by Guy Lawson
“I’m just saying you’re fucked now, too,” Marquez said.
Israel wanted to beat the living hell out of Marquez. He went for a walk instead, cursing his fate. Israel decided he had to "nd a way to bypass Marquez. Israel had to make the investment decisions himself. How could he do any worse than Marquez? But Marquez wasn’t going to be easy to get rid of—not with the problem unsolved. Sam started to write investors letters on his own. As if to compensate for the creeping terror he felt, the letters to Bayou’s members became breezy, upbeat, even #ip. The market was booming and Bayou was expertly keeping pace, investors were told. By October, Bayou was up 26.5 percent for the year.
“The proliferation of day traders in the market can no longer be summarily dismissed,” Israel wrote to his investors. “The complete, instant access to stock information has made this group a force to contend with. But when the market declines, most day traders su!er the death of 1,000 cuts. In the meantime, this is the world in which we live, and fortunately for Bayou it is a world we understand well.”
Undergoing treatment for lymphoma, Marino despaired. He seriously considered walking into an FBI o$ce and giving up the whole charade. But then he came up with another plan, which he shared with Israel and Marquez. Bayou should engineer its own death, Marino said. By crafting trading losses in a speci"c way, Marino said, they could kill Bayou over a period of months. Just as they had constructed "ctional pro"ts, they could concoct "ctional losses. So long as the losses were created in a way that could withstand basic scrutiny—though not close examination—no one would be wise to the scheme. After all, who deliberately made themselves losers?
The plan meant Israel and Marquez would have to swallow their pride and withstand the humiliation of admitting defeat. Sam would have to concede that Forward Propagation hadn’t worked. Marquez would have to reveal that his “strong hand”
strategy had failed. But there was no way Israel or Marquez was going to commit hedge fund hara-kiri. Not when Bayou was on the cusp of greatness—even if it was a fantasy.
At the end of the year, Sam told the sta! that the fund’s goal was to reach $100
million. Bayou now marketed itself as the “ONLY” safe harbor for the inevitable crash when the Internet bubble burst. Sam wrote that Bayou’s cautious short-term, low-risk incremental strategy was a counterbalance to the hubris he saw enveloping American society. Bayou’s pro"le was changing rapidly. Serious investors were increasingly looking for a fund like Bayou, which o!ered predictability in a market that was clearly overheated. “Each of us is ready for a large payday,” Sam wrote to Bayou’s sta!.
“Assuming we do this correctly, we will realize the dream.”
For a while, Sam seemed prophetic. The NASDAQ had plunged in the "rst half of 2000, and Bayou was able to take advantage of the trend. Sam shorted scores of Internet companies and made steady progress. If he’d been starting with a clean slate, Sam’s record during the correction would have been outstanding. But he wasn’t. Bayou was in a deep hole, and even Sam’s streak wasn’t able to solve the problem.
As the market tanked and Sam’s predictions came true, in a matter of months Bayou grew to $10 million and then $20 million. The cognitive dissonance of great success coupled with catastrophic failure was sickening. Behind the grinning facade of sudden success, Sam was in free fall. On the way home one night he was pulled over for drunk driving. Cocaine was found in the car. Always expert at talking his way out of trouble, Israel insisted it wasn’t his cocaine and managed to avoid a felony conviction—which would’ve imperiled the fund. Alcohol and drugs had become Sam’s way to cope with anxiety, depression, low self-esteem—the counterweights to his bouts of grandiosity.
As Bayou’s woes multiplied, and the fund continued its meteoric rise, Israel’s back problems multiplied and intensi"ed. Weakness in his neck and numbness and tingling in his "ngers forced him to wear a support collar. Adrift on a sea of prescription drugs, Sam was quick to fly into rages—as his father had, something he had hated as a child.
Sam’s wife Janice insisted he seek help. Days later, she walked into Sam’s home o$ce to discover him bent over a pile of white powder on his desk with a rolled-up twenty-dollar bill in his nose. Busted, Sam went for the big lie: The white powder wasn’t coke.
He was outraged by her intrusion. How dare she suggest he was taking illegal drugs?
The Israels began to see a marriage counselor. Sam believed he was sincerely attempting to repair their marriage. He confessed to things that he’d done that had harmed their relationship. But he couldn’t say what was really troubling him. His conduct was becoming increasingly bizarre. Once, when Janice arrived home from a short trip with the children, they pulled into the driveway to discover Sam outside the house to greet them. He was naked apart from cowboy boots, a pair of his wife’s bikini underwear, a lacrosse helmet, swim goggles, a life jacket, and a cape. When Janice didn’t laugh, Israel grew angry. What was her problem, he demanded. Where was her sense of humor?
Trying to save his marriage, Israel sought help from a psychiatrist. His need for mental counseling had to be kept secret from Bayou’s investors, though. Any whisper of instability would lead to a rush of redemptions. As soon as the psychiatrist met Sam, he diagnosed him as bipolar. The condition was not uncommon among Wall Street traders.
The doctor put Israel on a bewildering mix of drugs, including Depakote (for seizures), Neurontin (an antiepileptic), lithium (an antipsychotic), Wellbutrin (for depression), Zoloft (for anxiety), and Synthroid (a hormone)—all on top of his "stful of painkillers.
The drugs made Israel even less predictable, loosening his already tenuous grip on what was going on around him.
“My shrink zombied me up ridiculously,” Israel recalled. “This was when bipolar was the new diagnosis. Suddenly everybody was bipolar. It was the adult version of attention de"cit disorder. It turned out there was a dirty secret with the doctors. The more drugs doctors sold, the more points they earned with the pharmaceutical companies. They were sent on trips. They received gifts. The whole thing was a scam.
Pharmaceutical companies were just like Wall Street traders. They "xed the game. Only they were fucking with my mind. Everywhere I turned, I kept looking for something real. Something where people weren’t cheating. I kept saying to myself, ‘Please show me something real.’ ”
CHAPTER SIX
Boy in the Bubble
The morning of September 11, 2001, was glorious in New York City. The sky was cloudless, the warmth of the late summer sun softened by a gentle breeze carrying a whisper of the coming fall. Driving his son to school in his new Porsche Cayenne, Sam was feeling the best he had for months—maybe years. The year had been di!cult, with the market in "ux. The total losses at Bayou had grown to $12 million, so the problem persisted. But Sam was optimistic. Jimmy Marquez had #nally agreed to permanently leave Bayou, decamping to a tiny o!ce across the parking lot formerly used by Dan Marino. But the biggest news was that the fund had grown to $70 million, an incredible feat, leaving Sam with a queer mixture of elation and fear.
Then there was the promise of this #ne fall morning. The previous Friday afternoon, Sam’s Forward Propagation program had lit up like a slot machine with a row of cherries. Normally, the computer o$ered contradictory data points—some pointing to buy, others to sell. But that Friday, all ten lights on the computer had pointed in the same direction: Go long. It appeared to be a massive opportunity to take advantage of an unprecedented buy signal. Since the fraud began—really since he had watched Freddy Graber trade on inside information—Sam had been trying to #gure a way to make a lot of money quickly. The pressure of #lling the hole had turned that urge into an urgent demand. And here it was, at long last: a chance for Sam to vindicate his trading system and solve the problem.
On the previous Friday, Sam had put 95 percent of Bayou’s money into long positions. He’d then doubled down, using leverage to ramp up his positions. If the market followed the predictive powers of Sa
m’s program, Bayou would make $15
million or more.
“I was way long,” Sam said. “I had tech stocks—Microsoft, Motorola, Micron Technology. I’d loaded up on S&P futures. Monday morning the preopening noise was screaming. I was going to make great money. I felt fantastic. Then the radio said two planes had "own into the World Trade Center. When I got to work I found out that the market had closed. There was no trading. Nothing. I couldn’t get out of any of my positions. It was obvious the market was going to tank. I couldn’t do anything until trading started again.
“When the market #nally opened the next week I got slaughtered. Margin calls meant we had to liquidate the positions, no matter the loss. We didn’t have the money to hold on for a week or two until things stabilized. We had to sell into the panic. In just a few days, Bayou lost thirty-#ve million dollars. That was nearly half of what was in the fund. The situation was impossible. I was trapped.”
Marino wanted to close the fund. The disaster could be seen as a blessing in disguise, he believed. With so much tumult, Marino thought Bayou’s losses could be hidden. He wanted Bayou to post a huge loss, which no one could sensibly blame on them. The loss would include the $12 million—in real money that Marquez and Israel had lost, as well as the #ctional performance. Bayou would return the remaining money to investors with an apology. Investors would be upset, but there were many other hedge funds suffering the same ignominy.
Sam refused. He would have been left with at least $2 million in personal liabilities.
It was a sum that would have forced Sam into personal bankruptcy, costing the Israels their home as well as his reputation.
“Going bankrupt in the hedge fund business is a death sentence for a trader,” Marino said. “Don’t even think about trying to manage money again. Sam didn’t want to do it.
He begged me to give him a chance. He felt entitled to the opportunity Jimmy had been given to trade his way out of the hole. He said it wasn’t his fault that the loss was so big. When was the last time two planes hit the World Trade Center? When had the exchange closed for #ve days? There was no way for his trading system to account for an absolute random event like a terrorist attack.
“Then Sam pointed out that if we did report a big loss to investors it would mean that we had to have broken the fund’s rules about limiting risk. We were only supposed to have overnight exposure of 10 to 15 percent of the capital of the fund. How could we explain taking such a massive loss? The act of reporting a loss would be the same thing as closing the fund. I thought Sam made good arguments. I said yes. We felt obligated to the investors to recover the money we had lost.”
“Dear Member,” Israel wrote in a letter to investors on October 17, 2001. “Our inevitable duty here is to remember that business, like life itself, must go on in the face of the tragedy of September 11th.” Israel didn’t claim he had entirely escaped the consequences of 9/11. Bayou had lost 4 percent, he wrote. The fund was up only 1.21
percent for the year. Given the circumstances, Bayou’s performance was miraculous—on paper. “We feel lucky to be in a position to close the year in a strong manner,” Israel wrote. “We will attempt to stay as liquid as possible, and will be even more vigilant about always maintaining downside disaster insurance.”
THE EVENTS OF 9/11 permanently transformed Bayou. Trading out of the hole was no longer a realistic option—unless a miracle occurred. The terrorist attack had turned Bayou into a Ponzi scheme. Not technically: Charles Ponzi had never actually traded the International Reply Coupons he used to lure investors, while Sam traded constantly at Bayou. But the essence of a Ponzi scheme was its pyramid-like shape. To pay existing investors who redeemed, Bayou would need to bring in money from new investors. In such uncertain times, with the entire nation fearing another attack, Bayou needed to attract money—a lot of money very, very quickly.
For Sam the disastrous losses proved to be the opportunity for him to discover his genius. Over the years, he’d become a student of human nature. His di!cult childhood had given him unusual emotional intelligence—when he chose to use it. As a rule, grifters come from modest backgrounds and have to spend years learning how to dress and behave among the rich. Sam had grown up with money; he’d dated wealthy girls, played football with wealthy boys, and smoked dope and driven home drunk from smart Westchester parties. He knew the realities lurking behind their seemingly ideal families. He understood their insecurities and anxieties. He moved among them with serpentine ease precisely because he was one of them. Sly "attery, self-mockery, humorous boastfulness—Sam’s rhetorical arsenal was formidable because it was preconscious. He was able to convey the most comforting message—we are alike, we are friends, we can trust each other—in a thousand di$erent ways. He knew what they wanted because it was what he wanted—and what he’d invented for himself.
“When an investor came in, the #rst thing I wanted to know was how much they knew about the market,” Israel recalled. “Before they interviewed me, I interviewed them. I got people to talk about themselves. I asked questions. There is nothing people like more than talking about themselves. If someone was talking about themselves they weren’t talking about me. Then I’d say that I could tell them an extraordinary story about how my machines work, how my programs run, the genesis of the trading program. I could tell them all about my life’s work. But #rst I needed to know if they understood charts.
“I was deferential to some of my investors, but usually I wasn’t. I was in a position of strength. The narrative of Bayou was powerful enough that it spoke for itself. I’d grown up around people who were extraordinarily wealthy—like Sandy Weill and Larry Tisch.
I knew how to stroke them. I knew how to get what I wanted from them. But I discerned that family money was shitty money. If someone came from big money, they invariably had time on their hands to harass you. They wanted to be directly involved because it was cool. They were given money by Daddy or Mommy, aristocrats with family who came to America on the Mayflower, and they wanted to make their parents proud. So they meddled. It wasn’t stable money—rich kids were flighty.
“I liked people who had market experience, who understood trading, but didn’t have the time to do it themselves. The best money came from the big funds that invested in smaller funds like Bayou—‘fund of funds’ is what they were called. There was no direct relationship with the investors, only the manager of the fund of funds. I didn’t have to bother with forty di$erent people. They could put in large amounts of money all at once. I also didn’t want people who really shouldn’t be putting money into a hedge fund. From the start, I didn’t want anyone whose life would be changed by my success or failure. I didn’t want anyone’s college funds. It had to be discretionary money. At the start the minimum was a hundred grand, then we raised it to $250,000, then half a million.”
After the initial meeting at Bayou’s boathouse, Sam would invite investors to come upstairs—“to see where it all happens.” Up a "ight of stairs there was a second "oor with one grand o!ce. This was Sam’s domain. The aerie was carefully staged to convey a sense of boyish eccentricity. Memorabilia were arranged around the room—an antique rowing shell, signed footballs from the days the Israel family partly owned the New Orleans Saints. Pride of place was reserved for an old GI helmet from World War II that summoned the heroics of Sam’s grandfather and namesake. Sam always had the latest version of every imaginable gadget and high-tech doodad. The fratlike exclusivity was part of the sales pitch.
To qualify, the would-be member of Bayou had to #ll in forms acknowledging himself to be a “sophisticated investor”—a kind of self-"attery most often belied by the facts.
The view of the Long Island Sound was spectacular. Like Freddy Graber, Sam blasted music—Paul Simon’s “The Boy in the Bubble” was a favorite song—as he barked orders at his clerks like a demented General Patton. When he was in the "ow, Sam sent four assistants scurrying as he bought and sold shares with mind-boggling speed in head-spinning amounts.
On the wall were sixteen computer screens he could manipulate with toggles. On the screens, masses of data pulsed with the various stocks and sectors that he was following—oil and gas, automobiles, futures. As a lark, Sam would often have one screen devoted to a live shot of NASA’s launching pad when a rocket was about to be sent spaceward.
There was one special screen Sam always pointed out. This was Forward Propagation.
He told investors he made his money on the small movements of the market—a quarter and an eighth of a point, just as Phil Ratner had done for Freddy Graber in their halcyon days. Every morning, Sam said, he put millions into the market; every night he liquidated his positions and he was back in cash. Israel’s program was supposed to give him the power to foresee the future—not for long, but for a “tick,” as it was called in the stock market, the split second it takes for a stock to go up or down a point. Forward Propagation was accurate 86 percent of the time, Sam said. The machine was not infallible—such a proposal was absurd, Sam knew. But in Wall Street terms 86 percent was a fantastic rate of success. The precision of the number, a statistic plucked from the sky by Sam, seemed to infuse the machine with godlike powers.
Israel now promised investors absolute returns; he didn’t need to resort to relative indicators to prove the value of his fund. Sam’s letters to Bayou’s members grew longer as he wrote about the kind of macroeconomic trends that ordinarily shouldn’t concern a technical trader like Sam. By inclination and experience, Israel was skeptical about the economic prospects for the coming decade. The fraud he was perpetrating, with such astonishing ease, had convinced Sam that the United States was in the midst of a bubble. The markets were all crooked, he’d long believed. He was living proof of the hidden truth.
“The Emperor Has No Clothes” was the title of one of Sam’s investor letters. The four-page letter was remarkably prescient about broad trends for the coming years. The value of stocks was greater than the value of the gross domestic product, a disproportion that far exceeded the decadence before the crash of 1929, Sam wrote. The ratio between price and earnings for shares was hopelessly out of line. Real estate was in a bubble. Government and personal debt levels were unsustainable. Severe energy problems faced the United States. A worldwide recession loomed. Like a few of the smartest people on Wall Street, Sam could see that the end was nigh. It was much harder to turn that realization into money. As Sam weaved in and out of stocks—Ariba, PepsiCo, Vignette—he was consumed by trying to #gure out how to use his insight to save Bayou. The United States was going to tank—Sam just needed to come up with a way to make a killing when it did.