We had Michael Lewis on TechTicker yesterday. He told the story of how his Merrill broker sold him Lehman preferred and auction-rate securities just before the financial crisis. Lewis has since fired Merrill and moved to Schwab. — HB.
Best-selling author Michael Lewis knows his way around Wall Street and the world of money. His first book, Liar’s Poker, chronicled his misadventures as a bond trader in the go-go 1980s. In Moneyball, he explored the way economic analysis is applied to baseball. And in The Big Short, which has just come out in paperback, he chronicled how a few shrewd investors managed to profit during the meltdown of the housing and credit bubbles.
Lewis has learned, from personal experience, to cast a jaundiced eye on establishment Wall Street firms and the innovative financial products and advice they sell. That has let him to a generally conservative posture when managing his own money. But even those with the most market knowledge violate their own rules.
In a recent interview with us, Princeton economist Burton Malkiel, a longtime advocate of the efficient market theory – i.e. the notion that individuals can’t beat the market – said that he occasionally tries to pick individual stocks and sectors because it’s fun. Similarly, Lewis found himself sitting on some toxic assets in the fall of 2008 that he had purchased at the advice of a large Wall Street brokerage firm.
As he tells Henry Blodget and I and in the accompanying video, Lewis is, in general, highly sceptical of the large Wall Street brokerage business model. “The stock market is not necessarily rigged against individual investors,” he says. “But if you’re listening to what brokers are telling you, they’re shading the odds against you rather than for you.”
Why? The big firms have evolved since the 1980s, “away from servicing the customer and maintaining nice, happy relations with the customer to managing friction with the customer on behalf of the firms’ traders,” Lewis says. Since large Wall Street firms are trading in the same stocks, bonds, and other securities that they’re advising institutional and individual customers about, “there’s an inherent conflict of interest and you’re not likely to come out of it well if you’re on the other side of the desk.”
On the whole, however, the stock market is a much safer place for individuals than the bond market. “The bond market I’d say is generally rigged against the individual investors,” Lewis declares. “But there’s a caveat. It’s rigged to the extent that Wall Street firms know what they’re doing. And in the last four or five years we had this episode where these Wall Street firms created a poker table where they were the fools, and as a customer you could actually do quite well being on the other side of trades from them.”
That’s the story he tells in The Big Short. (If you’re interested in being entered for a drawing of a free paperback copy of The Big Short, send an e-mail to [email protected])
Lewis’ advice for individual investors: “be conservative, don’t listen to brokerage advice, and index.” But he admits to violating his own rules. Which brings us back to those toxic assets.
Through a family connection, Lewis had long had an account with Merrill, Lynch. And at one point, “I had succumbed to the advice” and agreed to put a small amount of his retirement funds into investments recommended by the broker. “It was like I couldn’t be bothered to think about it. I said: ‘here’s a little bit of money, I just don’t want to lose it.'”
The funds ended up in two positions that promised a bit of extra yield at what turned out to be a very high risk: preferred shares of Lehman Brothers and Auction Rate Securities, fixed-income instruments that were frequently promoted as an equivalent to cash. Of course, when the meltdown came in the fall of 2008, the Lehman preferred shares were essentially wiped out, and the Auction Rates Securities market froze. Individual investors found they were unable to access the funds. “At that point, I shut it down, closed the account and moved my money to Schwab,” Lewis says.
The famed author takes pains to point out that his broker wasn’t dishonest. “He didn’t know any better than I did what the risks were,” he said. But Lewis re-learned a lesson he thought he had already learned. “That made it clear in my mind that I’m the responsible party, and I’m not going to be browbeaten and sold.” And it reinforced the notion that investors should avoid making too many decisions.
When managing his own money, Lewis largely makes portfolio allocations – deciding what portions are in stocks and in other asset classes. But while he invests in stocks primarily through indexes, Lewis does admit to having a view on the market. “It’s a very conservative view. I feel like we are in very perilous times, and I skew the portfolio slightly toward large battleship companies” that might withstand turbulent economic seas.
In The Big Short, Lewis chronicles the way in which newfangled, innovative financial products — credit default swaps, subprime securities, collateralized debt obligations – led to disaster because virtually none of the highly experienced, highly paid professionals involved appreciated the risks they entailed. The same holds true for individual investors, as Lewis found out. “What bothered me was that I hadn’t even heard of these things,” he concedes. “On my own, I never would have conjured up Auction Rates Securities or Lehman preferred” as an investment.
The upshot? As an investor “I want to minimize the things I hear about,” Lewis says. “The things you hear about are usually not good for you.”