Steve Eisman: They mistook leverage for genius

Steve Eisman was one of the few who predicted the 2008 financial crisis, and he made his name by foreseeing the collapse of subprime mortgage market.

They’re all getting screwed you know you know if they care about they care about the ballgame or they care about what actresses went into rehab i think you should try medication no no we agreed if it interferes with work you hate wall street maybe it’s time to quit i love my job you hate your job i love my job you’re miserable i love my job i love my job honey

Mark steve iseman welcome to the offense i’m glad to be here so you’ve been portrayed in a book and in a film what did you prefer i would say they were both fairly accurate as the way i was back then and let’s just leave it at that okay okay so i’ve heard that some brad pitt’s almost caladium in the film it’s not true i got a phone call from adam mckay who was

The author director of the movie in november of 2015 to say that he was writing the movie and that there was a possibility that brad pitt would play me to which i responded that the only thing brad pitt and i have in common is that we both have really good hair okay so being one a few people who sold the financial crash coming how did it feel to have see this big

Disaster unfold and not being able to do anything about it the analogy i use it’s a little bit like noah in the ark yeah so you know noah’s on the ark he’s okay and that he saved his family but he’s not exactly happy hearing everybody screaming outside that’s was sort of my experience all right did you think the financial market potential market from the financial

Sector would get back get back to business and get back to some kind of normal as quickly as it did no i didn’t expect it would it would happen that quickly you know a lot of that was the fact that the government backstop the system and once the become a backstop the system it was what the financial markets did come back but the banking system has been changed so in

The book and the film it becomes very clear that you’re you betting against the subprime mortgage market is not just a trade but it’s kind of a moral crusade are you still on this moral crusade i’m not because a lot has changed you know dodd-frank i think really fixed a lot of things leverage has come down enormous ly the consumer financial protection board has

Been put in place to protect consumers i the world’s very different from what it was pre-crisis hmm but now many of these things are threatening i mean donald trump has promised to repeal vast parts of the dodd-frank act for example it’s not something i’m in favor of i think that will be a big fight you know it’s possible the industry is going to get deregulated

To a degree we’re not going to go back to what we where it was so for example you know citigroup used to be levered 35 to 1 today its levered 10 to 1 i feel if we go into some type of deregulation maybe you get 2 to 3 turns more leverage it’s not something that i’m personally in favor of but i don’t think it’s a calamity hmm so do you think with donald trump be

President today if more than one banker had gone to jail for the financial crisis it’s an excellent question and the answer is i don’t know you know i don’t know i’m cold about it i’ve thought about it a lot i think there’s a definite very strong sentiment that it was wrong that nobody went to jail i’m not going to say if that sentiment is right or not but there’s

Definitely a very strong sentiment in the country that that’s the case and i think people are very angry that nobody did go to jail again i’m not going to say whether that’s right or wrong and if people had gone to jail i think that would have soothed some of the hangar that was seen in the election so it’s possible that impact of the election but it’s impossible

It’s impossible to say right so now taxes are going to be can’t and finance regulators because the populace to campaign against wall street 1 correct correct okay so what do you do with investment then i hear you you are investing quite a lot in bank stocks well i mean there’s there’s two issues there’s what i think about finance the financial system and what i

Think about financial stocks and the two don’t necessarily correlate so with respect to the financial system i think that what’s been done has been a good thing but it’s been very intense bank the dodd-frank act and the fed forcing people to deliver to de-risk etc so from a financial system i’m very happy i could say very strongly the united states financial system

Has never been held this healthy in my lifetime but it’s been very painful for financial stocks because as you deliver and do risk you make less money and therefore it hurts your stock price so the last six years or so have been extremely painful for financial stocks especially banks as they’ve delivered and dearest well if we’re going to go into world where we’re

Going to deregulate and leverage is going to go up at least some just reverse the story so therefore financial stocks should do well right okay like i said financial system financial stocks but you are not necessarily the same an interest rates in america are going up yes that’s very good for banks all right so america is kind of moving from a monetary stimulus

To a fiscal stimulus with something but it’s like that’s something i’m in favor of yes i think it’s a good thing the infrastructure investment yeah that’s right until not believe that quantitative easing is a successful strategy why not there are too many negative impacts for from it to i mean look it was a noble experiment there was no fiscal expansion there was

No other game in town so i don’t blame the fed for doing it the idea was that lowering rates would cause people to go up or out on the risk curve and vest in the economy and really the other thing happened was they went out on the risk curve by buying back their own stock they didn’t really invest in the economy and with lower rates that hurts consumer because

They makes us money we pay the money in the bank so i haven’t you know when we started the monetary policy of quantitative easing us growth was one-and-a-half to two percent and after we did it it’s one and a half to two percent so in my view quantitative easing is a failure alright so in november you said to the guardian in europe but europe is screwed you guys

Are still screwed referring to their non-performing loans in the italian depends of the country yes are we in europe still screwed well my wife wish i hadn’t said that yes so okay oh we in big trouble not big it depends on the country you know italy has a very large non-performing loan problem i don’t see the italian government doing anything to really solve that

Problem if they like before christmas that was a nasty suppose that was just monte de paz yeah and you never like to say monte de partie because it’s such a great name and the world’s oldest bank as the world’s oldest bank correct and i don’t you know you could try and simmel to deposit ten times fast it’s very hard but it’s not really solving the problem i mean this

Is something called a texas ratio which is a ratio that bank analyst achon myself compute which is non-performing loans divided by tangible book value plus reserves basically the numerators all the bad stuff divided by the money you have to pay for the bad stuff and one of the great lessons about bank analysis is that one in texas ratio gets over a hundred percent

The bank is done and in italy the two largest banks are in paisa and you credit and their texas ratios are at ninety percent and every other bank in italy is over 100 percent so i don’t envy italy the problem ok famous ahma is the country there’s the bigger than i think it won’t come and i think the problem with the banks generally in europe is that they are still

Under capitalized and they they are they do not make enough money per dollar employed basically european banks don’t charge enough for this services they never have and they’ve tried to make up the difference with leverage and in a world where you have to use less leverage that model doesn’t work what about deutsche bank quite the same well don’t you make sort

Of the poster child for that let’s think about this this way so today if a bank has a 1% return on asset and is loved or ten to one the return on equity is 10% that’s the simple formula so you know citigroup for example doesn’t even have a 1% roa but they’re not that far off but deutsche bank today has a 30 basis point roa they need to improve their profitability

By more than three times there’s no way georgia bank on its own can improve its profitability three times the entire european banking system has to be price you know how that’s going to ever happen i don’t know but until it does your paint banks it could be a problem they’re going to be a problem so you’ve been in here in london for a few hours now and you must

Have realized already that the only thing people talk about here with breakfast yes so what financial risks do you see coming from brexit big question is a big question okay what will happen in march i have no idea you have no i really have no idea honestly i don’t think and more importantly anybody else has any idea that it’s going to be an adventure a not so

It’s going to be a fun adventure but it’s going to be an adventure so you said that we’re very bad at dealing with crises that develop very slowly and you put the blame on the big financial crisis of 2007-2008 on income distribution really do you see that changing at all i mean let me explain that yes because it’s not intuitively obvious how the two are connected

So you know my thesis is that one of the underlying causes of the financial crisis it was bad income distribution so you know when i say that people’s eyes generally clays are like you know what are you talking about but i think that there’s a cause-and-effect relationship in that you know starting in the 90s when income distribution started to get really poor

In the united states rather than focus on that and what the solutions worth of that problem let credit get democratized that was the euphemism for will will make loans to people that we didn’t make loans to before so rather than get people’s incomes up they let them lever themselves and one of the ways people lever themselves was by taking out loans on their homes

And loving themselves that way and so i think one of the causes of the subprime mortgage crisis is that you know post dodd-frank hard to get a mortgage loan yeah you know incomes have only started to start growing again we’ll have to see what it does the new administration can do anything hmm so it don’t frank it’s harder to get a loan but well it’s hard to get

A mortgage why although i don’t think that i caused a defect of dodd-frank i think it’s more of an effect of all the fines that were imposed on the banks for the mortgage crisis and so the banks i think not unjustifiably are kind of worried about making mortgage loans that they might they might not should or should not make so the financial crisis what he said

The main problem was the products the tools available or the culture ah i would say is one of the unsung aspects of the financial crisis that people have definitely not written that up about which is psychology yes and what i mean by psychology is you have an entire generation of wall street executives who grew up in the 90s in the early aughts who really only had

One experience which is they made more money every single year now what they didn’t really notice was that as they were making more money every single year the leverage of their various institutions was increasing every single year now they thought they were making more money because it was them but really what was happening as they were making more money because

Their institution was becoming more levered and really what happened was they mistook leverage for genius i wrote that sentence by the way i read that i do it’s a good son it’s a good sentence i don’t write a lot of good sentences but that’s definitely one of them tweetable yes it’s very good right if i tweeted i would tweet listen i am so let’s imagine you went

To a wall street executive in circa 2006 and you said to the ceo of you know pick the name of your institution and you’d say dude listen the entire paradigm of your career is wrong you have to deliver so did you ever have a conversation like that i did i’ve never told this story before there’s like ai now it can be told story okay um so the day is february 2008

And i have a meeting with the head of risk management and one of the big wall street firms we won’t name them anyone else today but it wouldn’t matter because i would have had the same it would have been the same conversation with any of them given what was discussion one so i sit down with a head of risk management of one of the big farms it’s one month before

Bear stearns almost to the day and i say to him you have got to deliver and you’ve got to deliver now because armageddon is coming the point of it is the direct that’s almost a direct quote i used the word armageddon and he looks at me and he says you know i hear what you’re saying but you know we at x we can be much more levered to the bank now back then there

Was a bank based in detroit called net city it was a medium-sized regional bank and it had a lot of subprime mortgages so it was a bit of the topic of the day and so i said to him you know do you know what happens if knacks city goes down and he says no what happens i said nothing the regulator’s come in they seize the bank they pay off the depositors they fix the

Bank they sell the bank the government takes something of a loss end of story do you know what happens if your firm goes down planet earth burns who should be more levered and he looked at me like i was speaking ancient greek like he just it was so outside his paradigm it’s like he didn’t know i was talking about and i realized it was over that there was no way

These guys were going to do what needed to be done before the world blew up but i think we’re going to see someone to go to jail right i mean you can have to break up the bank partido i don’t know i don’t know i have a feeling in a few years people are going to be doing what they always do in the economy tanks they would be blaming immigrants and poor people it’s

Not x equate from you is that hollywood’s a great quote it’s a great mark it’s not yellow it was written by adam mckay with the author and director and but did you think in those terms back then oh i always think in those times always thinks in terms of disaster yes why is that just i have a very strange dna do you see this paradigm changing at all this culture

I was told check it steady change they’ve been beaten to a pulp yeah you know the dodd-frank gave much more power to the fed to regulate the banks that power was put in the hand of governor daniel tarullo and i think he’s done a tremendous job of delivering the banks in the united states you know i would say the ceos of the bank’s fought him kicking and screaming

But i’d say in the last year or two they gave up and i know you said before that europe’s done not as good of a job with that that’s correct why well it’s what your starting point so you know just pre-crisis citigroup is levered thirty five to one deutsche bank is lowered over 50 to one so today’s citigroup is levered ten to one and deutsche bank depending on how

You calculate is probably levered twenty five to one so everybody’s leverage is lower european banks have always been much more levered than us banks so they’re still more levered they just left levered than they were right not they’re not delivered enough to my taste yes but that again we gets back to the paula mills they’re not profitable enough per dollar

Employed so the regulator’s in europe let them be more levered i think it’s a mistake but that’s the way the systems it works okay and everyone’s asking you what the next one of the crisis is going to be so i don’t have a dick i know i’m not going to ask you money i will ask you that question i say you know everybody’s trying to pick the next big short and i’ve

Done that already i’m in no rush okay thanks a lot steve eisman thank you

Transcribed from video
Steve Eisman: “They mistook leverage for genius” By EFN Ekonomikanalen