CW 534 FBF - The Collapse of Bear Stearns with Douglas Brunt Author of “Ghosts of Manhattan” & Former CEO of Authentium

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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 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 and 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 hear that too.

Yeah, there's a lot of all of that. And so, you know, you go out for a big night for at A, you know, 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 on the expense tab. But the next day we throw a few trades your way. And the commissions, you know, are far in excess of any, you know, $5,000 bottle of wine.

Yeah, yeah. Well, Wall street, it just, to me seems like the modern version of.

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 on that point, 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 derelict's outs at three in the morning on a Tuesday at a strip club.

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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 of the book too.

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 a lot of crooks on Wall street too, and 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.

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 $250,000 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.

Yeah, 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 back, gets the Goodfellas, walk through the backstage in the kitchen and they like plant a table right out in 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, 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 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 and you're really are out a lot on the week and you know, when you're right out of college, all of 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.

Yeah, 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. You know, 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 whole thing went down, you know, if you had to kind of explain the financial crisis to an outside, to someone that didn't know much about it, that was 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 CDOs, 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. 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. The book really is a human story, but this is the backdrop. And so I 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. 4. 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 accomplishment.

It actually goes back to Bill Clinton.

Well, fair enough. Yeah, fair enough.

He had legislation passed in like 94, 95. 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 or.

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 know to 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. 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 old. You don't have to make a payment back. So there's really a high incentive to get these mortgages out there and 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. You know, it's the classic story of the bartender who buys the million dollar home. And you know, the one we've all heard about, the mortgage crisis, you know, so that's number three. Number one's government. Number two is the banks write 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? What 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. But so your first couple things are, 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 the writing 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 them 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, there are 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 you don't have to make any mortgage payments for the first two years. But then when the, 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. 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 forces 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, 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. So they buy the derivatives, which is 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 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.

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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 a 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 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 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 they could have stopped the problem by actually examining this instead. What a few people do. If you read Michael Lewis, the Big Short, oh yeah, Steve Eisman come along and they actually do look under it. And these aren't even sophisticated. You know, the person at Eisman 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, memories can be short. And the motivations behind it, which the motivations in every of the five steps that I mentioned, except for Moody's, really, which was just incompetence, was to make money. And so there has to be sensible regulation to have 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, 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 cost 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 theory. 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. And again, this is tricky stuff. But they are doing some of this now too. There's sort of clawbacks and there's vested equity. Vested Over a period of time. And there are ways to look at doing that, to see that 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 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 say, hey, give back your money. But most the time they've usually spent it anyway. Just look at the Enron guys. Right. And Bernie. Oh gosh, what's that?

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 spe. So that's the thing. But anyway, yeah, very interesting. Well, tell us 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, 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 of paperback, actually, 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. It's 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. 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, etc. Etc. Then I'll represent you. And I said, of course. So I worked with the agent for a period of time and I thought, 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 Simon at 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 read it 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.com 229 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, Douglas.

Thanks very much for having me on.

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