The Sellout

1. Wall Street's Transformation: From Advice to Risk

Most of all, I wanted to focus on Wall Street, which had made billions upon billions of dollars in profits from mortgage bonds and were now bleeding billions in losses.

Shifting Priorities. Wall Street's traditional role as an advisor to companies and investors was gradually replaced by a focus on trading and risk-taking. This shift was driven by a combination of factors, including the conversion of private partnerships to public companies, the rise of technology, and the shrinking profit margins in traditional advisory services.

• The 1980s saw a surge in trading, particularly in bonds, as inflation was tamed and interest rates fell.
• Firms began to leverage their balance sheets, borrowing heavily to invest in new types of securities.
• The focus shifted from providing advice to taking on risk, with traders and risk managers becoming the new power players.

The Rise of the Trader. The culture of Wall Street changed dramatically, with traders and risk takers like John Meriwether and Lew Ranieri becoming the new heroes. These individuals were not just smart but also had a penchant for gambling, a willingness to take risks, and a desire to make money, often with other people's money.

• The success of Salomon Brothers and its bond traders led to a broader revolution that swept Wall Street.
• Young MBAs no longer wanted to advise CEOs; they wanted to use leverage to take over companies.
• Risk taking became an obsession, with randomness viewed as a friend that increased the odds of making the ultimate payday even bigger.

The Seeds of Meltdown. This transformation, while initially profitable, sowed the seeds of the 2008 financial meltdown. The focus on short-term gains, the use of leverage, and the creation of complex financial instruments created a system that was inherently unstable and vulnerable to collapse.

2. The Rise of the Mortgage Bond and its Architects

Frequently called the “Godfather” of the mortgage bond, Ranieri, the former vice chairman at Salomon Brothers, reportedly coined the term “securitization,” which refers to the packaging of mortgage loans into bonds.

The Birth of Securitization. The concept of securitizing mortgages into bonds was relatively new in the 1970s. It involved pooling illiquid loans (mortgages) into a single bond and selling them to investors, thus removing them from the banks' books.

• The first mortgage bond was sold in 1970 by Ginnie Mae, a federal government agency.
• Lew Ranieri at Salomon Brothers is credited with pioneering the market for mortgage-backed securities.
• The goal was to get banks to take loans off their books and sell them to Wall Street, which would then sell them to investors.

Ranieri vs. Fink. The market for mortgage-backed securities was pioneered by two men: Lew Ranieri of Salomon Brothers and Larry Fink of First Boston. They were both outsiders who saw the potential in this new market and were driven by ambition and a desire to make money.

• Ranieri was a college dropout from Brooklyn, while Fink was a self-described "Jew from Los Angeles."
• They were both outsiders in the Wall Street hierarchy, and the nascent market of mortgage bonds was one way to break in.
• Their rivalry fueled innovation and growth in the market, but also led to increased risk taking.

The Complexity Grows. The mortgage bond market grew increasingly complex, with new types of bonds being created, such as collateralized mortgage obligations (CMOs), interest-only strips (IOs), and principal-only strips (POs). These new instruments allowed investors to tailor their risk exposure, but they also made the market more opaque and difficult to understand.

3. Leverage and the Illusion of Control

Well, if you’re telling me you haven’t had a loss yet, that doesn’t make me happy. All that means is you’re not taking enough risk.

The Power of Leverage. Leverage, or the use of borrowed money, became a key component of Wall Street's business model. It allowed firms to amplify their gains, but it also magnified their losses.

• As firms converted from private partnerships to public companies, they began gambling with public shareholders' money.
• Lower interest rates made borrowing cheaper, encouraging speculators to borrow more.
• Leverage became an obsession, with firms borrowing multiples of the amount of capital they had to invest.

The Illusion of Control. The use of computer models and complex financial instruments created an illusion of control over risk. Traders believed they could predict market trends and prices, but they often failed to account for the randomness of events and the possibility of unforeseen losses.

• Traders used technology to find historical patterns in the way markets behaved and crunch data in ways that would have been impossible just a few years earlier.
• Armed with this information, traders for the first time seemingly had a real edge.
• The randomness of events meant little to this new breed of executive on Wall Street.

The Danger of Complacency. The success of the carry trade, where firms borrowed cheaply to invest in higher-yielding securities, led to complacency and a disregard for risk. Firms became increasingly comfortable with taking on more and more debt, believing that the good times would never end.

4. The Culture of Greed and the Lure of Easy Money

Bottom line, we want hungry, street-smart people, and that’s why we want you.

The Allure of Wealth. The culture of Wall Street in the 1980s was characterized by a relentless pursuit of wealth and power. The lure of easy money led to a disregard for ethics and a willingness to take excessive risks.

• Cocaine use was rampant on trading desks, and call girls made midday trips to offices all over Wall Street.
• The focus shifted from serving clients to making money, with brokers churning accounts and bankers pushing companies to take on debt.
• The pursuit of wealth became an obsession, with traders and executives earning millions of dollars a year in salary and bonuses.

The Outsider Mentality. Many of the key players on Wall Street were outsiders who had broken into the industry through their own hard work and ambition. This outsider mentality fueled their desire to succeed and their willingness to take risks.

• Bear Stearns was founded by "tough Jews" who couldn't get jobs at the elite firms.
• Jimmy Cayne, a college dropout and bridge player, rose through the ranks at Bear Stearns.
• Lew Ranieri, a mailroom clerk, became the "Godfather" of the mortgage bond.

The Erosion of Ethics. The focus on making money led to an erosion of ethics and a disregard for the consequences of their actions. Wall Street became a place where anything was permissible as long as it generated profits.

• The "pay to play" culture of municipal bond underwriting led to corruption and scandal.
• The use of junk bonds to finance leveraged buyouts led to the dismemberment of some of the nation's largest corporations.
• The creation of complex financial instruments made it easier to hide risk and avoid accountability.

5. The Perils of Unchecked Innovation and Complexity

Sometimes our technology in creating these securities outpaces our ability to cope with them.

The Dark Side of Innovation. While financial innovation can be beneficial, it can also lead to unintended consequences. The creation of new types of bonds and derivatives made the market more complex and opaque, making it difficult for investors and regulators to understand the risks involved.

• The creation of CMOs, IOs, and POs made the mortgage market more complex and difficult to understand.
• The use of derivatives, such as interest rate swaps, grew to immense proportions, creating a completely unregulated market.
• The complexity of these instruments made it difficult to assess their true value and the risks they posed.

The Limits of Models. The reliance on computer models and mathematical formulas created a false sense of security. Traders believed they could quantify and manage risk, but they often failed to account for the human element and the possibility of unforeseen events.

• The models were only as good as the data that were fed into them.
• They failed to account for the randomness of events and the possibility of sudden market shifts.
• The models also failed to account for the human elements of greed and the lust for power.

The Opaque Nature of the Market. The lack of transparency in the derivatives market made it difficult for regulators to understand the risks involved. No central clearinghouse existed for these complex instruments, and regulators had little or no idea that this market even existed.

• The derivatives market became a huge casino, with trillions of dollars being bet by the big banks on a daily basis.
• The market was hidden and opaque, with no central clearinghouse and little or no regulation.
• Regulators had little or no idea that this market even existed and that it was growing swiftly.

6. The Government's Role: Incentives and Intervention

The Ronald Reagan–era tax cuts spurred the economy and the stock market to new heights. But it was Fed Chairman Paul Volcker’s policy of squeezing inflation—one of the great economic achievements of our time—that spurred the bond market.

Government as Enabler. Government policies played a significant role in fueling the housing bubble and the financial crisis. Tax cuts, low interest rates, and deregulation all contributed to the growth of the mortgage market and the rise of risk taking on Wall Street.

• The Ronald Reagan-era tax cuts spurred the economy and the stock market to new heights.
• Fed Chairman Paul Volcker's policy of squeezing inflation spurred the bond market and made risk taking through trading various forms of debt the Wall Street business model.
• Low interest rates made borrowing cheaper, encouraging speculation and the use of leverage.

The Push for Home Ownership. Government policies aimed at increasing home ownership, while well-intentioned, also contributed to the crisis. The government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac were pressured to guarantee increasingly riskier loans, which ultimately led to massive losses for U.S. taxpayers.

• HUD secretaries Henry Cisneros and Andrew Cuomo prodded Fannie and Freddie to guarantee riskier loans.
• The GSEs became large, powerful players in the mortgage market, with an implicit government guarantee.
• The government gave a huge tax break to savings and loans if they could sell assets such as mortgages.

The Failure of Regulation. Regulators, such as Fed Chairman Alan Greenspan, bowed to pressure from the banking industry and made it easier to take enormous risk. They failed to force Wall Street to adopt more restraint, and they often missed the warning signs of a looming crisis.

• Regulators such as Fed Chairman Alan Greenspan, as well as various chairmen of the Securities and Exchange Commission, appointed by Republicans and Democrats alike, bowed to pressure from the banking industry.
• They made it easier to take enormous risk and, despite periods of market unrest, never forced Wall Street to adopt more restraint.
• The SEC and congressional committees with oversight responsibility over Wall Street had little or no idea that the derivatives market even existed.

7. The Inevitable Burst: A Market's Reckoning

But they always do.

The End of the Party. The good times on Wall Street couldn't last forever. The combination of excessive risk taking, high leverage, and a housing bubble that had grown to unsustainable levels led to an inevitable market correction.

• The junk bond market imploded in the late 1980s, leading to the demise of Drexel Burnham Lambert.
• The mortgage market began to unravel in the mid-2000s, as defaults rose and the value of mortgage-backed securities plummeted.
• The credit crunch of 2007 and 2008 exposed the fragility of the financial system and the dangers of excessive leverage.

The Domino Effect. The collapse of the mortgage market had a ripple effect throughout the financial system. The implosion of Bear Stearns was a sign of things to come, as other firms began to experience massive losses and funding problems.

• The collapse of Bear Stearns' hedge funds signaled the start of the credit crisis and the end of Bear.
• The credit crunch would get worse, and so would Cayne, and so would Bear Stearns.
• The Street needed to consolidate; there were too many investment banks chasing the same deals.

The Human Cost. The financial crisis had a devastating impact on the lives of ordinary people. Home foreclosures rose, and many families lost their homes and their savings. The crisis also led to widespread job losses and a deep recession.

• The U.S. housing market began to unravel in late 2006 and early 2007, so did the value of nearly every mortgage bond Wall Street had created.
• The demise of the hedge funds was initially considered by Bear Stearns’ management, Cayne and Spector in particular, as an isolated event without any broader implications for the market or the entire firm.
• The credit crunch would get worse, and so would Cayne, and so would Bear Stearns.

8. The Aftermath: Bailouts, Blame, and Broken Systems

What I set out to do in this book is pretty straightforward: to explore how the combination of government policies that encouraged home ownership even for people who couldn’t afford to pay their mortgages and Wall Street’s greed had led the country into economic despair and ended American dominance of the world’s financial system.

The Government's Response. The government responded to the crisis with a series of bailouts and interventions, including the Troubled Asset Relief Program (TARP), which was designed to purchase toxic assets from banks.

• The government bailed out AIG, Fannie Mae, and Freddie Mac, and many of the big banks.
• The government's actions were controversial, with many critics arguing that they created moral hazard and rewarded irresponsible behavior.
• The bailouts were also costly, adding trillions of dollars to the national debt.

The Search for Scapegoats. The financial crisis led to a search for scapegoats, with blame being assigned to everyone from Wall Street executives to government regulators to homeowners who had defaulted on their mortgages.

• The players would be the top executives at the Wall Street firms—people such as Cayne, but also, and just as significantly, former Merrill Lynch CEO Stan O’Neal and former Citigroup CEO Chuck Prince.
• There were also the lower-level executives, the top traders who’d raked in titanic bonuses piling up billions of dollars of mortgage debt, almost without any close supervision from above.
• There were the all too few who had refused to sell out, whose warnings and calls for change were often ignored or derided.

The Broken System. The financial crisis exposed the flaws in the regulatory system and the dangers of unchecked risk taking. The crisis also revealed the extent to which Wall Street had become disconnected from the real economy.

• The crisis exposed the flaws in the regulatory system and the dangers of unchecked risk taking.
• It also revealed Wall Street’s transformation of its business model from a stodgy advice-driven enterprise to one that took tremendous risks.
• The crisis led to a loss of faith in the financial system and a growing sense of economic despair.

9. The Human Cost: Beyond the Balance Sheets

“You don’t understand what’s going on here,” Cayne said with desperation in his voice. “My future, my kids’ future, my grandchildren’s future is at stake!”

The Personal Toll. The financial crisis had a profound impact on the lives of individuals, not just those who lost their jobs or their homes but also those who were caught up in the culture of greed and risk taking.

• Jimmy Cayne, once a powerful CEO, was reduced to a shell of his former self, his health and reputation in tatters.
• Larry Fink, once a Wall Street rock star, was forced to rebuild his career after losing his job at First Boston.
• Howie Rubin, a brilliant trader, became a symbol of the excesses of the mortgage market.

The Loss of Trust. The crisis eroded trust in the financial system and in the institutions that were supposed to protect it. People lost faith in Wall Street, in government regulators, and even in the American dream.

• The crisis led to a loss of faith in the financial system and a growing sense of economic despair.
• The crisis exposed the flaws in the regulatory system and the dangers of unchecked risk taking.
• It also revealed Wall Street’s transformation of its business model from a stodgy advice-driven enterprise to one that took tremendous risks.

The Cycle of Greed. The crisis also revealed the cyclical nature of greed and the tendency of Wall Street to repeat its mistakes. Despite the lessons of the past, firms continued to take on excessive risk, driven by the lure of easy money and the desire to beat the competition.

• The randomness of events meant little to this new breed of executive on Wall Street.
• Even as the markets grew more complex and the stakes got higher with wild market swings, a concept known as volatility, risk continued to dominate the Wall Street mind-set.
• In the new world of Wall Street, randomness was a friend because it increased the odds of making the ultimate payday even bigger, even as it increased the odds of losing.

10. The Cycle Continues: Lessons Unlearned

Most of all, I wanted to focus on Wall Street, which had made billions upon billions of dollars in profits from mortgage bonds and were now bleeding billions in losses.

The Return of Risk. Despite the lessons of the financial crisis, Wall Street has shown a remarkable ability to forget the past and return to its old ways. Leverage has increased, and firms continue to take on excessive risk in the pursuit of profits.

• The randomness of events meant little to this new breed of executive on Wall Street.
• Even as the markets grew more complex and the stakes got higher with wild market swings, a concept known as volatility, risk continued to dominate the Wall Street mind-set.
• In the new world of Wall Street, randomness was a friend because it increased the odds of making the ultimate payday even bigger, even as it increased the odds of losing.

The Need for Reform. The financial crisis highlighted the need for meaningful reform of the financial system. This includes stricter regulations, greater transparency, and a renewed focus on ethics and responsibility.

• There were other factors that contributed to the financial mayhem that reached its peak in the fall of 2008: risk takers such as Meriwether, Ranieri, and the traders they spawned would take over the management of the big financial firms; the government would entice Wall Street to innovate and create new types of debt on one hand and provide aid and comfort to the risk takers to trade these newly created bonds on the other; regulators such as Fed Chairman Alan Greenspan, as well as various chairmen of the Securities and Exchange Commission, appointed by Republicans and Democrats alike, bowed to pressure from the banking industry, made it easier to take enormous risk, and, despite periods of market unrest, never forced Wall Street to adopt more restraint.
• The government would entice Wall Street to innovate and create new types of debt on one hand and provide aid and comfort to the risk takers to trade these newly created bonds on the other.
• Regulators such as Fed Chairman Alan Greenspan, as well as various chairmen of the Securities and Exchange Commission, appointed by Republicans and Democrats alike, bowed to pressure from the banking industry, made it easier to take enormous risk, and, despite periods of market unrest, never forced Wall Street to adopt more restraint.

The Importance of Memory. The financial crisis serves as a cautionary tale about the dangers of greed, hubris, and unchecked risk taking. It is a reminder that the pursuit of wealth should not come at the expense of ethics and responsibility.

• The roots of the story lie farther back than that year, much farther back. One of them, in fact, can be traced all the way back, I discovered, to the 1970s and to a city hardly known as a major financial center, Cleveland, Ohio.
• It’s there we’ll begin.
• The roots of the story lie farther back than that year, much farther back. One of them, in fact, can be traced all the way back, I discovered, to the 1970s and to a city hardly known as a major financial center, Cleveland, Ohio.

Last updated: January 14, 2025