIS: No.

GROSS: No?

Mr. LEWIS: No. The last thing they wanted was to collapse the financial
institutions they made the deals with because then the financial
institutions...

GROSS: They wouldn’t get paid.

(Soundbite of laughter)

Mr. LEWIS: They wouldn’t get paid.

GROSS: Right. Okay.

Mr. LEWIS: Yeah. No. The last thing they wanted.

GROSS: But I mean, didn’t paying them off help collapse the financial
institutions?

Mr. LEWIS: Well, yeah, but it's true that in making smart bets that are
essentially zero sum bets with big Wall Street firms they cost the big
Wall Street firms money. The big Wall Street firms became the dumb money
at the table. That's one of the strange subplots of this whole period
is, how on earth did these big Wall Street firms become the dumb money
at the table? But it wasn’t really the job of Charlie Ledley or Steve
Eisman or Michael Berry to worry about whether Wall Street firms knew
what they were doing.

I mean, historically, it was the Wall Street who were ripping off their
customers. I don’t think it occurred to them that they had the
wherewithal to rip off Goldman Sachs. So I think when they cut these
deals with the big Wall Street firms I think they assumed that the Wall
Street firms know what they're doing and they’ve hedged their risk in
some way.

GROSS: So you see these guys who made a fortune by betting against the
financial system as basically being people who were running around
saying, the emperor has no clothes. Nobody listened, so they finally
just bet against the emperor.

Mr. LEWIS: Yes. Once they realized the emperor had no clothes their
impulse wasn’t to tell everybody. Their impulse was to make a bet
against the emperor. But once they'd made their bets, then they wanted
to tell everybody.

GROSS: Got it. Okay.

(Soundbite of laughter)

Mr. LEWIS: I don’t regard these people as saints. I don’t think there's
a lot of room for saints on Wall Street. I just regard them as sensible.
And the big problem on Wall Street in recent history was there's been so
few sensible people.

GROSS: My guest is Michael Lewis. His new book is called "The Big
Short." We'll talk more after a break. This is FRESH AIR.

(Soundbite of music)

GROSS: My guest is Michael Lewis, author of the new book "The Big
Short." It's about investors who anticipated the subprime mortgage
meltdown and made a killing by betting against subprime mortgage bonds.

So I want you to give us - and this is where it gets like really crazy,
but give us an example of the kind of trench...

(Soundbite of laughter)

Mr. LEWIS: Tranch.

GROSS: Tranch.

Mr. LEWIS: Tranch.

GROSS: That these guys, that the guys who betted against the system
investigated and realized that this is crazy, investing in something
like this is crazy, we're going to bet against. So it’s complicated to
explain but it's fascinating for its badness.

(Soundbite of laughter)

GROSS: It's fascinating for how...

Mr. LEWIS: All right. Well, let's just take - since Charlie Ledley knew
nothing about the bond market when he started this...

GROSS: Yeah.

Mr. LEWIS: ...let's take the example of Charlie Ledley and what he
decides to bet against.

GROSS: Great.

Mr. LEWIS: All right. So Charlie Ledley sees they are these things
called subprime mortgage loans, which he knows absolutely nothing about.
But he kicks or he calls people who are originating subprime mortgage
loans, he talks to friends in the market and he realizes that a lot of
them are squirrely. A lot of people are borrowing money to buy houses
and lying on their forms about how much money they make. They're being
encouraged to take out loans they couldn’t possibly repay, all that. So
these loans, they go into a big pool where they - so a Wall Street firm,
Goldman Sachs takes pools of thousands of loans and turns them into
bonds.

And the way it does that is it says, as they say in Wall Street, they
tranched them up, they sliced them up. They say, all right, here's this
pool of loans. The money's coming into the pool from the people paying
off their mortgages. The money goes out to the people who buy bonds in
the pool. And the people who are willing to buy the bonds that lose
their value when the first loans aren't paid off, they get a higher rate
of interest because they have the most risk.

The people who buy the bonds that are the last to get hit, that get the
final payments, whatever money trickles into this pool goes out to them
first. Those people get the lowest rate of interest and are - the
highest rated bonds, triple-A-rated bonds. So the dregs of this pool are
the triple-B-rated bonds, the lowest rated bonds. If you own the triple-
B-rated bonds associated with this pool, your bonds are going to be
wiped out if the pool experiences losses of just eight percent. So if
just eight percent of the loans go bad you’re not going to have a bond
anymore. That's a very risky bond, especially when you’re dealing with
subprime mortgage loans.

But that's not where it ends. The Wall Street firms, having trouble
selling these triple-B-rated bonds to people, pool and find all the
pieces of triple-B-rated bonds and they put them into another pool. And
they go to the ratings agencies, Moody's and Standard & Poor, and they
say, say look, there are all these triple-B-rated subprime mortgage
bonds but some of them are loans that are made in California and some
are loans that are made in Florida and some are loans that are made in
Michigan. They're diversified. They're not all the same thing.

Surely some of them are going to be money good. So if we put these all
into one big pool and tranch it up again, how much of it will you rate
triple-A? And the ratings agency says, 80 percent. They say, we think
that this pool is diversified enough that, you know, if things go really
bad only about 20 percent of them are going to be really seriously at
risk. So, 80 percent are really safe. So you have now this called – this
is called a CDO, a collateralized debt obligation. And 80 percent of
this is rated triple-A.

Bear in mind now, that underneath this all are subprime mortgage loans
and pool of subprime mortgage loans in which only eight percent have to
go bad for the whole CDO to be worth zero.

Charlie Ledley sees this and he says, I want to bet against those
triple-A CDOs because I think basically all these subprime mortgage
loans are the same thing. So Charlie Ledley goes to Bear Sterns and
says, I want to buy insurance. I want to buy a credit default swap on a
double-A or a triple-A tranch of a CDO. And Bear Sterns says, fine. No
one's done that before but we're happy to do it and you only have to pay
one half of one percent in premium a year to do it.

And Charlie Ledley can't believe it because he thinks that the odds of
these pools of subprime mortgage loans going bad are very high and
certainly they - more than eight percent of them are going to go bad.
And yet, he can basically buy insurance on them for free - for almost
free.

GROSS: So it’s kind of amazing that Charlie Ledley was able to see this
but all of the financial institutions selling these subprime mortgage
bonds didn’t see how vulnerable the institutions themselves would be
when these things collapsed. How - like, how did they not see it?

Mr. LEWIS: This is the great question and this is why I think this is a
story of human perception as much as anything else. I think people see
what they're incentivized to see. And I think that basically when you
back away from this crisis what happened was this: Wall Street firms
were able to make a lot of money arranging for loans to be made that
should never have been made. The way they did it was by disguising in
various ways the risk of those loans.

They did this so well that after a while they disguised the risk for
themselves. And the great irony of this whole crisis is that the people
who orchestrated it ended up losing fortune from it. That they
themselves wound up heavily invested in the worst sorts of bonds that
they created.

GROSS: So when you look at the reforms of the financial system that are
being proposed now, what do you see?

Mr. LEWIS: Well, for the last 18 months, we have been dealing with the
symptoms of the crisis rather than the cause. There has been no reform.
And so it’s been delayed and that's not surprising. I mean, financial
markets move quickly and democracy moves slowly. The crash of 1929
happens in 1929 in Glass-Steagall, which reforms Wall Street in a
radical way, doesn’t happen until 1933. There aren't even proper
hearings on Capitol Hill about the crisis of '29 until I think late '32.

And so it's not that surprising it's taken a while. But the ideas that
are now being batted around - and it does look like financial reform is
about to get moved to the front burner - they're some really good ones.
It's just a question of whether they can be pushed through over the
objections of Wall Street because they're all antithetical to the
interest of Wall Street.

The first is, it's crazy that a Wall Street firm can advise customers to
buy and sell stocks and bonds and at the same time be making bets with
its own money on those stocks and bonds. That...

GROSS: They’re betting against them.

Mr. LEWIS: Yes. Exactly.

GROSS: So, in other words, you’re the broker. You tell me buy the bonds
and then you bet against those bonds.

Mr. LEWIS: Yeah.

GROSS: They're going to fail.

(Soundbite of laughter)

Mr. LEWIS: Yeah. That it creates a natural, horrible, poisonous
relationship between Wall Street and the people it advises if the Wall
Street firm is making its own side bets at the same time it's advising
the customers what to do.

GROSS: Yeah. It's such a conflict of interest because you’re telling me
to buy it and that whatever I'm buying is going to succeed and I’ll make
money, but at the same time, you’re betting that what you tell me is
going to succeed is going to fail, and if it fails you make money.

Mr. LEWIS: That's right.

GROSS: That's a terrible conflict, isn't it?

Mr. LEWIS: Well, yes, and especially since the Wall Street firms
increasingly make their money with their own side bets. So inevitably
what happens is the customers get used as part of - as a tool for their
own portfolio to get out of things they don’t want to own and so on and
so forth. So that, there needs to be a - the so-called Volker rule,
named for Paul Volker because he's advocating it, makes total sense, is
to say to these firms, you can't trade for your own accounts in things
when you’re advising customers. So that's a really simple reform but
it’s going to be devastating to Wall Street.

Another simple reform, I mean, it's so obvious that you can't believe it
hasn’t happened yet, just simply eliminate these bilateral private
transactions that go on between these firms that leave them exposed to
each other, like credit default swaps. Why should Deutsche Bank be able
to call up Morgan Stanley and do, you know, make an $8 billion bet that
neither one of them actually records on their balance sheets. It creates
horrible uncertainty and instability to have this kind of murky world of
side bets going on and nobody knows who's got them. So you never know
how actually healthy these institutions are. So, all things that are
traded, credit default swaps, for example, should be traded through
exchanges and on screens so everybody can see them.

Now that kind of transparency, again, is an anathema to Wall Street
because they make a lot of money off the opacity. They make a lot of
money out of people not seeing what the right price of things should be.
So - but they're fighting that tooth and nail.

And the third thing that's very obvious, so obvious you can't believe
that it hasn’t happened is, why on earth are the ratings agencies,
Moody's and Standard & Poor, paid by the people whose bonds they are
rating? It's inevitably going to lead to problems because they're
incentivized to please the people who pay them.

GROSS: Well, Michael Lewis, we’ve been talking about some incredibly
important, really complicated stuff, so let me move to a different
subject, which is congratulations on your Oscar, and by that...

(Soundbite of laughter)

GROSS: ...by that I mean that your book "The Blind Side" was adapted
into a film starring Sandra Bullock, for which she won an Oscar. You
were actually at the Oscars. So was that fun for you?

Mr. LEWIS: It was a gas. And I don’t think it's healthy for a writer to
spend too much time in the presence of movie stars. He's quickly made
aware of his own insignificance. But it was a lot of fun. I’d say the
other funny thing about the event, about the Oscars is that at some
point there's so many famous people in the room that nobody's famous.
That in fact, the best thing you can be is someone no one's ever heard
of because at least you’re interesting then.

But the whole experience was fabulous. Who would've thought? Who
would've thought that "The Blind Side" would win an Oscar?

GROSS: And since you write about finance so much, was the book purchased
outright or do you get some kind of points for...

(Soundbite of laughter)

Mr. LEWIS: Are you asking me if I got rich off the movie? This is what
happens, when I wrote my first book, "Liar's Poker," Tom Wolf, the
author took me out to lunch and he said to me about the movie business,
have nothing to do with it. Go across the country, hurl your book in,
have them hurl the money out and come back as fast as possible. And
that's sort of what happens. You don’t keep a stake, even if you try to
insist on it. I suppose maybe John Grisham does but I don’t. You get
what's called net profits. And there are no such thing as net profits.
They give them to you because there are no such thing, so you never see
a nickel. So even "The Blind Side"...

GROSS: Because of the accounting...

Mr. LEWIS: Yeah, because of the accounting. "The Blind Side" I think
cost $29 million to make and another $20 million to promote and it's
going to take in 400 million when it's all said and done with the DVD
sales and it will not make a cent. And if you can figure it out, how
they do that, you know, more power to you.

(Soundbite of laughter)

GROSS: Maybe that's your next book. So the movie rights have already
been purchased to the book that we’ve been talking about, your new book,
"The Big Short,” right?

Mr. LEWIS: Brad Pitt and Paramount bought the movie rights a few weeks
ago.

GROSS: You think it'll actually get made? Not everything that gets
bought gets made.

Mr. LEWIS: No, most things don’t get made. But the odd thing is Brad
Pitt is starring in the movie adaptation of "Money Ball," my baseball
book, which starts filming in June. And I think what I've learned from
that process is that if a star wants to make a movie, the movie gets
made. And he really wanted to make "Money Ball." And if he bought this
and he really wants to make it, I think it will get made.

It's hard to turn Wall Street into on-screen drama. But these characters
are so bizarre and unusual and interesting, I think there's at least
hope.

GROSS: Okay, so I'm going to bet that he would want to play Michael
Berry, the guy who has Asperger’s and started as a doctor and ended up
with the hedge fund and bet against the system.

Mr. LEWIS: I don’t know but it's a good guess.

GROSS: Okay.

(Soundbite of laughter)

GROSS: But I'm not a betting person.

Mr. LEWIS: No, I've already cast the movie in my head. Philip Seymour
Hoffman plays Eisman. I was going to have Matt Damon play Michael Berry
and then get the Judd Apatow crowd to play the Cornwall Capital guy.

(Soundbite of laughter)

GROSS: Very good.

Mr. LEWIS: And just have - Brad Pitt can direct it.

GROSS: Very good. Very good. Michael Lewis, thank you so much for
explaining some really complicated, really important stuff for us. Thank
you very much.

Mr. LEWIS: Thank you. I did my best.

GROSS: Michael Lewis' new book is called "The Big Short." You can read
the first chapter on our Web site, freshair.npr.org. Or you can also
hear an excerpt of the interview that we didn’t have time for. It's more
about his experiences with movie adaptations of his books.
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A ‘Justified’ Outing For A Loose-Cannon Lawman

TERRY GROSS, host:

Actor Timothy Olyphant starred as stoic sheriff Seth Bullock in the HBO
series “Deadwood.” Starting tonight on the FX cable network, he’s back
playing another man with a badge, this time in “Justified,” a modern day
Western based on Elmore Leonard stories.

TV critic David Bianculli has this review.

DAVID BIANCULLI: The odds against Timothy Olyphant finding another TV
role even close to matching the quirkiness and intensity of “Deadwood”
were pretty high. After all, David Milch's “Deadwood” was a weird
Western mixture of Shakespeare and "Rocky Raccoon." It was one of the
best TV shows of the past decade, with literally dozens of fabulous
characters and actors. And Olyphant's reluctant sheriff, a quiet man
with a very short fuse, was one of its biggest standouts.

Yet, here the actor comes again the new FX series “Justified,”
intentionally and successfully flirting with his own TV past. His new
character, Raylen Givens, is a present-day U.S. marshal, but he's wild,
wild West all the way. He's a fast draw and an expert shot. He wears a
Stetson, maybe the first TV cop since Dennis Weaver's McCloud to get
away with that. And after outdrawing and killing one bad guy, Raylen is
transferred from the sunny skies of Miami — home of “Burn Notice” and
“Miami Vice” — to his former home in the backwoods of Kentucky. From
gold mines to coal mines. In both cases the territory is filled with
delightful oddballs.

“Justified” isn't quite in the league of “Deadwood” — very little is —
but it pulls off that same tricky balancing act of mixing tense drama
and low-key comedy, often in the same scene. No wonder: “Justified” is
based on stories by Elmore Leonard, who also inspired the movies “Get
Shorty” and “Out of Sight” and on TV, such snappy, short-lived series as
“Karen Sisco” and “Maximum Bob.”

Every TV lawman who's as much of a loose cannon as Raylen has a boss
whose job is to try to rein him in. Usually, they're written and played
as either hyper-tense shouters or anguished mumblers. But Nick Searcy,
as Raylen's old friend and new captain, has a different approach:
sarcasm. Here he is in episode two, confronting Raylen about yet another
shooting that, to borrow from the show’s title, Raylen claims is
justified.

Mr. NICK SEARCY (actor): (as Art Mullen) Oh, Raylen. Just a second, shut
that door. I got a call this morning from AUSA David Vasquez. Wants to
talk to you about your shooting Boyd Crowd(ph).

Mr. TIMOTHY OLYPHANT (actor): (as Raylen Givens) What’s there to talk
about? He pulled first, there was a witness.

Mr. SEARCY: (as Art Mullen) But you see, 10 days ago you shot a man in
Miami. Put it like this, if you was in the first grade and you bit
somebody every week, they’d start to think of you as a biter. He also
wants Avery to come up to Lexington to talk about it.

Mr. OLYPHANT: (as Raylen Givens) Fine with me.

Mr. SEARCY: (as Art Mullen) Which part? The part about her talking to
Vasquez or the part about her coming up to Lexington? Raylen, you can’t
sleep with her.

Mr. OLYPHANT: (as Raylen Givens) I know.

Mr. SEARCY: (as Art Mullen) Raylen...

Mr. OLYPHANT: (as Raylen Givens) I won’t. You starting to regret me
coming here?

Mr. SEARCY: (as Art Mullen) Not yet.

BIANCULLI: I don’t think he’ll regret it for a long, long time. Eight
years ago, the FX network made its reputation with “The Shield,” and one
of that show's key players, Walton Goggins, is featured in “Justified,”
too. In “The Shield” he played Shane. Here he plays an old friend of
Raylen's who has wound up on the other side of the law — but who, like
Raylen, hasn't lost any of his swagger or his sense of humor. They're
lots of fun to watch — and, in no small part because of them, so is
“Justified.”

GROSS: David Bianculli writes TVworthWatching.com and teaches TV and
film at Rowan University. His new book is “Dangerously Funny: The
Uncensored Story of the Smothers Brothers Comedy Hour.”

You can download podcasts of our show on our Web site, npr.freshair.org
and you can join us on Facebook and follow us on Twitter @ nprfreshair.
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Transcripts are created on a rush deadline, and accuracy and availability may vary. This text may not be in its final form and may be updated or revised in the future. Please be aware that the authoritative record of Fresh Air interviews and reviews are the audio recordings of each segment.