AIPIS 172 - Waffle Street: The Confession & Rehabilitation of a Financier with James Adams

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It's my pleasure to welcome James Adams to the show. He is the author of Waffle street, the Confession and Rehabilitation of a Financier. This was also turned into a Dandy Glover film entitled Waffle Street. James, welcome. How are you?

I'm great, Jason. Thank you for having me.

Yeah, it's good to have you on. Give our listeners a sense of geography where you're located.

Well, I currently reside in Lancaster, Pennsylvania. When the time, at the time I was writing Waffle street and the events depicted in the film happened, I was living in North Carolina.

Okay, fantastic. Now, Waffle street, that is a takeoff, I assume on Wall Street. Is that the impetus?

Yeah, my working title was From Wall street to Waffle House and we decided to just truncate it. So that's where I spent my six months in the diner.

Okay, well, tell us what you mean by that. What happened at Waffle House, which, by the way, Waffle House is such a funny, iconic brand. Every time I go to the South, I just make it this funny tradition to always have one meal at a Waffle House. Make sure I clog my arteries a little bit. And you know, it's just kind of a funny place. I just like it for some reason.

Oh, yeah. I mean, as you said, it's, you know, one of the preeminent iconic institutions of the Southeast. In fact, as Hurricane Matthew was swept through, you know, FEMA has this Waffle House indicator, red, green and yellow, to determine the state of the hurricane based on whether or not Waffle Houses are still serving because they're the very last retail installation ever.

Close.

That gives you a sense of their resilience.

Yeah, yeah, I had no idea. That's, that's really funny. Really funny. Well, what. Tell us about the title and Wall street and Waffle street or Waffle House. What do you mean by that?

I had worked in institutional finance for, oh, I guess it had been.

About.

Eight years prior to my layoff.

I'd worked for two insurance companies and a money manager. And it was my second layoff and I was just kind of emotionally burned out after the global financial crisis. I had been on the front lines in the mortgage market. My company managed billions of dollars of this for pens.

You know, endowments, some national banks. I mean, we were big players. And so when I was let go, I just needed a break. And I didn't feel right about collecting unemployment for a number of reasons, one of which was because, you know, it was firms like mine and all of the chicanery on Wall street that had, you know, created the recession in the first place. But I wanted to do something outside of finance, and I think, as my character says in the movie, clear my head and work with my hands. So McDonald's didn't hire me, despite three attempts to get on with them. So I applied to Waffle House and they accepted me on the spot. So I started the following Monday.

So you were this high flying financier on Wall street and you applied for a job at McDonald's and they turned you down, and then you went to work for Waffle House.

First of all, why did McDonald's turn you down? Do you know?

They never gave a reason. They just quit returning my calls. I don't know what the issue was. I think maybe when I had talked to the franchisee, I don't know if they had thought that I was just sort of playing games or wouldn't be a good employee given my background. But I was very forthright and candid. I didn't know if I was going to stay in finance or how much of an industry was going to be left for me to go back to after 2008.

Despite the economic recovery since then, most of the large institutions are shadows of their former selves. And the ones that have gotten bigger, the fees they've charged have come down. It's an industry that went from a cowboy situation to a situation where it's gotten a lot less profitable and a lot more heavily regulated very quickly. I don't think the solid days of institutional finance are coming back anytime soon.

Interesting. Do you care to say what firm you were with when you worked on Wall Street?

We used a pseudonym in the book, and I'll maintain that Alpha Managers. I do want to say that.

I always worked with actually very honest people. So some of the things that get played up in the first few minutes of the movie are a little bit overblown. But we knew that the mortgage market was frothy. And the way I describe it is we were ready for a Category 5 storm. We got hit with a Tsunam So I think everybody, including the Federal Reserve chairman, underestimated the magnitude of the problems in the real estate market. We knew it was pandemic, but we didn't know it was that bad.

Yeah, yeah, and neither did I. I knew there would be a mortgage crisis and I was predicting it in live seminars and so forth, getting into arguments with some people, because I just knew the lending was far too liberal. I mean, you just knew there had to be a mortgage crisis. The part I didn't know is that there would be behind that a Wall street crisis. I had no idea the shenanigans Wall street was up to, you know, selling the same loan multiple times in different pools. All of these different kinds of collateralized debt obligations and things and all these new acronyms we all learned afterwards. But you were right there in the mix. I mean, take us back in what year do you want to take us back to? 2003, 2004, 2005? Tell us, you know, give us some of the insider view of what was going on, if you would.

James, I can give you one or two anecdotes that stick out to me. One is shortly after I arrived at the money Manager in early 2006, some of our asset backed securities folks had gotten back from a big industry conference and it was likened to the Predators ball where all the junk bond guys would get together in the late 80s right before the junk bond market collapsed. And they were saying it's a similar.

Situation in terms of the enthusiasm and the reckless underwriting. That was a good barometric reading, if you will. The one that really hit me though when you started to see the writing on the wall was in early 2007. This is 18 months before Lehman collapsed. I remember, I think it was February of 2007 when some of these asset backed security linked derivatives, the ABX indices, started to crack. We had to get on a phone call with some invest in Tokyo. We managed well over $10 billion in Japanese money.

They were starting to get nervous and we were saying, oh don't worry, it's just the weaker players being shuffled out of the market and it's really just on the lower rated securities and some forced selling and the fundamentals in the higher rated tranches are sound. We based that on the idea that there had never been a double digit price decline in American home values since the Great Depression across the United States. So if you are well diversified and you weren't just lending entirely in Phoenix or wherever else, you should be. Okay? And that was a really scary thing. It turned out there was no place to hide anywhere in the American mortgage market.

That is just unbelievable. So some of my listeners may not relate to what you're talking about. So were you, like, what exactly was your role? Were you bundling these loans and putting them into pools and then selling them off? Which part of it were you in?

That was not me. That was the guy actually across the hall from me that was doing that. And what you're referring to is what they usually call a collateralized bond obligation or a collateralized debt obligation, alternatively known as a CDO or a cbo.

Most of what we did was to purchase these pools of mortgages on behalf of institutional investors. I wasn't at a broker dealer like a Bear Stearns or a Merrill lynch that was originating it. We were buying it and managing it on behalf of large institutions.

Okay, tell us what you saw. You said that people underestimated the market. Even the Federal Reserve underestimated the size of the problem. Why did they do that? What was the. What was the thinking back then? Did they just think the prices would go up forever and that rising tide would float all the ships? Or where was the mistake here? I mean, I know there were multiple mistakes, but maybe you can highlight a few of those.

Yeah, it would take a book. It's taking many books, right? Like, there's a whole subgenre of literature for this. I think the big things that stick out to me are we knew that the rent to home price ratios were skewed. Right. Ultimately, the value of a home has to be tied at some level to the value for which it can be rented out to a tenant. We knew those were off. The problem was there wasn't enough post depression history. People say, well, even if on this fundamental basis, homes are overvalued and it's cheaper to rent than to buy. And we know credit conditions are loose. If you look back 70 years to the Depression, you know, we've never had any truly serious reckoning. So it was sort of like you're reasoning from empirical experience as opposed to first principles. And maybe that sounds a little technical, but it's sort of like just because something hasn't happened in a long time, if the fundamentals are such that they can still happen. So that was one thing. The other issue was people underestimated the domino effects of leverage. You had alluded to this earlier. When you have a borrower that takes out a mortgage that gets sold to a pool, that gets sold to an insurance company, and then the insurance company issues a policy against that, or let's say you throw a hedge fund somewhere in the mix. I actually visually depict this a number of places in the book. It's this layer upon layer of leverage that creates this systemic instability. Even though you had a greater collapse in the total value of the stock market during the dot com bubble bursting than you did in the real estate peak to trough because real estate was financed with layer upon layer of debt. The unwinding effects were multiples of what happened in the dot com era when stocks collapsed.

Wow, that's just amazing. Is there another shoe to drop in the economy? It sure concerns, it concerns me, it concerns a lot of other people. What are we in for? You know, now that you lived through that you were in the middle of this the last time around. People talk about the derivatives market and how insanely overinflated it is and how frothy the stock market is and how it's ready for a big fall. I think the high end housing market could certainly experience some troubles. I don't think the bread and butter housing market is really that far frothy. I mean, you know, a little bit in places but you know the sort of basic necessity housing in linear markets seems to be pretty okay to me. We've got this massive amount of debt.

Maybe it's just a new world and the famous last words this time it's different come to mind or maybe it's not and we're in for another crisis. I don't know. What are your thoughts?

I don't think about any one market in particular as being terribly overvalued relative to another. I think housing was relatively easy to say it was overvalued versus the bond or stock market in 2007.

The real issue that scares me is.

The balance sheets of G8 countries, of countries in the Eurozone, in the US in Japan where we basically shifted a lot of the debt burden from big institutions and households to the federal government. And so what's happened is with these quantitative easing programs that have really gotten underway in earnest in Japan for one and Eurozone is doing it now too. You're basically allowing people to have their cake and eat it too by shifting all of the burden onto governments, onto these treasuries of these big countries who then shift the burden to the central banks. The explosion in central bank balance sheets is completely unprecedented in modern history. So they've been able to do it so far without a lot of inflation. And as a politician this is like the greatest thing that's ever happened. If you can just print money and Give your constituents what they want without ever cutting.

No consequences.

Right? Without cutting benefits, raising taxes, and without generating a bunch of inflation. This is the greatest thing that's ever happened. So I think they'll do that until there's a crisis. And I think that Japan is the canary in the coal mine. So I don't know if.

I want to say if, but I don't know when or how this thing breaks, but when it does, it's going to be really ugly and governments aren't going to be able to pull the system out of this downward spiral.

So the question is, we've created all this money out of thin air, all this currency. It would seem like we should have inflation, yet we don't have very much of it. In fact, the Fed finds it difficult to even get to target inflation and keep the Phillips curve happy. I mean, is this crisis going to be an inflationary crisis or some other flavor? It just seems like the inflation's gotta be baked into the system. Maybe, or, I don't know, maybe it's not.

You know, I've put this question to people who are far, far more well read and smarter than I am, and I've yet to get a good answer. Because historically, when you create liabilities, when a central bank does this, you get not only asset inflation, but you get inflation in consumer prices. What's happened is banks have gotten disintermediated for regulatory reasons, balance sheet constraints. All of the credit creation now, or much of it is occurring outside of bank channels.

In a way, you can have this asset inflation without the huge growth in money supply. I don't know what's going to create a huge wave of consumer price inflation. But I do know that there has to be some potential fallout from having created all of this, what they call base money, when central banks just create electronic liabilities. But again, I don't know how or exactly why this thing will break, but it has to feel pressure at some point.

James, you are the smartest, most overqualified Waffle House worker ever.

But I was a bad waiter. That's the whole point of the story and the point I do. Okay, in the ether, but when it comes to where the rubber meets the road or the waffles meet the plate, as it were, I was pretty inept and I wasn't faking it. And it was the hardest job I ever had.

That's no joke. I wasn't that good at it. I tried, but I just was not that good at it.

This is hilarious. You have an amazing story. It's just a weird story, but yeah, that's awesome. I love it. So can you explain what you were talking about? About how I think you said the credit supply or the debt was being created outside of bank channels and it's the first time that that's happened. What do you mean by that?

I don't have the facility with the statistics that I would have had just a few years ago. But historically when you wanted to borrow money, you basically went to the bank and the bank was going to give you whatever loan and it was going to stay on their books. And against that loan that they book as an asset, people can.

Write checks. So there's an asset of your loan that's backing the checks that basically serve as money. Well, what's happened is as. So banks create because we use bank liabilities, we write checks on them or debit card transactions, whatever. Bank liabilities are effectively money. Well, to the extent that people are lending to each other outside of the banking system, that means you can still have growth in credit, but you don't have growth in the money supply. So what that means is asset prices and credit can grow, but you don't have the growth in the money supply. You really need to have a lot of inflation. So as banks have been disintermediated from the lending process, you've got this situation where asset prices and consumer prices are decoupled. And again, that has not really been the case historically, but it's really accelerated over the last 10 years.

And where are they disintermediating the banks? I mean, I mean the banks get disintermediated by websites that, you know, do peer to peer lending. You know, there's so much disintermediation going on with the Internet and the sharing economy and so forth. But peer to peer lending, I mean, that's not that big a force.

No, no, no. And you raise a good point. It's because in many cases the banks will originate loans. Fannie Mae and Freddie Mac are great illustrations. Right. I might go to the bank for my mortgage, but then that gets underwritten to regular standards so that that mortgage can be pooled and then sold to an insurance company, a pension fund, a mortgage bond fund that you might hold in your 401 plan. So you've got all of these again, insurance companies, pension funds, 401 plans, college endowments, holding mortgages. Whereas. And it's a huge part of the market, whereas historically the banks would have originated those mortgages and kept them on the books themselves. But the great thing about securitization from a bank standpoint is they can keep collecting the servicing fees and they don't have to hold any capital against it. It's been a huge business for Wells Fargo for years. So it's very lucrative for the banks because it's all fees and they don't have to commit any balance sheet to it. That's really what's happened. It's the securitization markets, in many cases, hedge funds that are lending directly, where if I need credit.

I can go to them, or syndicated bank loans. J.P. morgan. Well, there was a story in the Journal today about Sprint needed to borrow, so they go to a syndicated bank. But all those loans, many of them get sold to mutual funds now or to insurance companies. Banks are still part of the origination process, but they don't hold the debt the way they used to.

Right. What that means is you don't have fractional reserve banking in as large a presence as it would have been when the banks were lending the money, because the banks take advantage of fractional reserve banking, or I'll call it fractional reserve lending for our purposes. And every dollar that's lent creates what, a ratio of 10 to 1 or something like that in terms of new fake money? Because that loan is an asset for the bank, whereas a deposit is a liability for the bank. It's the opposite of the way we think of it, Right?

That's correct. And everything you said is exactly right.

I should be an economist. Yes.

Well, I'm sure as somebody who's well versed in the real estate markets, you'd understand the realities of economics more than somebody who's at the whiteboard all day.

Yeah, well, those Harvard guys have all the credentials, though. Your take on where we might go now then, like, you know, sort of back to the original question I asked you. And I hate to put you on the spot and say, do you have a prediction? But everybody wants to hear predictions. Right?

You know, so with that in mind, and that was very good how you pointed that out, how that that lending is happening outside of bank channels. And I'll tell you one place in the real estate market that's a pretty big factor, is that, you know, the banks will only do 10 loans per person on the typical. What's called agency financing, the Fannie Mae, Freddie Mac type financing. So you can only buy 10 properties with that type of financing, whereas before, you could buy a virtually unlimited amount of properties and get financing before the Great Recession. And so the market has been filled in by private lenders and by Private equity groups and hedge funds like going under the names of B2R, Lima One Capital, first key. These groups out there are taking that money, which is not part of the banking system, as you so aptly point out, and they're lending it. And the rates are not bad. They're not as good as the Fannie Mae, Freddie Mac agency type loans, of course, but they're not bad. I mean, they're, you know, they're fairly competitive. And so that doesn't create as much new money. It creates more debt, but it doesn't create more money out of thin air the way fractional reserve banking would. Exactly, yeah. Very, very interesting point. No, no guest before has made that distinction that you made. So I thank you for that. Any thoughts on predictions or the future of where, where the world's going? I mean, will Japan default on their debt? There's. They're so in debt or. I mean, it seems like they'll just get bailed out. Everybody will just be bailed out all the time by, you know, more fiat money creation. What do you think?

That's right. It works till it doesn't.

Again. When the US did that back in the 70s to finance Vietnam and other things, you got a lot of inflation because the fractional reserve mechanism kicked in again for the third time. I don't know how or when, but I know that I strongly suspect it ends in tears. The good news is that if you look around the call it the global ballroom.

The US might not be.

Adorable, but she's prettier than a lot of the other girls you might want to dance with.

That's why I look at Japan. It's got the worst demographics, it's got the worst balance sheet.

They are the one to really keep your eye on because they are at the cutting edge of this, you know, massive government deficit coupled with massive money printing. So.

I think that might be a way to tell, you know, when you start seeing smoke out of Japan, you might expect some more fire elsewhere. The good news is the US looks better than Eurozone and we look better than Japan.

The US looks better than any major player by a long shot. And the fact that it has the reserve currency, the world and the military to keep it that way because that's the way you ultimately keep your reserve currency status at the end of the day is through military force, but first with negotiations and economic hitmen and other methods. But at the end of the day, it's always the ability to inflict violence. The largest consumer base, I mean, I think the US has Got a really comparatively very bright future to the other things. But yeah, it's, it's interesting. We, you know, we had a guy on the show before James who was a couple years ago, he was talking about how you should buy options to short Japanese debt. And Japan's eventually going to default, just let the options decay pay for them, but eventually you're going to hit. And now he's, he's been wrong all these years, but maybe he'll be right someday. I don't know.

I don't think that's ultimately the trade. And I'll tell you why. Because look at World War II when the US had a higher debt to GDP ratio than they did. And in fact, if you watch movies like.

Oh, what was the one with Ryan Philippe, Flags of Our Fathers, right, where they're out selling war bonds trying to raise money and they say, well, if we can't raise the money, we'll print it. And that's what happened a lot during the FDR and Truman eras. So Japan will do the same thing. A government can keep its interest rates wherever it wants to, so long as it can print money to buy the bond. They can pay whatever rate they want on their bonds and keep the yields wherever they want. What they can't necessarily control is the value of the yen or their inflation rate, the short on Japan. If you want to buy puts, buy them on the USD JPY exchange rate with, with a strike of 120 or something and pick whatever strike and maturity or expiration you want. The currency is what I ultimately would short, not the debt itself.

Interesting, interesting distinction. Again, our listeners and myself included are just into buying simple real estate investments, things we can all understand. And there aren't a lot of big powers outside of a stage that control the destiny of buying little basic bread and butter houses and renting them to people. I just love that business, you know, it seems to be very tried and true. You know, not in bubble markets, just linear, boring markets. You know, Charlotte, North Carolina was one of our markets for many years and it's not now. But you know, that's, we've, we've done a lot of business there and now we like Memphis and Indianapolis and many other markets like that around the country. So that's my favorite thing. But what are you up to nowadays? I mean, the book, the movie deal, that's super exciting and I can't wait, is the movie out yet? Tell us about that.

Oh yeah, so we actually had a digital release on March 15th, so it's on Amazon Hulu Itunes if you want to buy it for download. But we actually debuted on Netflix last month. We're trending on Netflix. We were popular on Netflix, so for a couple weeks, we're right there on the landing page as soon as you logged in. So it's doing very well on Netflix. I don't know the total number of clicks yet. I'll hopefully get a report in a few weeks. But yeah, we've been very pleased with the response and the distribution of the film. And I believe it'll be out on DVD either later this year or early next year.

Well, I will be watching Waffle street tonight, I tell you. That's my commitment. I will be watching it tonight, so I can't wait. But what are you up to besides the book and the movie? I mean, are you in business now or strictly being an author or what? What, what are you doing? Are you working at Waffle House part time?

I don't, I don't know if they'd have me.

Are you driving for Uber?

I still, I still eat at Waffle House at least, you know, once every month or so. But in any event, I actually.

Tried a couple different things after the Waffle House stint, trying to figure out where I wanted to go in the industry and eventually landed at a trust company.

As an analyst, as a senior research analyst. I really enjoy that. That's more dealing with clients at the retail level, which I think is really where you're going to see more focus in the industry. A lot of power has shifted from the institutions to the retail investors, so I get excited about that. And then just about four months ago, I came over to another shop in my hometown with a gentleman who's had a business there for.

13 years. He's had a registered investment advisory firm and he basically asked me to come on with him. And so far it's been great. I expect to be on that side of the business for the next few decades anyway, so it'd be nice to be on terra firma. The one, the one other thing is, as a result of the film, I actually had another screenwriting opportunity. So I've written a movie about some Native American lacrosse players that completely have upended the college game. And I'm really excited about that. And it does look like we've got a very good chance of getting that thing done. We've got a very prominent production partner. I don't want to jinx myself by divulging too many details, but there may be some part time screenwriting opportunities going forward as well. So, yeah, this whole experience has just taken me places I never would have expected.

Fantastic. Well, very interesting discussion, James. Give out your website, the movies website, Twitter handle, whatever you want people to know so they can follow you. And listeners. Make sure you check out Waffle Street. Can't wait to see it tonight. But go ahead and share your information, if you would.

It's Twitter. The Twitter handle is just WaffleStreet and our website is WaffleStreetMovie.com and, you know, if you want to watch it, just Google it and it'll take you right to Netflix or to Amazon or itunes.

Fantastic. James Adams, thanks so much for joining us.

Thank you, Jason.

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