Nine years after the Great Recession mortgage bond crisis of 2008, no executives with any seniority on Wall Street faced criminal consequences. Although a few suffered civil penalties like fines, the lack of jail time left many asking, why?
September 2017 marks the ninth anniversary of the most explosive month of the Great Recession. Over one dramatic weekend nine years ago, legendary Wall Street firm Lehman Brothers declared bankruptcy, brokerage giant Merrill Lynch threw itself desperately into the arms of Bank of America, and insurance conglomerate AIG became an 80% ward of the federal government. That very bad weekend in mid-September followed hot on the heels of the previous week’s fireworks, in which mortgage giants Fannie Mae and Freddie Mac entered “conservatorship” status with the Federal Housing Finance Agency.
Like a ghost revived from horrors past, on September 11, 2017, the Justice department brought civil charges against Deutsche Bank mortgage bond trader Paul Mangione for fraudulently structuring sub-prime mortgage bonds back in April 2007, more than ten years ago. Mangione doesn’t face jail time, but rather civil penalties such as fines. So, we’re still reaping the consequences of the subprime mortgage debacle more than 10 years later, and still nobody’s going to jail.
My personal, deeply unpopular, view is that financial executives didn’t go to jail from the sub-prime mortgage crisis because they didn’t commit crimes. Poor money management is not a crime, nor is losing money for your firm or investors. Executives were guilty of believing too deeply in a flawed financial model or failing to respond quickly enough to systemic risks, but that’s a series of human errors, not jailable offences. Many observers of the sub-prime mortgage crisis disagree with me.
Jesse Eisinger, a Pulitzer Prize-winning financial journalist, just published a book this summer, called The Chickenshit Club:The Justice Department and Its Failure to Prosecute White-Collar Criminals, disagreeing with me. I mean, he’s not literally rebutting my argument, but rather he’s explaining the complex history of why nobody went to jail for the mortgage sub-prime crisis and the Great Recession more broadly.
As a general rule, I think it’s a tonic to learn from smarter, better-researched people who disagree completely with me. So I recommend the book whether you agree or disagree with me.
Eisinger’s answer to the question of “why no jail time?” as hinted at by his profane title, is that institutional weaknesses in the US justice system, from the SEC to the Justice Department to especially the Southern District of New York, made them unwilling and unable to catch white collar criminals and put them in jail.
Eisinger contrasts the earlier experience of the Enron prosecutions of criminal behavior by executives following the 2001 collapse of the trading giant with the absence of criminal prosecutions of Wall Street executives involved in the sub-prime mortgage collapse. So what changed between 2001 and 2008? In Eisinger’s telling, many factors combined.
First, a backlash developed against the damage caused by the aggressive prosecution of Enron’s accounting firm Arthur Anderson, a former “Big-5” accountancy, which drove them out of business in 2002.
Government prosecutors worried about the kind of collateral damage – to innocent employees, customers, investors – if they took down Wall Street firms, especially given how weak big firms were in the aftermath of 2008.
Second, prosecutors developed a preference for reaching a new kind of agreement called a “Deferred Prosecution Agreement,” (DPA) in which corporations – but importantly not individuals – agreed to pay fines as a result of bad actions. Typically a DPA meant a hefty corporate fine, ultimately paid by shareholders rather than executives, and an agreement to hire an outside monitor against future ongoing bad behavior.
Not incidentally, these monitoring agreements became extremely lucrative for big private law firms, encouraging a kind of Big Law lobby for more DPAs in place of criminal prosecutions.
Next, he describes a classic kind of regulatory revolving door between government prosecutors and lucrative white-collar defense practices. Eisinger believes many ambitious prosecutors want to eventually make ten times more money in private practice defending white collar criminals. So, they might not want to be overly aggressive prosecuting white collar criminals that could be their future private practice employers.
Finally, Eisinger describes prosecuting white collar crime as a particular skill, requiring a certain institutional culture of risk-taking and a consequences-be-damned attitude. Between the Enron/Arthur Anderson backlash and the rise of DPAs, our regulators lost their taste for putting executives behind bars. Running up the score with DPAs and corporate civil fines became easier than the more difficult task of jailing executives.
Interestingly, legal heavyweights making 2017 headlines such as James Comey, Preet Bharara, Eric Holder, Sally Yates, and Bob Mueller make cameos in Eisinger’s book, often in an unflattering, or at least mixed, context.
I spoke to Eisinger about his book recently. As a former mortgage and CDO salesman myself, I tried to explain, the actions of Wall Street folks described in civil complaints about sub-prime mortgage securitizations fell within a normal range of activity of how we did our jobs. Eisinger didn’t buy it.
But even reading the September 2017 civil suit about Paul Mangione at Deutsche Bank, I’m struck by how banal the complaint is. Mangione’s emails and phone records show he is deeply skeptical about the quality of mortgage underwriting standards. He neither created those mortgages nor had any real ability to influence their creation. His job was to take the product he received and try to make bonds he could sell out of them. To refuse to do that would be to refuse his way out of a job, at least a job as a sub-prime mortgage trader at Deutsche Bank.
I remain skeptical. Eisinger’s right to point out the troubling weaknesses in our current system of prosecuting white-collar criminals. I stick to my often unpopular stance that the sub-prime mortgage and CDO traders did not commit crimes for which they deserved jail.
Note: I reviewed Gary Sernovitz’ book in September, and we did a phone interview back then, which I’ve now posted as an audio interview, Part I – on the big personalities in fracking. Part II – on environmental issues, will follow. I recommend listening to the audio version, but I’ve posted a transcript of our conversation as well.
Mike: Hi, my name is Mike, and I used to be a banker.
Gary: And I’m Gary. I guess I’m sort of still a banker, at least a private equity investor.
Mike: As you know, I read and really enjoyed your book, and I reviewed it on my site. I just want to praise you for doing what I think is my favorite thing, which is taking a complex issue upon which nobody agrees, and everybody thinks the other side is complete fucking idiots, and saying no, we’re not all idiots. We could understand each other. So thank you for doing that. That’s really great.
Gary: Thanks for the praise and clearly, that is not the dominant mode of American discourse, as evidenced by the discussions heading into November.
Mike: Yeah, it’s really difficult to not see the other side as either morons or dupes or evil. And I would say if you just say the word “fracking” we’ve already introduced the idea the other side is one or all of those things. I appreciate you describing yourself as a New York liberal. And I described you as deep in enemy territory there for fracking, and yet you have to both answer for your profession, which is to be investors in energy and in oil and gas and fracking, but at the same time, be a thinking person.
Gary Sernovitz
I don’t know who’s more unattractive, oilmen or Wall Street guys, but every once in a while, I’ll say something mildly positive about a Wall Street guy in some column and people will write inevitably “You’re such a jerk talking about the banksters as if they’re not all evil.” Okay, sorry.
Gary: I manage to work for a private equity firm that invests in the oil and gas business to be the worst of both worlds.
Celebrities of Fracking – Aubrey McClendon
Mike: Some of the interesting parts about your book are combinations of celebrating capitalism, and ingenuity of the shale revolution, and incremental changes. And then part of that celebrating capitalism is celebrating some of the funny and interesting characters who made good off of the thing.
I’m interested in some of those. Some of them I’ve heard some of their names but don’t particularly know them, but I understand they’re rock stars of your industry. I’d love to chat about those if you don’t mind.
One, your favorite seems to be Aubrey McClendon who I guess died after you’d written the book. I don’t think you referenced his death, or maybe you do?
Gary: No, he died in what is not terribly clear ‑‑ whether it was self-inflicted or not, but drove about 80 miles an hour into a highway overpass the day after being indicted.1 Obviously, a lot of speculation on the timing of that.
The late Aubrey McClendon, from a 2011 cover story
Mike: Certainly looks suspicious, as a complete outsider.
Gary: The conclusions most people have drawn ‑‑ but I think there has been no official word from the investigation one way or the other. Not necessarily that there needs to be, but the funny thing about the book is there was an alternate book that was just sort of a straight biography of McClendon that kind of was impractical to write with my job and with need to write ‑ he’s backed by a firm in his later life that competes against my firm in terms of providing capital to oilmen. I ended up putting that to the side.
Mike: There’s a book worth or more of Aubrey McClendon stories?
Gary: Yeah, sort of every chapter you find he’s Zelig of the book. In every chapter he kind of finds his way. There is a small Aubrey biography woven through it unwittingly, just because he is one of the more colorful characters. He kind of harkens back to a different kind of swashbuckling capitalism. Partly he enters the oil business, kind of a wildcatter, and partly he did have a very unusual role just that effectively the company he had, Chesapeake, was thought of as somewhat small, sort of volatile, high risk.
Mike: A wildcatter spirit of a company versus the more corporate people?
Gary: And hold onto your seatbelts when you deal with Aubrey and Chesapeake in general. When the shale revolution started ‑‑ it wasn’t really him, it was another company, Mitchell Energy that started it. So when it started, what Aubrey did was really kind of sort of start this competitive frenzy in successive basins where people would discover oil, maybe we have a shale here in north Louisiana or east Texas or North Dakota on the oil side, or Pennsylvania or Ohio. And Aubrey had thousands of guys knocking on doors, and an unlimited appetite for capital and complexity, and everything that just got billions of dollars.
Then everyone looked around and oil companies pursuing more normal course ambition ‑‑ “Well, Aubrey’s going to suck up all the opportunities!” and so he was the catalyst in these basins for this frenzy. Then ultimately, you know what happened was he kind of didn’t fully grasp ‑‑ no one did, how good this was going to be. So he ended up with a lot more gas and crashed the price of gas. So many basins worked, and successively cheaper prices, and that happened on the oil side, and then also just any companies with too much debt heading into a downturn is always going to be in trouble. He kind of got a margin call on his personal account for two billion dollars.
Mike: I should be so lucky someday. I will be so upset when I get a two-billion-dollar margin call.
Gary: That’s how much he was worth at the peak. I don’t know what the margin calls was for but my net worth went down by a couple billion dollars. Then he kind of got kicked out of Chesapeake because of all sorts of other somewhat old-school CEO perks that are sort of beyond ‑‑
Mike: Sort of pledging shares, right, for his own purchases?
Gary: More like he had the right to buy interests personally in all the oil wells Chesapeake owned, which is a thing ‑‑
Mike: I see, a conflict of interest.
Gary: Yeah, just kind of was not done that much anymore. Then he got backed by a private equity firm and they bought eight billion dollars of properties, oil properties right before the oil price collapsed. The bigger issue facing him was not really this indictment, which is somewhat on a pretty secondary issue, but really was on financial difficulties, and five or six different companies all bleeding cash, and all big debt problems.
Just sort of the world coming in ‑‑ he owned 20% of the Oklahoma Thunder and he had pledged that for a loan. I think maybe it was last weekend [September 2016] for some reason he needed to have the largest collection of Bordeaux in the world. So that’s being auctioned off now by his estate. Somewhat in bad form, and got a lot of bad publicity. He had pledged 20 million dollars to Duke his alma mater.
Mike: I read about that, that Duke said “where’s our 20 [million]?,” and the heirs didn’t find that tasteful.
Gary: Oh, the Duke alumni, the Duke community ‑‑ just say yeah, that’s a charitable donation. It is unclear what will happen, but it is definitely a very 19th century or very early 20th century, Dreiser story of rising and falling and rising and falling.
Mike: Captain of Industry or Robber Baron type.
Gary: Outside the realms of normal corporate America or the norms of it. Obviously kind of very entertaining but did have an impact on it. He was known to be an extremely nice guy.
Mike: Presumably a gregarious salesman type.
Gary: Yeah, he wasn’t cynical. His margin call was on buying – insatiably – stock in his own company, so he obviously believed in it. He was not a dark figure but an irresponsible figure, then left a lot of obviously shareholders, partners, and everything holding the bag, based on sort of a wild irresponsibility in terms of how he built his business.
Mount Rushmore of Fracking – Lucky or Good?
Mike: What I liked about your ‑‑ on the one hand celebration of capitalism and innovation and in a sense “here’s the new shale billionaires” ‑‑ you have a “Mount Rushmore” of four of them, who rose above the others. On the one hand, we have a tradition in the United States of celebrating these people as paragons of capitalism and far-seeing geniuses, of which Aubrey is included with that, with Mark Papa from EOG and this guy Harold Hamm, and I guess George Mitchell, one of the originators of the techniques.
Sernovitz has a “Mount Rushmore” of fracking
But then I appreciate that you also say there’s an aspect of the story which is these guys have just sort of dumb luck combined with bizarre personalities, like you’re describing with McClendon with his appetite for risk and appetite for everything ‑‑ I appreciate it. And then trying to figure out: Are these guys just beholden to their own personalities and limitations and that’s why they did these odd, risky, crazy things, which turned out to be “right place, right time,” at the right scale? Which is obviously huge they all did that.
There’s this awesome passage which I’d also like to read, which is among my favorites of the whole book, which is describing Aubrey:
“Aubrey feels sometimes like seeing the country’s best restaurant critic blissfully eating from a box of day-old donuts. People respect the critic for the sensitivity of his palate, but maybe the man just likes to eat.”
I really liked that.
Gary: That’s brilliant.
Mike: It is really. It encapsulates that we celebrate these capitalists for their amazing talent and yet I don’t know, maybe the guy’s slightly insane and just has no taste at all. It’s just awesome, but of course, I love day-old donuts too. I can relate.
Gary: I think people in the oil business are very fond, and this is probably in any business, “My successes are because I’m smart; his successes are because he’s lucky.” Being in a business one gets a bit more color on who was lucky, who was smart. Most people are some combination thereof. But I think the thing to remember about the entire industry is before the shale revolution the US onshore ‑‑ we had a company in Corpus [Christi] working in South Texas, about drilling wells for 400,000 dollars to find 2 million dollars’ worth of gas.
Mike: Scratch and peck kind of little tiny companies.
Gary: Yeah. And anyone in the oil business, like Exxon, which looked in contempt at the US onshore business as a bunch of losers who couldn’t make it doing big international stuff in Kazakhstan or offshore Angola or Equatorial Guinea. There was a certain very admirable hustle, that kind of never-say-die that kept ‑‑ people shouldn’t have been drilling before ’98 in the US if you think about where were the best reserves of oil and gas.
It was just – globally – it was just the infrastructure wasn’t there to displace it. Then the shale revolution came and suddenly ‑‑ the amazing thing wasn’t just that actually underneath the stuff that these guys were scratching and pecking, as you say, were an amazing volume of oil and gas but actually oil and gas was a lot cheaper to extract than the stuff Exxon was doing.
Mark Papa
It’s one of these stories of “the first shall be last, last shall be first” that really came out of nowhere. And everyone got caught up in it. Then there’s all these micro stores because there’s a lot of basins that have risen. Think about there in Eagle Ford, which is the one closest to you guys. Eagle Ford now is – the most shale wells have been drilled in Eagle Ford. It’s now kind of a mature basin. It was really developed by EOG, gets a lot of the credit ‑‑ Mark Papa.
Mark Papa left EOG in 2013
And kind of was one where it was a stealth play. And then there’s this mad rush for the Eagle Ford. Now the Eagle Ford is kind of considered well, there’s A) it’s drilled up a lot, and some of it’s more natural gas, and some of it’s more natural gas liquids, and it’s not that good. And by the way, if you go to West Texas, the Permian, there’s an Eagle Ford stacked on top of another Eagle Ford. There’s all these thousands of feet of different benches you can drill horizontal wells in.
Eagle Ford is now considered okay, a little mature, maybe some opportunities, but you’re only interested in moving back there if you can’t find anything in the Permian in West Texas and New Mexico. There’s dozens of different kinds of stories of rises and falls and the business ‑‑ there’s not just a lot of amazing oilmen who picked exactly the rise and fall correctly. There were some who were just there in a basin that ended up rising. And there are some that did guess it correctly. There are some who came in too late and ended up losing a lot of money.
Mike: There’s a bunch of things I want to follow up on that. One is the Permian which I don’t know much about but a month ago [September 2016] the general newspaper readership got a sense that Apache Energy had a huge find. I want to follow up on the “genius capitalists” of the thing.
There’s a local guy who I don’t know personally, but was celebrated around the discovery of the Eagle Ford. Suddenly this guy I hadn’t heard of before, named Rod Lewis became a known shale revolution gas billionaire. Part of his legend – and I don’t think he appears in your book, is as a very blue-collar guy checking old oil wells and then ‑‑ sudden success is always overnight and it took 20 years that we didn’t know about…
But you do describe a guy, and I don’t know if you have stories about him or his thing, but you do have a thing that sounded very similar to that, in your book. Terry Pegula, who sounds similarly this blue-collar guy in the business of helping plug old oil wells and then suddenly seems to, out of nowhere, have acquired a massive amount of leases, which is then first worth a billion and then three or four billion a couple years later. Do you know the Rod Lewis story to tell? Local people might be interested. I’ve only heard basically what I just told you.
Terry Pegula
Gary: Petro-Lewis is a very well respected company and definitely considered one of the Eagle Ford’s central private play. I don’t know his story particularly, but Terry Pegula, who now owns the Bills2 and Sabers and the savior of Buffalo was definitely almost like a hoarder of leases.
Terry Pegula and wife Kim
Mike: Clean your stuff out, man. We’re going to call the cops on you. He was that guy?
Gary: Yeah, and would take them from other companies with the agreement that I will plug these wells ‑‑ a natural gas well sometimes can produce for a century maybe, at very low volumes, but it gives you the right, based on the lease, to actually drill beneath it. Even if you have a well producing 50 dollars a day of stuff, it does give you the optionality ‑‑
Mike: Vertically you can go below that existing small-producing well.
Gary: Yeah. He didn’t do that on purpose. No one thought when he was hoarding these leases that there was going – Qatar was going to be in Pennsylvania and eastern Ohio. He was just doing it because he liked doing it. I think also as a car dealer once said to my wife his view, “If it’s free, it’s for me.” People would just give it to him because it took liabilities off their hands. I don’t know the Petro-Lewis story but that’s one of those kind of amazing stories, sort of the wheels of markets and capitalism and fortune and luck and idiosyncratic histories that people like to wrap up sometimes in a more heroic narrative.
Mike: We love the narrative of the blue-collar guy making good. That’s a pleasing capitalist ‑‑ it’s terrible when the rich remain rich. It’s great when the poor suddenly make it rich.
Harold Hamm: Humble, but sensitive, Trump supporter
Gary: That’s why Harold Hamm, hearing him getting offended by “fracking,” he is the single person who’s gotten richest individually off the shale revolution. He is one of 13 kids, a sharecropper in Oklahoma, who barely graduated high school. Never went to college. Didn’t have shoes until he was six. A story out of a different century and now is the 70th richest man in the world. He signed a giving pledge with Bill Gates.
Mike: I think you described him getting into North Dakota because he was one of these losers who had no other chance.
Continental Resources CEO Harold Hamm endorsed Republican Presidential front runner Donald Turmp.
Gary: Exactly. He admits it. He’s a humble guy in some ways. He kind of admits “I couldn’t afford what we were paying” ‑‑ basically you’re paying option value for leases in North Dakota.
And I heard Harold Hamm speak, and he gave a very pro-Trump soliloquy, like 45 minutes long with slides, more of a presentation. He talked about a very obscure argument. I don’t even know what happened, but Trump came to Colorado and also said basically the same thing Hillary said, which is communities should be allowed to regulate fracking in their backyard.
And Hamm’s like: “Forgive my friend Donald. He didn’t know what he was saying. He agrees with me.” Even the word “fracking.” He’s one of Trump’s chief supporters. And he made it clear that if you use the word fracking around him, the conversation is over, because it is an insulting term to describe hydraulic fracturing.
Mike: Okay, words matter and that’s a hurtful word for him.
Gary: Yes.
Mike: Okay. He sounds a little sensitive, but anyway.
Gary: You’d think 70th richest man in the world and 12 billion dollars would make you less sensitive. Apparently, that’s not the case.
Mike: Words have power and he’s a man who can be hurt by that word.
Please see related audio post (upcoming)
Part II with Gary Sernovitz – on the environmental issues of fracking
Before becoming an oil private equity guy, Gary Sernovitz was the next F. Scott Fitzgerald, and authored two novels, Great American Plain, and The Contrarians.
I just really enjoyed this episode of the podcast “Criminal,” episode 51, so decided to repost it here. Most people with bad credit are not victims of identity theft. But for those who are victims of identity, its obviously a nightmare. The nightmare described in this podcast is even worse than most.
I spoke with an old friend Trevor, a former Director of Research at a Hedge Fund of Funds. In college, a mutual friend of ours imaged a radio show named “What the Fuck Do you Do?” in which he interviewed people in jobs that nobody else understood the name of, or the function of. This interview is in that spirit. He spoke about the business, lucking into one of the best bosses in finance, and then leaving it all. This interview is also in the spirit of Trevor himself, a recovering banker trying to figure out what’s next for him.
What is a Fund of Funds?
Trevor: Hi my name is Trevor and I used to be the director of research for a fund of funds.
Michael: Trevor, thank you for agreeing to be part of Bankers Anonymous. I’m wondering when you said you’re a fund of funds manager, what percentage of people that you ever talk to, who you identify yourself as a fund of funds manager say, “Oh, I know exactly what that is,” or do people have no idea what you’re talking about?
Trevor: People have no idea what I’m talking about.
Michael: What do you usually say?
Trevor: And it’s usually a stultifying opener when I say – people say what do you do and I say, “I work for a fund of funds, fund of hedge funds.” Three-quarters of the time there’s a blank stare and then one-quarter of the time people actually ask a follow-up question about what it is. But the topic of finance generally sends people running away from the conversation. So I usually lie now when I tell people what I do.
Michael: What’s your backup answer now, zoo keeper?
Trevor: I raise bees, African honey bees which produce a very spicy variety of honey.
Michael: Awesome. I know what a fund of funds business is more or less, although I’ve not worked at one, but is it easy to describe what that means?
Trevor: It is. It is a collection of funds run by other people managed by the fund of funds operator. Usually I give people the analogy of mutual funds because most people know what mutual funds are. The business model is if I was going to create a fund of mutual funds, so instead of you investing in mutual funds directly and picking ten mutual funds, you could invest in Trevor’s fund of mutual funds and by investing in my one fund you get exposure to however many underlying mutual funds I choose to put in the portfolio.
The fund of hedge funds is the same idea but instead of underlying investments being in mutual funds, the investments are in hedge funds. That’s usually when people freak out because they’re like “Oh my god, hedge funds; now you’ve lost me. Aren’t those all terrible?”
Michael: Are you part of the evil hedge-fund world?
Trevor: Yeah.
Michael: I’m familiar with that, where people hear fund of funds and suddenly there’s a blank stare and everybody’s like “Oh my God look shiny object over there.”
Trevor: And, to interrupt you, then the smart people say, “Oh, so that’s an extra layer of fees, so basically you pay fees to the hedge funds and then I pay fees to you, and then there’s multiple layers of fees. So it’s not really a business, it’s just a set of fees.” That’s what the savvy, cynical, smart people usually observe right away.
Michael: The classic criticism of hedge funds themselves is they’re not really an asset class but a compensation scheme. As a derivative of a hedge fund you could be a compensation scheme on top of a compensation scheme.
Trevor: Yes.
Michael: But having been in the world, do you think the added expense is worth it?
Trevor: The firm that I worked at launched multiple products going back over the last twenty years and their long-term results easily beat the S&P500 with better performance characteristics, as net of all fees.
Michael: Performance characteristics: Volatility, Return, what else am I worried about – draw down I guess; how much did you lose in a bad year?
Trevor: Yup, and then one more which is correlation to the index. If the index is going one way the fund of funds is not necessarily having the same pattern. So there are fund of funds which have been able to outperform the broad-based market net of all fees over a five, ten, fifteen, twenty-year time frame.
Michael: And your fund did that?
Trevor: Yes.
Michael: So post-credit crisis in 2012 is the world different for fund of funds?
Trevor: I think there will always be a need for fund of funds because institutional investors want access to alternative investments and part of that is access to hedge funds. A lot of those programs don’t have the resources to research hedge funds, and invest in them, and monitor them. So if you’re a 200 million dollar endowment for a secondary school or small university,
Michael: Basically, tiny.
Trevor: And you allocate twenty percent to hedge funds, so you have 40 million dollars going into hedge funds. And of that, you have half of that going into long/short equity hedge funds, you can’t hire the staff to adequately research and monitor it. So middle-sized endowments will always have a need for a gatekeeper to help them.
Then a lot of larger institutions often hire funds of funds to create a starter kit and they will put together fund of funds for the larger college endowment, and then the endowment will eventually take it over once they’ve learned the ropes.
And the last category that’s probably never going away is if you’re a high net-worth individual but you’re not super, ultra-rich, you can’t afford to create your own diversified portfolio hedge fund because they generally have a one million dollar to five million dollar minimum, so if you, say, only have ten million dollars to invest and you put twenty percent in hedge funds which is two million dollars, you can invest in two hedge funds, maybe, which as everyone knows you don’t want to take on concentration risk in really any asset class. So the high-net individual but not ultra high-net will always need a fund of funds to create a diversified pool.
Michael: Is that essentially the customer base of your business, medium-size endowments and high but not ultra high-net worth individuals?
Trevor: When the firm first launched it was mostly high net-worth individuals, which I think is if you go around to your friends and say, “Hey I’m starting this business, will you invest?” And then over time they generate the track record and credibility, their shift was towards institutional clients. The current composition is ninety-five percent institutional and five percent individuals.
Michael: I’m sorry, ninety-five percent institutional and five percent individuals?
Trevor: Right, so the shift over time was dramatically towards institutional money meaning pension plans, charities, endowments, foundations as opposed to individual investors.
Michael: I obviously know you quite well and I know you have a mathematical background but can you describe what it’s like to work for a fund of funds? What’s the main skill set that’s useful?
Trevor: I think everybody approaches selecting managers differently and there are places that run Monte Carlo simulations and all sorts of back testing and modeling and then there’s people on the totally other end of the spectrum who just meet with a manager and think, “I like that guy.”
Michael: More a feel on what’s a good manager or good investor.
Trevor: Yeah, and both approaches probably work fine, as long as you do the one that makes sense to you. Our firm fell somewhere in the middle where we did a lot of number crunching and we would look at past track records and look at when managers had losses how did they respond to those losses. Hedge funds generally have access to leverage so when the economic environment deteriorates does the manager double down to take on more risk in hopes of making all this money back quickly; or if they have losses and a bad environment do they reduce exposure and risk and crawl back slowly? Looking at quantitative information to assess how a manager responds to risk and how much risk they take on.
Michael: So it’s a mix. It doesn’t sound like rocket-science math.
Trevor: No, there’s some standard deviation and draw downs but probably high school level math.
How Do You Get a Job at a Fund of Funds?
Michael: In 2002 you were not in the financial world. How does one get a job at a fund of funds shop?
Trevor: I think it’s a strange path. Probably very few people coming out of college have heard of this industry. So I happened to get into it by a sequence of events where my uncle had worked for a guy who ran the company and he hired me to do some software programming. Then I joined running operations and gradually made a transition to the investment side while doing the CFA program. It was a very idiosyncratic route.
Michael: The work environment was somewhat idiosyncratic also?
Trevor: Yes, I think I worked for one of the nicest people in finance, certainly shocking and refreshing to find someone who is very principled and fair and entertaining. I remember an early conversation where the boss said, “You know, I’d really like to take Fridays off in the summer, but if I take Fridays off what am I going to do about all the employees? Maybe they can work half a day. Oh fuck it, just everybody gets Friday off.” But that was also tempered with if you made a mistake he would come down very hard on you. It was very high expectations but it was a very fair environment.
One great memory which is that my boss used to come into my office and he would say, “You know, when I had my first consulting job, my boss would come in and he would say, ‘I’m going to give you six months to work on this, and if it turns out well you get full credit. And if it goes badly, you’re fired.'” And I’d think ha-ha that’s great, good story. He told me this anecdote maybe three or four times over the course of two weeks, and the fourth time it dawned on me; those are the rules. If it goes well, I get full credit, and if it goes poorly, I’m fired.
Walking Away From It All
Michael: Okay, you’re no longer fulltime with the same fund of funds and as I understand it you’re interested in other things. Why would you do that?
Trevor: Great question. A friend of mine told me he would come up to New York and shoot me if I lived there for more than five years.
Michael: So it was fear that drove you away.
Trevor: At year eight I was getting worried that would actually happen.
I love spending time out of doors and I love farmers markets and I love a slightly slower pace of life. It’s very hard to achieve that in New York where your apartment can be very small and dark unless you’re extremely successful. People don’t generally host dinner parties or hang out in their apartments which I think is why I think a lot of the public spaces in New York are so great. Peoples’ existence in their own apartments is not a great hosting venue. But all that being said, I wanted to move out West and have access to the out of doors.
Michael: While maintaining your anonymity for this program, we’ll just say you’re in California, somewhere in California. They’ll have to try to find you. I think I’m hearing you say actually when it came down to money versus friendships you found the friendship part more compelling. This sounds very un-banker-like of you.
Trevor: Certainly I would rather have more money than less money. I did have this idea I would work hard and save up money for a while and then leave and do something else. I’m in the process of executing that transition and certainly some days I wake up and I think what an idiot; if I had stayed and followed the traditional succession plans, I’d be a gazillionaire.
Michael: But even making the choice to leave and get into a different mode of life, it’s still hard to think: “Wow, but I could have had this money!”
Trevor: I think it’s hard to take a path where you’re relatively senior and successful and basically go into another industry or set of interests where you don’t have any credibility or expertise necessarily, but you think it’s a more satisfying and rewarding way to spend your time. I’ve discussed this with my former boss and he wisely wrote back and said, “Money means nothing if you are unhappy.”
Michael: Wise words.
Trevor: If it’s a calling that’s good for you, and there are certainly plenty of people in finance who genuinely enjoy it. Then I think it’s a great career track. But money corrupts and it’s an industry that can lead people to stay working in it when they don’t get a whole lot of meaning out of it.
September 2017 marks the ninth anniversary of the most explosive month of the Great Recession. Over one dramatic weekend nine years ago, legendary Wall Street firm Lehman Brothers declared bankruptcy, brokerage giant Merrill Lynch threw itself desperately into the arms of Bank of America, and insurance conglomerate AIG became an 80% ward of the federal government. That very bad weekend in mid-September followed hot on the heels of the previous week’s fireworks, in which mortgage giants Fannie Mae and Freddie Mac entered “conservatorship” status with the Federal Housing Finance Agency.
I spoke to Eisinger about his book recently. As a former mortgage and CDO salesman myself, I tried to explain, the actions of Wall Street folks described in civil complaints about sub-prime mortgage securitizations fell within a normal range of activity of how we did our jobs. Eisinger didn’t buy it.
Mike: Hi, my name is Mike, and I used to be a banker.
