by Guy Lawson
“I made myself a computer nerd,” Israel said. “I could see I needed to know the technology and how it worked. Freddy didn’t have any computers. I tried to get him interested, but he just wasn’t into them. He was set in his ways. Freddy and I got our charts once a week, on the weekend. I’d go to his house on Sunday night, or we’d talk on the phone. That was all the technical analysis he did. Freddy wouldn’t even have a computer on his desk.
“By this time I didn’t want to go out with brokers at night so much. I would go home to eat dinner with my wife. Then I would drive forty minutes to Stanley’s house in Connecticut. We’d work on the computer program we were building until three in the morning. I’d drive home, sleep for a couple of hours, and then go to work. I did that for years. Stanley and I were going to create our own charting system. Everyone was looking at patterns from the past. We weren’t interested in the past. We wanted something to look into the future. I wanted the computer to tell me what was going to happen.”
Israel became a follower of the physicist Jurgen Ehlers, who was examining a similar question from the point of view of synchronicity. The German scientist had founded the Albert Einstein Institute and studied general relativity. It was Ehlers’s study of “hidden symmetries” and the predictive possibilities of “frame theory” that fascinated Sam—how quantum physics might enable him to anticipate movements in the market as if stocks were particles of light. It was heady stu" for a liberal arts major who had barely paid attention in high school algebra.
In 1987, Wall Street learned about the ghosts lurking in the new machines. “Portfolio insurance” was one of the strategies program traders used. Computers calculated the optimal stock-to-cash ratios for various prices in the market. With the computer programmed to trade the instant the set parameters emerged, portfolio insurance was supposed to be like buying a put option—a kind of guarantee that a stock could be sold at a speci!c price. In the fall of ’87 there were stirrings in the press that the new preprogrammed trading systems contained an inherent $aw—a contradiction that could lead to a !asco. The problem was so obvious it beggared belief that it hadn’t been noticed by the supposedly smartest traders on earth. If all the program traders had set their machines to sell in a falling market, then it followed that when the market fell all the program traders would be selling at the same time, creating a crash.
All through ’87, the market kept climbing, a bull with no apparent end in sight. By August the Dow had gone over 2700, an amazing 70 percent increase in less than a year. It was a streak that Sam considered unsustainable. For months he’d shorted the market, expecting a decline—but none came. The frustration was incredible. On Monday, October 19, 1987, Sam shorted the market on his own account, as usual. The previous week had been unusually turbulent, with a sharp downward movement. Sam sensed that the trend was going to continue. This time he was loaded for bear. He’d shorted the S&P, betting on the market dropping. He was also on the short side of United Airlines. He was about to get very lucky. On Black Monday the crash started from the opening bell as terror swept across the NYSE and around the world. It was the largest-ever percentage drop in the value of global stocks in a single day.
“I made a lot of money that day,” Israel said. “It was my biggest day ever. I was short on everything. It was just fantastic. But I didn’t gloat or brag. I couldn’t even talk about it. Freddy lost a couple of million. My dad was down a million or so. I was selling my puts slowly and I was getting back prices I couldn’t believe. A put would be selling for !fteen on the screen and I’d get a report back at thirty-eight. People were in a panic—even George Soros. Everyone around me was getting wiped out. But I couldn’t look happy about it, so I kept my mouth shut.”
The following day, the traders arrived at 1 New York Plaza in a state of shock. It was as if the prior trading session had been a hallucination. Sam could see that no one had a clue what would happen next. Israel believed the crash was part of a larger correction.
The !ve-year run that began in 1982 had created an unrealistic sense of value on Wall Street. Sam continued to short. But over the following days prices stabilized and then started to rise as the market began to recoup the losses from the crash. Sam was mi"ed.
Then he !gured out what was happening. The Federal Reserve was supporting the market. Specialists were required to “make” a market in the stock they covered, which meant they had to keep buying even when there was no one to sell the shares to.
Liquidity had vanished from the market as cash reserves disappeared. Stock worth $50
a share suddenly had no buyers—not at any price. Finding the bottom of the market in the middle of a computer-and panic-driven selling spree seemed impossible.
But there was a lender of last resort: the Federal Reserve. As the market fell, the Fed intervened by instructing banks to lend money to the specialists. So specialists pledged stock to the banks as security for loans to buy stock with no real market value. To pay for the massive rescue, the Fed was creating money out of thin air. The end of the gold standard in the seventies had turned the American dollar into a fiat currency, effectively giving the Fed the power to print money. It was a kind of Ponzi scheme, Israel thought, but at the highest level of abstraction—and secrecy.
Sam believed he’d discovered the central illusion at the heart of American capitalism.
He had the dizzying sensation that there was nothing underneath the whole edi!ce of Wall Street, the dollar, the American economy. The Fed acted like the Wizard of Oz, creating an ornate fantasy, with Alan Greenspan as the man behind the curtain.
Growing up, Sam had seen how his family had been on the inside of market manipulations and political plots to prop up Third World dictators. Now he’d glimpsed how Wall Street really worked.
CHAPTER FOUR
Other People’s Money
The crash of 1987 broke Graber’s spirits. The margin calls ruined many of the traders Sam most admired. A generation of hedge fund heroes had been badly damaged, many forced out of the business entirely. “Anybody could lose it all on Wall Street at any time,” Israel said. “It was sickening to watch. Great traders were crushed. The crash really hurt Freddy. He lost con!dence. Trades that used to be second nature to him suddenly became hard to make. Doubts crept into his trading. You can’t trade from fear.”
After Black Monday, Sam’s sense of himself was becoming grand, even grandiose—like Freddy’s in his prime. Sam believed, if only a little and secretly, that he’d traded like Jesse Livermore, the Wall Street legend who had shorted the market in the crash of 1929 and made $100 million.
After leaving Graber, Sam bounced around for the next few years. Trading his own money, he was able to build up nest eggs, only to repeatedly go broke trying to trade on inside information. RJR Nabisco, National Cash Register, Donald Trump’s attempt to take over United Airlines—Sam was able to scavenge tips, only to be undone by bad timing. Every time he accumulated a good sum of money the same thing happened.
Three times Sam went on a winning streak, and three times Sam went broke. But it was a trade on Kansas Southern Railroad that nearly ruined him.
“I got a tip that it was going to be acquired from a guy who was literally on the board,” Israel said. “You couldn’t do better than that. I went into the stock big. But the deal got delayed and delayed. It was !nally going to be announced on a Monday. Then the deal went bad. I lost four hundred grand in one day. It killed me. It was the fourth time I’d taken a huge loss. This time I swore I was never going to let it happen again. I wasn’t going to put any of my assets in my name. That included houses, cars, bank accounts. I was going to live like a mobster—nothing in my name. No matter what, I would never put myself in that position again. I would not go down. I would not do it.
Never ever ever.”
The Israels had a healthy baby girl in 1990. The birth was one of the happiest times in Sam’s life. But the pressure of having a newborn led the couple to !ght. As the arguments grew worse, Janic
e asked Sam to leave the house. “We started so young,”
Sam recalled. “We were adolescents when we got together, high school sweethearts.
Our whole adult lives were together.”
The split hit Sam hard—but it also set him free. Sam was in his early thirties, caught between his party years and the responsibilities of fatherhood. He moved to a bachelor pad on the Upper East Side of Manhattan. Weeknights, he haunted the city’s nightclubs and bars. On the weekends, Janice allowed Sam to come home to see their daughter.
Janice didn’t ask about his life in Manhattan and he didn’t tell her what he was up to.
The schizophrenic existence began to tear him apart. Sam wanted to be a decent man, even as he was drawn by the lure of fast money and one-night stands. He wanted to tell the truth, even as he was surrounded by a culture that rewarded lying. He knew many things he was doing were wrong, but he couldn’t resist temptation.
After !nally reconciling with Janice, Sam moved back to the prefab house in Bronxville and set about trying to establish his own hedge fund. Sam was going to “trade the tape,” market parlance for executing the tiny high-velocity transactions he used to do for Graber.
“But I didn’t even know how to begin to start,” Israel said. “I didn’t know how to attract money. I didn’t know how to sell myself. I wound up trading a few hundred grand of my own money. That was all I had. Janice had stopped working because of our daughter, so we were broke. Janice was worried. We’d bought a piece of property and we were planning on building a house. My fund lasted six months. I had to get back to making money. I had to get a job.”
In 1993, Israel heard that Leon “Lee” Cooperman, the former head of research for Goldman Sachs who’d started a hedge fund called Omega, was looking for a trader.
Cooperman had been one of the guiding intelligences for Goldman, which ipso facto made him one of the smartest men on Wall Street. At the time, Omega was undergoing rapid expansion, growing from $250 million to many billions in the space of a few years, so Cooperman was happy to hire a canny trader like Sam.
“At Omega, we were one of the biggest players on the Street,” Israel recalled. “We traded high volume, high speed, high commissions. We could move markets. I spread our orders out to a bunch of brokers so no one person could know what we were doing.
We were paying so much in commissions that the brokers fed us the best information. I knew how to make money out of that information. It was like having a nonstop supply of information to front-run.
“Lee wasn’t interested. Making !fty, sixty grand didn’t really matter to him. If you added it up over the year, it would only amount to 2 percent of the funds he had in Omega, and that wouldn’t move the dial for him. It was nickels and dimes when you’re running billions and you need to make hundreds of millions to make your performance.
“I didn’t want to see that money go to waste—it seemed criminal to leave all that money sitting on the table. So I reached out to an old trader who had moved down to the Carolinas. Bert was still an active trader with his own money. We could trade in his name with my information. Every morning I gave him Omega’s positions for the day, and he knew how to turn that into money on a big scale, for us at least. My base salary with Omega was only one hundred thousand dollars, plus bonus. But with Bert I started to make real money—fantastic sums. Bert would take out enough to pay income tax—40 percent—and then we’d split the rest !fty-!fty. I’d meet him in Washington, D.C., or in Virginia, or I’d go down to his house, and he’d give me cash—hundreds of thousands of dollars at a time.
“When I was a kid with Freddy, he’d sent me to collect briefcases !lled with cash.
Now I was doing it for myself. I wasn’t just trading through Bert. I had guys all over the country front-running for me. I had bags and bags of cash arriving at JFK and La Guardia. Or up in the Pierre Hotel, just like Freddy did with me. I couldn’t trade in my own name because I was required to disclose all the trading I did. But when I used Bert and the other guys there was no way to get caught. After a while I put two safes in the house, one in the attic for jewelry, the other chained to the "oor in the basement for cash.”
In little more than a year, Sam had accumulated nearly $1 million. He and Janice began to plan to build a new home on the land they’d bought. Sam’s sense of himself was growing, as were his ambitions. He was tired of working for Cooperman, a taskmaster given to yelling—like his father. The ambition to start his own hedge fund had returned with a vengeance. The computer program he’d tinkered with for years was getting more accurate, Sam believed. He was ready to put his trading strategy into the market and forge his own fortune.
Bert was outraged at Sam’s decision to leave Omega and its illicit revenue stream—a fact he recalled vividly years later. “I couldn’t believe he was quitting,” Bert said. “Sam had the perfect job. Maybe he was only making a couple hundred grand with Omega, but he was making a fortune on the side. It was like the story about the boy killing the goose that lays the golden egg. The boy starts to think maybe he’s not getting rich fast enough with one golden egg a day, so he tries to get all the gold out of the goose all at once by wringing its neck. Then all he’s got left is a dead goose. That was Sam—the kid who didn’t know how good he had it. As far as I was concerned, Sammy should have o#ered to do the job for free. He should have paid Leon Cooperman just to be able to come to work and trade for him. But you couldn’t talk sense to Sam. He was in love with computers. He fell for computer trading hard, like a star-crossed lover.”
BY THE MIDNINETIES, the small and incestuous hedge fund business of Freddy Graber’s era had become a booming multi-billion-dollar industry. The types of funds were astonishingly diverse: macro, micro, global, quant. In this new age, running money came to be the ultimate goal for a trader. But there was one huge di#erence for the new breed of hedge fund heroes. Freddy Graber had traded his own money. The fate of his fund had mirrored his own. In the new paradigm, virtually all of the new hedge funds traded other people’s money. This meant the risk belonged to investors, who in turn demanded returns that were often impossible to satisfy. This combination was part of the untethering from reality that sent the S&P balloon flying off into a clear blue sky.
For young, corrupt, and soon-to-be middle-aged men like Sam, running money was like becoming a rock star. Or trying to. As Sam prepared to launch his fund, he was bursting with great expectations, like any garage band hoping to hit the big time. Sam would be the public face of the fund. His friend Stanley Patrick was going to be the lead trader. But there was one small wrinkle—the matter of a felony conviction. A couple of years earlier, Patrick had pled guilty to insider trading. The SEC had banned Patrick from trading for life. For Sam, the conviction was nothing more than a legal technicality. The solution was simple. Sam would front the fund. Patrick would be in the background. No one would know that Patrick was trading again. It was just a matter of keeping things on the down low.
The deception didn’t strike Sam as being at odds with his determination to run an honest fund. As he imagined it, his fund would be state-of-the-art. He wouldn’t have a fund that specialized only in technical trading, like so many others coming into the market. Nor would the fund have a conventional position strategy. Israel and Patrick were going to combine their trading program with their hard-won street-level experience. They were going to create a quant-like long/short, market-neutral fund run by highly experienced high-velocity traders.
“I’d been in the market for more than a decade,” Israel said. “I’d learned a lot of things about chart theories, wave theories, arbitrage strategies. I knew that charting for the whole day didn’t make sense. The !rst and last hours of trading were the important times. That was when the volume got done as funds got into or out of their positions. I also looked at transactional charts—not just the volume of shares traded but the number of deals that had been made and when the trades were made. I had two or three trend lines with the highs and lows for al
l the stocks I was watching. I’d put the assumptions about the past into the machine. From that, I would get projections about the high and low and open for the next day. It was intuitive to me.”
“Forward Propagation” was the name Sam gave to the computer program. The word forward spoke to the software’s soothsaying powers. Propagation aimed to conjure wave theory, biological reproduction, and religious evangelicism, all with a whi# of mathematical mysticism. Like fractals, the multiplying self-similar geometric shapes that occur in coastlines and snow"akes and lightning bolts, there were shapes to be divined inside the seemingly incoherent data, Israel maintained. With some !ne-tuning, the machine could give him the ability to see those hidden patterns in stock prices.
The heady egoism of Sam’s days with Graber was mutating into something more dangerous. Many hedge fund traders were eccentrics, following a peculiar trading strategy they believed could unlock the keys to the magic kingdom. Many were narcissists. But even in that company, Sam’s inner voice was starting to sound unhinged. He wanted his machine to “hear” the market, the way a conductor hears music a beat before it is played by an orchestra. If Sam succeeded—if he could divine how to decode the massive amount of information generated every minute in the market—his name would echo through the ages.
“I wanted a chart that was di#erent from everybody else’s. I wanted to be better than other people. I wanted to see what other people couldn’t see. What’s the advantage if everyone looks at the exact same thing? I didn’t want to watch history. I wanted to be history. I didn’t want to be in the game—I wanted to be the game.”