2312 FBF: The Collapse of Bear Stearns with Douglas Brunt Author of "Ghosts of Manhattan" & Former CEO of Authentium

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Welcome to the Creating wealth show. This is your host, Jason Hartman. And this is episode number 337. We are going to be talking to as our special guest today, Doug Brunt, who is the author of a new book entitled Ghost of Manhattan. And it's all about the very interesting Wall street lifestyle. And you'll also find it interesting that Doug is married to someone who is quite famous. And you'll hear about her as we talk. She's not in the news. She is the news. So you'll hear about that during the interview. But before we get to Doug Brunt, I'd like to invite back to the show Ken, our local market specialist from Atlanta. How you doing?

Good. Jason, how you doing?

Good. It's good to have you back on. And this time we're not going to talk about the market in general. You just agreed to, you know, come on and help me do the intro portion of the show before we get to our guests. So sometimes we do a show that is centered all around a particular market and, and that's not the case here. We're just going to kind of chat about a couple of current events and get your opinions on some things before we go to Our guest today. And what is the first one? Did you want to talk about construction?

Well, I think it's an interesting topic. It's actually fresh in my mind because we just were wrapping up a new construction house here in Atlanta and looking at the news, it seems like new construction is hitting a five year high right now. So it's definitely a hot topic.

It has come back and you know, I haven't looked at the stats on this lately, but I would guess that it's still paling in comparison to what it was at the peak, which was probably 2005 or 6, I would guess for single family home starts. What do you think?

Yeah, I would guess probably 2006 was the high. And you're right, we're probably half of where we were at that point in time. But we actually have hit back to the levels in terms of construction spending that we were at in September of 2008.

And it's interesting. You know, it takes. This is really good for investors if they understand it and they understand these business cycles and market cycles and the way they interplay together. Because it takes a long time to ramp up the construction machine. This is not quick unless you've got land sitting around that is already mapped and entitled and it's ready to build on, which is not usually the case. Even if you have that. It takes several months to to build and complete a community, but takes a while to ramp up that construction machine. And that's really good for investors in a lot of ways as long as they understand it and depending on how they interact with that. But you had some statistics and things that you wanted to share, right?

Yeah, sure. And to your point, it was kind of interesting. I remember the end of 2012, beginning of 2013, we sort of started to see things change where there was actually a pretty major land grab. Any of the developed lots and subdivisions that were out there that had just been sitting there for years, all of a sudden there was just a flurry of activity. You sort of knew that come summer you were going to start to see a lot of houses on the ground. And that's really what we've seen happen. When we saw it happening, we started to try to pick up some lots as quick as we could just because we saw the opportunity. The writing was on the wall.

Yeah. And you're mostly not a home builder, meaning a build it from scratch, be the developer type of person. You're mostly a buy it and rehab it person, right?

Absolutely. And we plan on continuing to do that. It's just that we saw that there was going to be an opportunity to pick up a few lots cheap and sort of ride this wave of new construction this year. And so we're taking advantage.

Well, tell us a little more. Get into some of the details that you wanted to share.

Yeah, so I mean the big thing is that. So construction spending is up. It's actually 17% higher than it was even a year ago. I mentioned we're really at a five year high and housing starts are up as well. And what's interesting too is that this new construction houses are selling in the midst of interest rates that are rising. Just this summer, the last couple of months we've seen interest rates rising and yet new construction is still full bore, full steam ahead.

But to be fair and to put that in perspective, interest rates are still historically incredibly low.

Right, Very true. No, you're in the broader context. But I think that the rising interest rates probably did give some buyers pause just to wait and see what they're going to do if they were going to come back down. And yet housing is still booming, but.

It still hasn't really solved the inventory shortage problem. I mean, the rates going up and the construction going up. We've still got really an overall in good markets, good neighborhoods and good markets. We, we always talk about the market, the msa, which is the metropolitan statistical area like Atlanta or Dallas or Dallas Fort Worth, whatever. But then you look at the micro markets or the sub markets within there and then you parse it way down to neighborhoods because housing is such a localized thing still in good areas. I mean, I mean, you would say there's an inventory shortage, wouldn't you?

Absolutely. We haven't even come close, I think, to solving the inventory problem. I think we're still just scraping the.

Surface with rates up and construction up. Any thoughts as to how much we've got to do to solve that?

I think we're going to see a lot of new construction over the next year. Two years, three years. Who knows how long we're going to ride this wave. But you've got to figure we haven't built any new inventory for the last five years. In a market like Atlanta, when you've got close to 100,000 new people moving into the market every year, no new housing being built, and we've sort of dug ourselves a little bit of a hole in terms of inventory.

Well, I think there's a lot of inventory in places like Detroit, America's largest bankrupt city.

You're probably right.

Yeah. But you're not interested in going There and starting up a satellite office there, huh?

Not so much.

Okay. All right, well, tell us more. You have some more stats you want to share?

Yeah. The other interesting thing was that the. I guess there was a survey done of home builders, and it seems like potentially the credit is actually easing for the acquisition and development loans, which I think is also going to speed up the recovery in terms of new construction. In fact, I actually had a meeting with my banker this week to talk about something else, and it came up and he said the same thing, that they're finally starting to loosen up and credit starting to flow a little bit better into the new home construction industry.

That'll create more building, a little bit more supply. But again, we. We're so upside down on this equation that I don't think it's anything to be very concerned with at this point. It always goes in a cycle. You know, this is the. The traditional definition of the business cycle.

Welcome to this week's edition of Flashback Friday. Your opportunity to get some good review by listening to episodes from the past that Jason has hand picked to help you today in the present and propel you into the future. Enjoy.

The money gets out there. And when it's cheap money, it causes inventories to build, whether it be housing, inventory, inventory of widgets in another kind of business. And that's what happens. And then there's still a lot of buyers gobbling up the widgets, gobbling up the houses, whatever they are gobbling up that inventory. But then at some point, you get to homeostasis, where it's kind of like equal. And that's a really great market. I love a market like that because as a broker, you can operate in that market where it's not impossible to get a property. The buyers aren't all totally discouraged and things work. You know, you can do business, you can do deals. Right now, frankly, we find this market kind of hard to operate in because people get too discouraged. You know, they go out there and they try to buy properties and there's not much to choose from. And, you know, if they're out on properties where, you know, they're on the open marketplace and they're making offers, a lot of times they're getting their offers turned down, even at full price, even sometimes above full price.

Sure, you're exactly right. If you're selling a house right now, you're definitely holding the cards right now in this market, it's definitely a seller's market. It's tricky to be a buyer right.

Now, so there's really A few kinds of markets. Most people think there's just a seller's market and a buyer's market. I say there's a seller's market which most people. Which the media would call a good market. Most people would call that a good market. When prices are going up really fast, the sellers hold all the cards and that's called a good market. For some reason, people liken it to a good market. Then there's a buyer's market where prices are depressed. And we're coming out of that. Obviously, we haven't really been in that market for about two, maybe even two and a half years now, depending where and depending what product type and in what geography. But then I also like to say there's a broker's market.

You know, where it's easy for a broker to operate. And I kind of look at that as the middle, sort of even keel market where it's kind of at an equilibrium. And then when you look at it in the renting and the tenant market, you have it there too. Sometimes you have an oversupply of properties for rent or lease and you don't have enough tenants to lease them, so landlords have to lower their prices. And then the other time you have where it's a landlord's market, that previous one would be a tenants market. Other times you have a landlord's market where you know, the landlord is in control. There's very little rental inventory. And landlords can raise rents. They can insist on really high credit scores. They can insist on, you know, no pets and just get that ideal perfect tenant. What are your opinions on the landlord versus tenant market? We talked about the buyer versus seller.

Market, at least in my. I can really only speak intelligently on Atlanta. To me, honestly, it feels like we've still sort of maintained this homeostasis that you used. We haven't seen any major trends where rents are falling or rents are rising. It doesn't feel like we're having a hard time finding tenants or an easier time finding tenants. It seems like the rental market, at least what we've seen, has pretty much maintained for the last several years.

Are you seeing rent prices go up now? We are across the country. I mean, I know that on my own properties I'm able to raise rents in between tenants fairly well nowadays.

You know, the stats in Atlanta say that they've risen, but just very minimally. I mean, we haven't seen any major bumps yet.

See, now if interest rates go up a lot more, then I think you'll. It'll be A landlord's market. Because I always say people really only have three choices. They can, they can buy, they can rent, or they can be homeless. And when I said that during one of my seminars, a smart Alex said, no, they can live with their parents. I guess that's true too. We call this the boomerang generation. And you know, that's actually an interesting point too. It's a little hard to quantify, but we know it's out there and it's going to be really good for investors that there's a lot of pent up demand of these, you know, what they call the missing households. That's people that have moved in with their parents or have doubled up that are going to eventually come out of that situation, come into the marketplace, whether they be a buyer or a renter. And either way, if you already own, that's great for you because if they're a buyer, they're going to put upward pressure on sales prices. We all like appreciation, right? But if they're a renter, they're going to put upward pressure on rents because there's more rental demand. So investor wins either way, Right?

Interesting.

Yeah. This is why I say income property is a multidimensional asset class. It's not just about price. Most people want to make it about price. It's just, oh, are the prices up or the price is down? You've got to put in that whole rental side of the equation as well.

Sure, yeah.

What else do you have on this, on the construction thing?

The only other interesting fact that I found that I thought was interesting was about a year ago you started hearing a lot of people talk about the build for rent model. And I knew a handful of folks that had sort of gotten into that. And I think that's because the market for new construction hadn't really picked up. Interestingly enough, the build for rent model is actually down from first quarter to second quarter. I think more builders are seeing that there actually is an opportunity for new construction with just the open market.

Well, tell us what you mean by that. The build for rent.

So it's somebody who's even similar to me where instead of buying and fixing a distressed property and renting it out, it actually makes sense to build a new construction house and put a tenant in it for cash flow. That was a new model that had cropped up where historically that represented a very small amount of new construction market. Well, just last year represented 5% of the overall. Actually 5.8% of the overall new construction market was specifically built for rentals that number is down a little bit, but it is an interesting market.

Yeah, very interesting. Okay, what else on construction? I mean, I see there's quite a few more points here on your article that you posted.

Yeah. One other thing I thought was interesting too is that the new home sales have shifted from purchasing completed homes in inventory to now there's so much pent up demand that folks are actually putting houses under contract before they're even completed. It was interesting to me because it's actually what we're experiencing right now. The house that we were building, we decided to go ahead and put it up on the market a couple of weeks before we were even completed and it went under contract within 24 hours.

Amazing.

It's unbelievable. It even surprised us just how much demand there was for new construction. It makes sense that there's a fundamental shift taking place.

You don't do a whole lot of new construction. That's a smaller percentage of your business. But what are you finding? I mean, how is that deal for the investor? What can they buy at per square foot for new construction?

You know, the one we did is actually we sold it. We ended up selling it retail. We didn't even sell it to an investor.

And when you say retail, you mean a traditional home buyer bought the property, right?

Correct. Somebody that's actually going to occupy the property.

Okay. An owner occupant. And what did they pay per square foot? Do you remember?

The owner occupant probably paid 80, 80 bucks a square foot somewhere. 90 bucks a square foot on this particular property. We looked at it real hard from an investment standpoint to see if we could make the model work. But the fact is, in Atlanta, we're still 22% below the high in terms of values. There's still just too much opportunity to buy distressed real estate, fix it up and be in it for just a lower per square foot cost than new construction. The model just didn't make sense in our market, just at least not yet.

Yeah. So on your rehabbed resale properties that our clients can find@jasonhartman.com what are you typically selling at to investors, you know, on a wholesale basis per square foot?

Yeah. So we're anywhere from 40 to 60 bucks a square foot.

That's still incredible.

It's still, I mean, it's really good price.

Yeah. Yeah. Talk to me about this age old debate and we were talking about it a little bit before we started recording about homeowners association versus non homeowners association. What do you think?

Well, it's a Good question. And it's funny, there's nuances in different markets. When I've talked to folks in California and they think about an HOA, they think about spending $200 and $300 a.

Month on an HOA, sometimes more than.

That, or even more, where $300 is a yearly HOA bill. In Atlanta, in your just traditional suburban neighborhood, you're really only talking about 20 or 30 bucks a month. And for my money, you know, I like the fact that there's a committee sort of overseeing the neighborhood and making sure that you don't have somebody, you know, doing mechanic work out of the garage or letting their grass get over a foot tall and all the things that just protect values in a neighborhood.

Yeah, and I agree with you there. I call that the minimalist hoa, and I think that one's pretty good. It keeps things from going real bad. But, you know, I'm wondering, how bad is the problem? You know, when you don't have an hoa, is it really that big a problem? I mean, certainly there are many areas around the country and in probably every city except Detroit, no, even in Detroit, that are nice without an hoa. I mean, they just have a pride of ownership to them.

Oh, I agree 100%. We've got plenty of neighborhoods that don't have HOAs, and they're primarily owner occupied and people take care of the yards. But when you start to get in sort of the B level properties, a little bit less expensive, older, and they become primarily rental neighborhoods, you know, you can run into some problems where renters don't necessarily have a pride of ownership, and it's possible that they start to let the yards go and that affects values. So really I think it just sort of hinges on what price point you're at.

Yeah. Tell us about one of our clients, and this is Philip we're talking about. I'm sure he's probably listening to the show. And what happened, he got in a bit of a quagmire with buying a property in an hoa. And then one of the problems you might encounter from time to time is a rental restriction, right? Yeah.

So one of the things, one of our lessons from 2012, we'd never encountered it before, and then we encountered it on about three different properties all about the same time, is we bought into an HOA and found out after the fact that there was a leasing restriction. And so, you know, the tenant had been actually been in the house for a while. We later find out that, hey, we're not even allowed to rent in the particular neighborhood. And the HOA came down on us pretty hard and said, hey, you need to get the tenant out of there. And so luckily, the tenant was willing to oblige and he moved out. And we actually put Philip's house on the market just to sell it. He didn't want to try to get too creative and do an owner finance or anything like that. He just wanted to go ahead and sell the property. And so we put the house on the market, and the house sold literally in about 30 days for almost 30,000 more than what he had paid for it only a year ago.

You know, that's so. In life, that is so, so true. So many times things can just be a huge blessing in disguise. I mean, what a nice capital gain.

Yeah, he wasn't complaining.

I mean, granted, at first I bet he was bummed out. I haven't talked to him about this particular thing, and I. I think he recently signed up for Meet the Masters event, which is coming up in January. And. Or maybe it was the Austin property tour, I'm not sure, but I saw a registration come through for Philip, so we're looking forward to seeing you. And at first he was probably concerned and bummed out. Right. Thinking this is. This is gonn to be bad.

He was nervous at first. Then we consulted with an attorney and just trying to figure out the best way to get the tenant out and keep the HOA happy. And so he was a little concerned at first. But when we started pulling comps and seeing what the neighborhood was doing and the market was picking up, you know, it didn't look so bad. And then, you know, obviously, to our pleasure, the house sold quickly for a really good profit.

Yeah. Fantastic. And give. Give us an idea as to, in your marketplace what percentage of the properties that you do are inside a homeowners association and what percentage are outside with no HOA?

Yeah, I would say about 15% of our houses are in HOA's. A part of that, again, is just a function of what year they were built and what price point they're at. So if we're selling a house north of 110, there's a pretty good likelihood that it's an HOA. But if it's less than that, then chances are there's not an hoa. So it's really more a function of our price points.

Sure. And when you consider lower end, middle and high end properties in your market, put numbers on those right now, if you would. Sure.

So low end. And I would say we don't even operate in the low end. But the low end in Atlanta, I mean you could, you could buy houses and fix them up and be in them for, you know, $40,000. Now they're not necessarily the kinds of neighborhoods you want to be in at night where middle of the road. What we would consider a B property is going to be closer to, you know, 60, 70, $80,000 somewhere in that, in that ballpark. And then our A properties are going to be around 90,000 and above. And again, those are still starter homes, but they're homes that make sense from an investment perspective.

And they've got a, they've got a decent pride of ownership in the neighborhood.

Right, right. So there's those neighborhoods are going to be primarily owner occupied neighborhoods.

Okay, good. Well, anything else that you'd like to share before we go to our guest today?

No, that's it. I appreciate you having me on the show.

All right. Thanks for joining us. We will be back with Doug Brunt talking about the Ghost of Manhattan in less than 60 seconds.

Here's your chance to catch up on all of those creating wealth shows that you've missed. There's a three book set with shows 1 through 60 all digital download. You save $94 by buying this three book set. Go ahead and get these advanced strategies for wealth creation. For more details go to jason hartman.com.

It'S my pleasure to welcome Doug Brunt to the show. He's the former CEO of Authentium and author of Ghost of Manhattan. And we're going to talk about some fascinating financial history today. And welcome. Doug, how are you?

I'm doing great. Thanks for having me on the show.

Good. I always like to give our listeners a sense of geography. Where are you located today in New York? You are in right in the heart of it. That's right. Right in the heart of it. Well, hey, tell us about Ghosts of Manhattan, which is actually a novel. But so many of these novels have such interesting true to life comparisons. So you know, I don't know if they're pure novels in any sense. But tell us about Ghosts of Manhattan.

It is a fictional story but it is set within historically accurate, in a historically accurate context in 2005, 2006, so the years leading up to the mortgage related financial crisis. And it follows the life of a fixed income salesman for Bear Stearns. So you really get a look at Wall street from the inside out. It has that sort of insider baseball feel of what is life like day to day on the trading floor as well as away from the Office, which is for folks who are in fixed income sales and trading still part of the job. There's a lot of nightlife and entertainment that goes with that job because they're essentially trading commodities. It's mortgage related bonds in the secondary market. So it's all the same bond. You can get the same quote from any bank or any broker. And so people do business with the folks that they've been out to the dinners with and the strip clubs with and things like that. So it follows this bond salesman and his personal life. There's a lot of the Wall street backdrop that comes into play there. So what's going on with the positions the banks are taking, what's going on with the mortgage crisis, but also all his relationships and what these people are really like more on a day to day and gets into the human side of it. What's going on with his marriage and his relationships with siblings and friends and parents.

Now that's the character in the book though, right?

Right. The main character, Nick Farmer, is the bond salesman at Bear Stearns. But there's a lot of accurate detail in terms of New York City and the different banks and the places that they go. The restaurants and bars are all places I've been and know people who frequent these places. And there is a lot of information. In broad strokes, I've gotten a lot of feedback from people who have worked in this area. And in broad strokes, they said it's entirely accurate on what leads up to some of the issues with the crisis as well as the lifestyle side of it.

Oh, sure, sure. And when you say the lifestyle, you talk about, you know, so it's whoever wines and dines them the most makes, makes the deal because it is a commodity item. So I assume it's even more than strip clubs. It's actual hookers. I mean, I've heard stories about that too.

Yeah, there's a lot of all of that. And so, you know, you go out for a big night at some expensive, you know, Danielle is a very expensive restaurant in New York City. You go out for this incredibly high end dinner with bottles of wine that are $5,000 plus on a regular basis, all in the expense tab. But the next day we throw a few trades your way and the commissions are far in excess of any $5,000 bottle of wine.

Yeah, well, Wall street, it just to me seems like the modern version of organized crime.

And I think there are a lot of people that share that view. But what are some of the comical stories that came out of doing research for the book and in the book and tell us more about that lifestyle component. I think everybody's interested in the human interest side, even if they look at some of these people with a lot of disdain.

And.

Some other feedback I got from the book is, hey, not everybody's a terrible guy on Wall Street. And that really is true. And there is a subset that lives their life very much the way it's depicted in this book. But there are also folks, you know, Wall street obviously serves a function that is positive to the economy, but there are inefficiencies in the way Wall street works, and there are ways to extract huge amounts of money for not, I would say, adding value to society, I guess, but there are very good people on Wall street and nice people and people who are not derelicts out at three in the morning on a Tuesday at a strip club.

And I believe that. And I know I'm making a sweeping generalization, but.

And there are those who think I made a sweeping generalization.

Right, right, right, right. You know, apologies to those who deserve it and no apologies to those who don't. How's that sound?

There we go. Well done.

There's. There's a lot of crooks on Wall street, too. And you know, a lot of people who are just frankly, caught up in the machine that is Wall Street. They went into a career in the financial services industry. They wanted to be a trader. It looks pretty glamorous ever since the 80s movie, the first Wall street movie, of course, and other depictions of it. And, you know, they. People get in and they find they don't know the way the game works until they're really in it, of course. So well.

And you're also at that point making a heck of a lot of money. You know, there are. This is something that's talked about a bit in the book, but in most industries that you and I might know, for 250 or $300,000 as an annual salary, you can hire a very talented person with a stellar education who's going to come in and work hard, take pride in his work, do a nice job and live well on that money. But someone making $300,000 on Wall street who's even in his late 20s or 30, that guy is a loser on Wall street. There's no trader at Bear Stearns making that level of money. It's two to three million dollars a year for someone who's early 30s and doing reasonably well as a trader.

Wow, that's just unbelievable. Now, do those guys all have MBAs or are there non MBAs there too.

There are plenty of non MBAs. There are a lot of folks who come in right out of undergrad and just stay with the trading, stay on the trading floor and work their way up.

Amazing. So tell us more about some of the comical stories and just more of the lifestyle stuff. And then I want to dive into the more technical side of it.

Maybe there are those who are more on the entertainment side of the business. So they don't take a position in the bonds. They basically broker transactions between people taking positions. So they're the ones doing heavy amounts of entertainment. And they'll go to a strip bar and they'll be. It's almost like that scene in Goodfellas when Ray Liotta comes in, he goes to the bag, gets the Goodfellas, walk through the backstage in the kitchen and they plant a table right out in of front of the thing. So everyone in the strip bar would know this person. And he's entertaining clients, he's in several nights a week dropping enormous sums of money. And they become, you know, it's like those guys in the Russian mob are the best customers and well known in the strip clubs. Whereas you suggested more than just stripping is going on.

Yeah, exactly. So your view of life on Wall street from this perspective, is the lifestyle just really corrosive? Does it have to be marriage jeopardizing? Is the stress level just enormous? I mean, give us a little example inside these guys heads.

And it can definitely cause stress on a marriage if you are still in the broker's broker kind of business because entertainment is such a big piece of it. You really are out a lot on the weekend and you know, when you're right out of college, all that's terrific. You're making great money, everything's on an expense account. You're going, you're basically partying more than you did in college and doing sort of a higher end type of partying. But when you hit your mid-30s, as the character in this novel does and is thinking about kids here, you know, some already have kids and you're. It really collides with some of the values that you need to have in a good marriage.

And no question about that and we should mention. So you're married to Megyn Kelly, is that correct? That's right, the Fox News anchor. Very famous. And she's great by the way. Love her work. Has she been a help in terms of writing the book and getting some insider stories?

Not on the insider stories bit. I mean the content hasn't come from her but she's the first person to read anything that I write and she's got great judgment on story and has given me great feedback. It's funny because my agent is formerly with the publishing house, so has been an editor in the past. And so my agent and Meg would read the books first and separately give me feedback, but their feedback would almost always overlap entirely. They had the exact same thoughts, and not just like little things, but more sophisticated things and ideas for structure of the story, which was always very comforting to have these two people who I know well and trust come back with some of the same thoughts. But she was a very talented editor for me.

Yeah, fantastic. So looking at kind of the history of the way this, this whole thing went down, you know, if you had to kind of explain the financial crisis to an outsider, to someone that didn't know much about it, that was not, not very informed or interested in this thing, what would you say happened? I mean, can you pin the blame on one company or one concept? Was it CDO's collateralized debt obligations? Was it Greenspan? I mean, you know, the whole system is so complex and intertwined, but you know, just kind of a very high level view of what happened. It's just sort of interesting once in a while to back up and look at things that way.

I have thought a lot about this because it's a thread within the book. I mean, the book really is a human story, but this is the backdrop. And so I've viewed it as there are five kind of players in this. If I had to pick one, it would be the ratings agencies, Moody's and Standards Poor. But it's sort of five things that happened in sequence that led to this huge eruption. So number one was the government promoted the idea that everyone should own a home.

Yeah. So that goes back to George Bush and Alan Greenspan as his accomplishments.

It actually goes back to Bill Clinton.

Well, fair enough. Yeah, fair enough.

He had legislation passed in like 94, and the mandate of legislation was to dramatically increase American homeownership.

And when you're, when you talk about Clinton in that, are you talking about the cra, the Community Reinvestment Act?

No, I'm blanking on the name of the legislation.

And that's okay because the name of any given legislation never seems to have much to do with what it actually does. Right.

But it does date back to about 94, 95. So the government says everyone should own a home, which is a great goal, but maybe it misses the mark in terms of what's realistic. A Bit. So that's number one. So number two is then the banks start making loans like crazy and not looking at the risk of these borrowers or the ability of these borrowers to repay. So they're essentially just writing these checks out and there are fees associated with initiating a mortgage. And so the banks are making money writing these mortgages. They're just writing with a ban. And so that's number two. You've got these very bad loans out there, typically with a teaser too, there's like a two year, you don't have to make a payment back. So there's really a high incentive to get these mortgages out there, get these people in homes that they own. So that's number two. Number three is Wall street comes along and bundles up all these mortgages into securities, the mortgage back loans and starts selling them. And again, there's money to be made by bundling the stuff up and selling it. So the banks are making money now creating these securities, but these securities are essentially bombs that are going to blow up and they're bundling together these mortgages that are doomed to fail. It's the classic story of the bartender who buys the million dollar home and the one we've all heard about the mortgage crisis. So that's number three. Number one is government. Number two is the banks. Right. The mortgages. Number three is Wall street bundles up all the mortgages into these mortgage backed securities.

Right, right. So before we leave, number three, can we talk about that a little bit? And was it just the quality of the borrowers? Was it the adjustable rate loans? Or even more sinister, was it the fact that loans were being sold many, many times and they weren't really even in the pools? In other words, you know, nobody was looking at what they were buying when they bought these pools of mortgage securities, you know, with thousands and thousands of loans in them, Tens of thousands, maybe hundreds of thousands, I don't even know. But you hear the stories about the same loan being in 33 different pools. The loans weren't really there, they were sold over and over again. It was just a complete show game.

Yeah, and that kind of gets to the fourth point, actually. So your first couple things, yeah, the adjustable arms came along, just creamed people when the arm came up. And there was definitely some of that. But the fourth point I would make is Moody's and Standard and Poor just missed it. And this is the one if I had to pick one, as this was the biggest problem, because, you know, the government, they want to do the right thing. They want People in homes, the banks, they were sort of following through, they were writing more loans. They probably could have screened for better borrowers. But you know, the government saying we want this. And then Wall street does what Wall street does. They bundle up all these securities are out there and they packaged up and sold it. Moody's and Standard and Poor's should have come along and done exactly what you were just saying, which is look under the hood and say, this is a disaster, this is doomed to fail. This is not a good security. It gets, you know, a D. But they looked around and said, well, they're, they're 10,000, you know, they're a thousand, whatever the number is. So the risk is all diversified so it gets an A rating. And no one really looked at these loans and said, well, in two years when this tease is up, so they don't have to make any mortgage payments for the first two years. But then when the tease is over and they start making payments, this person clearly does not have the finances to make the payments. So this is going to be a mortgage that fails. And when they start testing these things, they should see that there's like a 30, 40% fail rate inside these securities. But Moody's and Standard Force didn't do that. They just said there are a thousand securities. The risk is diverse enough so it gets an A rating. So now you have these bombs out there. But then Moody's and Standard and Poor hide the bombs underneath an A rating. So they're out there trading. And then that leads to the final thing, the fifth and final. So you've got government promoting it, you got banks writing the mortgages, you got Wall street packaging them up. You've got Moody's and Standard and Poor's missing the boat on the rating. And then fifth and finally is AIG comes along and does the credit derivatives. So they take these toxic mortgage backed securities and they start writing. What is the credit derivatives are basically insurance. So it's insurance that this security will not fail. And it's a way for. This is getting a little bit technical, but it's a way for the banks to get more levered. So I can start selling this and then if I insure it, I basically covered myself and I can sell even more. And so they buy the derivatives, which is, it's like, it's like writing a homeowner's policy on a house. But if you drive through the neighborhood, you can see the house is burning down. But then not only do they sell one homeowner, they keep selling more and More derivative products on it. It's like having 10 homeowners policies on a single house that's actually burning down. So what AIG did was by writing these derivative products was magnify the problem way beyond the scale of, of what it really should have been. I mean there were more credit derivatives out there being traded than the actual bonds that were the underlying security that they were insuring. So the problem became massive in scale.

Yeah, and here's the thing about AIG and this type of thing is that they were insuring in quotes, this product. But unlike a regular insurance company that is required by law to have certain amount of reserves to pay claims, they didn't, they weren't governed like an insurance company in this activity. What if these go bad? And what if we have to pay a claim, if you will, even PMI private Mortgage insurance, they have that. But, but here they could just write this in quotes. Insurance.

Right. And this was the total. This was. They were so unfettered and it was. Exactly. There's a, there's a line in my book that says if you compensate a person based on volume, he's going to give you volume. So you've got someone at AIG saying, well, if I write 10 policies on this horrible security, they're going to pay me X and if I write 1,000, they're going to pay me 10, 100 times X. So they're just cranking this stuff out and as you say, not in any way that is regulated. And so they just scale up the problem and again they've got the Moody's and Standard and poor a rating on the bonds that they're writing these policies under, which again, if Moody's and Standard important come, they could have stopped the problem by actually examining this. Instead, what a few people do, if you read Michael Lewis, the Big Short, Steve Isman come along and they actually do look under it and these aren't even sophisticated. The person at Eisman's shop who did it wasn't some long term finance person. They just had some common sense and said these look like mortgages that are not good.

Right.

And this thing looks like it could fail. And so they start betting the other way. And of course, and there are only a handful of people who do, but of course they all do very well.

Yeah, yeah, they sure did. Well, it seems like our country has a very short memory and maybe that's intentional because it's not rewarded to have a long one. I'm not sure, but I already see signs in the mortgage market of new Pressure by the Obama administration to make more loans to people, new funny products coming out and reemerging again, do you think? I mean, could this happen again, as you suggest?

You know, memories can be short and the motivations behind it, which the motivations in every of the five steps that I mentioned were, except for Moody's, really, which was just incompetence, was to make money. And so there has to be sensible regulation to have the. The Gordon Gekko greed is good thing to make it, which it can be in most cases. Greed is predictable and you can manage predictability to a positive outcome, you know, but if you don't have regulations in place that say, all right, this person, of course, if we're going to pay him more for doing 100 trades than we would for 10 trades, we need to make it better for everyone that 100 trades happens, you know, that needs to be at the right outcome as opposed to some toxic outcome. So I'm not sure that the regulation is sensible yet. So, yeah, yeah, I guess it is possible.

I really take a look back further. You know, I've got a pretty libertarian mindset and I think that when you go back even further, it's not necessarily that more regulation is needed. This is just my humble opinion, but, and you're welcome to differ, it's that if government got out of the game altogether, you know, if Fannie Mae didn't exist in the first place, a lot of this would have never been able to happen if these companies weren't allowed to get so big. And in a way, many of them are allowed to get so big because of regulation, because regulation limits new entrants into a market. We all know that you know instinctively that the more you regulate something, the fewer players can play the game because it costs more to comply with regulations. Certainly very few of us are going to take a company public because the regulations are so onerous. So that limits the number of public companies and yeah, you know, under the guise of also limiting fraud and so forth, you can say that, but to some extent it all becomes a good old boys club and creates the too big to fail problem in the first place. I mean, that's my thesis. When you back way up to the Great Depression.

And I think it can be argued your thoughts on that.

Well, I generally fall in your camp, which is free markets, less regulation. And so again, I don't think it's more of a. I just think it's. Maybe it's less regulation, but just sensible regulation. And one of the areas would be to try to match compensation with performance. And the performance of a trader might not play out in a 12 month bonus period. Time cycle might be 2, 3 years. So many of the Lehman Brothers had its best year in 07 and bonuses were biggest off the 07 year, which is when exactly. All the positions that they were building up were what killed the firm in 08. So they paid huge bonuses out to all these people who ended up destroying them for that work.

Yeah, they're rewarding them far too early.

Yeah.

So there should be.

Maybe there's some way to measure the performance over a period of years and compensate based on that.

I don't.

And again, this is tricky stuff, but you know, they are doing some of this now too. There's sort of clawbacks and there's vested equity with the vessel at reputed time and there are ways to look at doing that to see that, you know, the work that you did, if it's horrendous, the compensation is.

I don't have a lot of faith that a clawback would actually work though, because, you know, when these companies are going down and everybody's lining their own pockets with their bonuses, you know.

I don't know, I kind of doubt, at least in the last cycle clawbacks would have even worked, you know, unless the government enforced them. And the government stepped in and said, give back your money. But most of the time they've usually spent it anyway. Just look at the Enron guys. Right. And Bernie. Oh, gosh, what's.

Bernie Madoff?

Yeah. Well, no, no, I didn't mean Bernie Madoff. I was actually talking about Kaczynski. Kaczynski, thank you.

Oh, right, yeah.

You know, I mean the. What is it, the $6 million shower curtain? Most of this money's been spent, so that's the thing. But anyway, yeah, very interesting. Well, tell us, you know, any. Anything else you want us to know about the book or just your thoughts on the financial markets and Wall street in general?

Well, the book, you know, again, I would say that it's educational on the Wall street side of things, but again, it's really a human interest story set inside this period of time. It is just out in paperback actually, as of I guess, 10 days ago or so. And there's more information about it and douglasbrunt.com is my website and Twitter is ugbrunt.

And of course the book's available on Amazon and all the usual places.

Right, all the usual places. Barnes and Noble, Amazon in a lot of the small. But it's pretty good distribution in terms of the physical books being out there in stores and libraries and that sort of thing.

Fantastic. And Doug, just one last thing for you. I mean, you gave up a very lucrative career with Authentium in Internet security. You were an entrepreneur and you gave that up to write. Begs the question why.

I've always loved writing and have never pursued it professionally, but just as a hobby. And so I was CEO of Authentium for a few years. And in the last years was, you know, it was stressful and I was frustrated. And I was traveling a lot too, because the headquarters of the company was in Florida, but I was living in New York. And so I did a lot of flying out on Monday morning, flying back on Thursday night, Friday morning. And so as a way to relax instead of reading, I started writing this book. I just had an idea for a book I thought, oh, this would be fun to sort of toy around with. And I wrote it mostly on planes or in the airport lounges waiting for planes and things like that over the course of a year.

And I loved doing it. I mean, it really was relaxing for me. I couldn't wait to get to it. And when I finished the first draft, I showed it to Megan and she read it and said, this is actually good. You should show this to somebody. And so through friends, found an agent who's willing to take a look. And the agent came back and said, I like this. If you're willing to work with me on some things, I think you found an interesting voice, and et cetera, et cetera, then I'll represent you. And I said, of course. And so I worked with the agent for a period of time and I thought, you know, I love doing this. And the company actually reached a point where in 2011, I sold the majority of the assets off to a different guy. NASDAQ listed company, bought most of the company. There's only a small piece left. And our COO took that over and I left to write full time. And that's right around the time when I got the deal with Simon and Schuster to publish this and decided I'm going to give writing a go. I've actually just finished the second book.

My publisher hasn't even seen it yet. It's still kind of with me in the office and my agent's Reddit and Megan's read it, of course. I'm just finishing that up and getting ready to get that one out, which is more about politics.

Fantastic. Well, you've certainly got a lot of interest in terms of followers on Amazon.com229 Great reviews, so that's fantastic. And keep up the good work, keep telling the story, and we'll look forward to your next book. Do you have a title for that one yet? Douglas?

No, not yet.

Good stuff. Well, douglasbrunt.com and the title of the book is Ghost of Manhattan and ghost is plural. And so thank you so much for joining us today. Appreciate it, Doug.

Thanks very much for having me on.

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