By 1986 Ranieri wasn’t even sitting on the trading desk. He was busy ministering to the affairs of the firm. Moreover, his absence made the traders happy. It wasn’t that they disliked Lewie. But when the managers—Lewie and Michael Mortara—turned up, they would invariably dabble in the traders’ affairs. They’d tell the traders what they should or should not do; they’d want to know exactly why the traders had bought this or that bond. As one of the traders now says, “You didn’t necessarily have a good reason for every position. Sometimes you bought bonds just to find out what was going on in the street. You didn’t want someone hanging around asking you why you did such and such.”
Not surprisingly the traders found ways to discourage their managers from managing. One week in April 1986, when Ranieri decided he was going to spend some time on the trading desk, the traders’ first plot unfolded. Ranieri arrived early each morning, but the traders beat him to his desk. The first day they piled as much paper as they could find on his desk. Ranieri arrived at 7:00 A. M., saw the mess, and hit the roof. “Who did this?” he asked no one in particular. The traders shrugged and giggled.
The second day the traders removed the support pins from the swivel chair at Ranieri’s desk. When he sat down first thing in the morning, he crashed to the floor and nearly cracked his spine. It took minutes to hoist him to his feet while he cursed and shouted. This time he asked D’Antona who was responsible for the prank. D’Antona swore ignorance.
The third day the traders raised Ranieri’s swivel chair, so that though he sat down safely, when he pulled himself toward his desk, he banged his kneecaps on the center drawer. He was furious, “Fuck it, Johnny, I want to know who did this,” he said. “Well, Lewie,” says D’Antona, “I guess Mike [Mortara] just doesn’t like you out here on the desk” (a lie Ranieri should have spotted, since Mortara never arrived before 8:00 A.M. and so couldn’t have been the culprit).
“Who the fuck does he think he is?” said Ranieri. He then took all the garbage cans in the department and dumped them on Mortara’s desk—computer printouts, bagel chips, onion cheeseburger scraps, and other trader refuse.
The traders joined him, in a show of support, gathering the garbage cans from across the trading floor. When they had finished, Mortara’s trading desk was buried in a garbage dump. “It couldn’t have been more perfectly timed in the theater,” says one of the traders. “Just as Lewie was storming off one side of the trading floor, Michael was walking in from the other.”
When Mortara saw his desk, he responded just as Ranieri had. His first and only thought was revenge. He, too, turned to D’Antona, and asked, “Leroy [D’Antona’s nickname], I’m serious, who did this to my desk?”
“Michael, as God is my witness,” said D’Antona, “it was Lewie.”
Mortara was stuck. Ranieri was the one guy he couldn’t squash. He blew up in frustration, marched to his office on the forty-second floor, and didn’t emerge for the rest of the day.
“Finally we have some peace around here,” said one of the traders. And though Mortara eventually returned (after mortgage trader Mason Haupt had cleaned up the mess), Ranieri did not. As far as the traders were concerned, that was fine. That month, April 1986, the mortgage trading desk lost more money than ever before, estimated by several traders to have been between thirty-five and sixty-five million dollars. The mortgage traders offset the losses with profits they had squirreled away for a rainy day. They had done this by artificially understating the value of bonds on their books. The senior management of Salomon Brothers never knew.
The bad times befalling the mortgage department were characteristic of business throughout the firm. The year 1986 was a poor one for Salomon Brothers, and 1987 was worse, as revenues ceased to grow and costs spun out of control. In an effort to install management control, Gutfreund created a wealth of new titles. A board of directors of Salomon Brothers was born, consisting mainly of former traders. On top of the board of directors sat another new level of management, called the office of the chairman. To the office Gutfreund appointed two former traders and a former salesman: Lewie Ranieri, Bill Voute, and Tom Strauss. Each was asked to detach himself from the little local turf battles he had previously engaged in and to concern himself with the overall welfare of the firm. It was a nice idea.
“I have this theory,” says Andy Stone, seated in his office at Prudential-Bache Securities. “Wall Street makes its best producers into managers. The reward for being a good producer is to be made a manager. The best producers are cutthroat, competitive, and often neurotic and paranoid. You turn those people into managers, and they go after each other. They no longer have the outlet for their instincts that producing gave them. They usually aren’t well suited to be managers. Half of them get thrown out because they are bad. Another quarter get muscled out because of politics. The guys left behind are just the most ruthless of the bunch. That’s why there are cycles on Wall Street—why Salomon Brothers is getting crunched now—because the ruthless people are bad for the business but can only be washed out by proven failure.”
It was no secret throughout Salomon Brothers that the office of the chairman was divisive. It was simply a carryover from the battle between the three pillars of debt, with Strauss representing the government department, Voute representing the corporate department, and Ranieri representing the mortgage department. As a member of the government department put it, “Around here you are in the Strauss family, the Ranieri family, or the Voute family. Few have been in more than one.”
The problem wasn’t as mild as conflicting team spirit. The office of the chairman was noted for its catty animosities. Ranieri called Tom Strauss “a boob, all artifice. The man never had an original thought in his life.” He called Bill Voute “the most political man I’ve ever met. He never said anything without having a political agenda. He’s Machiavellian.” But his complaints about his two new peers were apparently mild in comparison with their complaints about him. He was willing to work with them; they eventually had him fired. On the other hand, as all three lived by the law of the jungle, perhaps it was a matter of their getting him before he got them. Whatever the case, the office of the chairman came to symbolize the force within Salomon Brothers working to dismantle the mortgage department.
The government trading desk was a counterpoint to the visible gluttony and ethnicity of the mortgage department. By Salomon standards, it was almost refined, which is to say that it took its meat rare rather than raw. Government traders could have been mistaken for socially conscious East Coast WASPs, had they only been a bit more repressed. Tom Strauss, their leader, was tall, thin, and perpetually tanned. He played tennis.
The mortgage traders resented this. They disliked what they interpreted as Strauss’s overhead smash of Salomon’s Jewish culture. When they talk of Strauss, they rarely fail to mention his game of tennis; they imagine him dressed in whites on the courts of the exclusive club. The two vices of which the mortgage department was free, hypocrisy and pretension, were the vices they least tolerated in others. “The difference between Strauss and Ranieri?” says one trader still at Salomon. “That’s easy. Strauss wouldn’t stoop to use the men’s room on the trading floor. He’d go upstairs. Lewie would piss on your desk.”
“Tom Strauss,” says Ranieri, “wishes more than anything he wasn’t Jewish. Ever since he joined the firm there’s been a joke that some terrible Jewish couple had stolen Tommy from his crib.” (And thus it perversely fell to a Roman Catholic—Ranieri—to guard the Jewish heritage of Salomon Brothers.)
“What Strauss hated about Lewie was that he was fat, uneducated, and lacking finesse,” says one of Lewie’s senior traders. “Strauss didn’t care about Lewie’s business. He didn’t care about Lewie’s profits. He didn’t even care about Lewie’s vision. He didn’t like Lewie’s lack of couth. Now that may seem like the sort of objection you have to the guy sitting next to you, but Lewie was the guy sitting next to Strauss. Strauss got to the top and looked to his right and said, ‘
Wait a minute, I thought I had moved up in the world.’”
The Strauss family (of which I was to become a member) had strong professional objections to the mortgage department. They disapproved of what they thought were the excesses of the mortgage group. The food frenzies and all that fatness pointed to a more fundamental problem. Costs were most out of control in the mortgage department.
Who cared? Revenues had always been what mattered. “You’re going to go and change the rules on us now?” was the response of a few traders. There had been so much revenue in the mortgage department between 1981 and 1986 that costs were a trivial issue. But as revenues subsided, costs all of a sudden mattered, too. A managing director of government sales was moved to the mortgage department in late 1985 and simultaneously put in charge of Salomon’s expense committee. That wasn’t just a coincidence. Someone had to control these people!
Many mortgage traders felt that since they were underpaid to begin with, and their boss agreed they were underpaid, the Salomon Brothers’ expense account could be used as a soft-dollar compensation system. They developed bad habits. “We used to send firm limos to pick up friends at the airport. We’d lend our telephone charge cards out to friends. For Christ sake, people would use Salomon limos to take their wives shopping on the weekends,” says one of the traders. “I have the ultimate expense story,” says a woman from the mortgage finance department. “One of the people in the department put through enough phony expense reports from fictitious trips to visit clients to buy himself a Saab with the proceeds.” This irked the Strauss family.
Voute’s feelings toward Ranieri were more a mystery than Strauss’s. But, then, Voute himself was more a mystery. While the other managing directors swarmed across the forty-first-floor trading room, Voute was an invisible link high in the chain of authority. He had an office on the fortieth floor, he appeared occasionally in the newspapers, but one never actually saw him. The one time I laid eyes on him he was standing beside his limousine in a photograph over a 1987 article in Business Week. The short article underneath said how Bill Voute would sure like to be chairman of Salomon Brothers. In spite of his reclusiveness, the initial move to dismantle the mortgage department came from his corporate bond family.
At the insistence of Voute and Strauss, a corporate bond managing director named Mark Smith entered the mortgage department at the end of 1985. “You could call him a spy,” says one mortgage trader. “You might call him a Trojan horse,” says another. “You can’t call him a Trojan horse,” says a third, “because we all knew what was inside, but Michael wouldn’t listen.” In fairness, Mortara didn’t have much choice but to let the horse through the gates. He could hardly resist the demands of Voute and Strauss. Only Ranieri could have done that. The question which had been on the tips of mortgage tongues was voiced for the first time: Where was Lewie?
Mark Smith was the first Big Swinging Dick to be seconded to the mortgage department from some other part of the firm (excluding Ranieri). The department had always been a family characterized by internal solidarity. Six months after Smith joined them, the first internal squabbles occurred. Smith persuaded Mortara to move Jeff Kronthal off the mortgage desk (Ranieri’s protege off the mortgage desk!) and into the corporate bond department. Smith then insisted on bringing Larry Stein, a government salesman, into the mortgage arbitrage trading unit, which consisted of Nathan Cornfeld, Wolf Nadoolman, and Greg Hawkins. Stein agreed to move on the condition Nadoolman be fired. Nadoolman was a profitable trader, but more important, he was a loyal member of the Ranieri family. Stein belonged to the Strauss family. Nevertheless, at the end of 1986, Mortara fired Nadoolman. The air was poisoned.
MERRILL HAS $250 MILLION LOSS ON UNAUTHORIZED TRADING, announced a headline in the Wall Street Journal of April 29, 1987. And then the small print: “Executives at Merrill Lynch privately identified the trader as Howard A. Rubin, 36 years old, who had been the firm’s head mortgage trader. They said he had far exceeded his limits in acquiring mortgages that were packaged into a particularly risky form of securities. The package involves splitting off the interest payments on the mortgages from the principal and selling each separately. They are known as ‘interest-only/principal-only’ securities, or IOPOs.”
Wall Street reporters were frantically trying to find out both who this man, Howie Rubin, was and what was meant by IOPOs. And though they eventually learned, how Howie Rubin lost more money on a single trade than anyone on the history of Wall Street remained one of the most beguiling mysteries on Wall Street. Not only had he seemed until that point to be one of those people who always landed on their feet, but he had been a raw talent. In the words of Lewie Ranieri, “Howie Rubin was the most gifted trader I have ever seen.” The story Merrill Lynch gave to the press was that Rubin had deceived them. A Merrill executive told the Wall Street Journal that Rubin “just put them [the bonds, the IOPOs] in his drawer. We didn’t know he owned them.” Just put them in his drawer? Could the upper management of a leading firm like Merrill Lynch be caught so entirely off guard?
A couple of weeks before the loss was announced, Rubin had lunched with a large buyer of mortgage bonds, Ernie Fleischer of Franklin Savings & Loan in Ottawa, Kansas. Thrift management, in general, was slowly improving, and Fleischer was at the vanguard of the change. He prided himself on beating Wall Street at its own game. Rubin explained IOs and POs to Fleischer (remember that they are a mortgage bond split in two. The interest goes to one investor; the principal to another). Fleischer liked what he heard. And while they were still at the lunch table, Fleischer asked Rubin to sell him five hundred million dollars of IOs.
In agreeing, Rubin took a flier. He sold Fleischer the interest payments on five hundred million dollars’ worth of bonds. That left him with the principal portion of the same bonds. The deal was consummated over dessert. Fleischer returned to Ottawa, and later boasted how he had made ten million dollars taking the other side of a trade that cost the Wall Street slickers a fortune.
The problem for Howie Rubin was how to dispose of his five hundred million dollars of POs. No bond plummets faster when interest rates go up than an PO (for reasons not really worth going into; believe me). Rubin’s risk was, therefore, that the bond market would fall before he had a chance to sell the POs. The bond market, when he returned from lunch, felt jittery. And he tried to off-load his POs through the Merrill Lynch sales force. But it was unable to sell them. Then the market collapsed. After a couple of days Rubin found himself with a loss too large to admit. Some say that at this point he bought more POs, doubled up his bet. Though it would certainly have been in character, there’s no evidence he did anything of the kind. No one seems to know why things got out of hand. Yet everyone has an opinion. And what all of Rubin’s former Salomon teammates swear, from Lewie Ranieri on down, is that Howie Rubin didn’t hide the bonds in any drawer. The only version of the story they accept is that the management of Merrill Lynch hadn’t a clue what a PO was, hadn’t established any rules for its use, had permitted Rubin to assume a huge risk, and then used him as a scapegoat for its ignorance. In the newspaper stories that followed the incident, anonymous traders from Salomon Brothers were quoted repeatedly defending Howie Rubin. It was as if he were still part of the Ranieri family.
To split a mortgage bond into its interest and principal components, the bond must first be registered with the Securities and Exchange Commission. SEC registration is a public event. The rest of Wall Street therefore saw Howie Rubin at Merrill Lynch register to issue five hundred million dollars of IOPOs. Mark Smith, Voute and Strauss’s man in the mortgage department, took note. He argued that Salomon Brothers should follow suit.
On the face of it, his suggestion made sense. The Merrill Lynch package of IOs and POs was overpriced. Smith figured that if Merrill could sell the fragments of mortgage bonds for such high prices, then Salomon, with its stronger sales force, should have no problem with a similar, cheaper deal. What he didn’t know, of course, is whether Howie Rubin had actually s
old his entire deal. But investment banks love nothing more than to undercut one another. So Salomon did the deal. Salomon issued $250 million worth of IOPOs.
By pointing out that the Salomon POs were cheaper than the Merrill Lynch POs, the Salomon sales force managed to move the dreaded things out the door to investors before the market collapsed. Of course, this completely undermined Howie Rubin’s efforts to escape disaster. That left Salomon Brothers in a position similar to Ernie Fleischer; it owned IOs, which rose in price when the bond market went down. That was fine; everyone at Salomon expected the market to crash. And instead of offering the IOs to the public, the firm kept them on as a bet. The mortgage arbitrage group—consisting of Greg Hawkins, Nathan Cornfeld, and Nathan Low—bought $125 million of the things. And the group of traders managed by Liar’s Poker champion John Meriwether bought the rest. Only one trader on the forty-first floor of Salomon Brothers seemed to have a view that differed from the rest: Mark Smith. In his trading account he, like Howie Rubin, owned hundreds of millions of dollars of POs (bought weeks before).
Smith was known around Salomon as an able speculative trader. His nose told him the bond market was due for a rally. He felt so sure of his bet that he told Hawkins, Cornfeld, and Low how stupid they were to bet against him. He occasionally wandered past John Meriwether’s boys to tell them that he, not they, had made the right gamble. The bond market felt good; it was going up.
When the market first dropped, it dropped slowly. But it was enough to wreak the havoc at Merrill Lynch that made the front page of the Wall Street Journal. A few days before the story, a market rumor alerted Salomon Brother’s that Merrill Lynch was sitting on hundreds of millions of dollars of POs it needed to sell. After a couple of days of decline, Smith, who had lost a small fortune but was still in the market, took a body count and decided that it was time to buy a few more POs. After all, Merrill Lynch was panicking, and that, as we all know, presents a chance to buy cheaply. So he bought more POs, and though they were not precisely the ones Howie Rubin owned, his position was virtually identical to Rubin’s. For the next few days the market stayed calm.
Liar's Poker Page 17