Liar's Poker

by Michael Lewis

  Ranieri was impulsive in a way that business school case studies seldom account for when they analyze managerial decision making. In her first day in the Salomon mortgage finance department, as she was being given a tour of the firm, Maria Sanchez recalls meeting Ranieri in a hallway. “I had no idea who he was,” she says. “He came waddling down the hall like a penguin, waving one of his long swords—he kept a collection in his office. He walked up to my tour guide and pointed to me with the sword and asked loudly, ‘Who’s this?’”

  “We were introduced, and he asked, ‘You Italian?’ I said no, I was Cuban. I was wearing a blouse with a long string bow tie. Lewie took out a pair of scissors and with this big smile on his face cut off my tie.

  He said he didn’t like ties on women. He pulled a hundred-bill from his wallet and told me to buy a new shirt. I thought, Jesus, what have I gotten myself into?“

  Eventually Ranieri was pressed to reform—by John Gutfreund. Though Gutfreund wasn’t above having a little fun himself, he was, after all, running a large corporation. His vice-chairman was beginning to look more like his chairman of vice. If he was going to promote Lewie, Lewie would at least have to look the part. “I remember one day Lewie came over and threw his American Express card at Liz [Abrams, his secretary] and told her to go to Brooks Brothers and buy him a wardrobe because John said he had to change his image,” says Andy Stone.

  Gutfreund’s concern went past the clothes, to the man. “Gutfreund was watching Lewie’s weight for him,” says another trader. “I remember once when we ordered pizza, Gutfreund came over. Lewie wouldn’t eat any until Gutfreund went away. Everyone knew which one was Lewie’s pizza. He had this look on his face: Touch that pizza and you’re dead.”

  Ranieri’s memory of his metamorphosis is slightly different. He recalls one day “being euchred” by his wife, Peg, and Liz Abrams into a trip to Barney’s. “I agreed to buy one new suit,” he says. “We walk through, and the guy helping us asks me what I think of these suits. Each time I said I liked one, this guy pulls it off the rack. Lizzie has told the guy I’m going to buy every one I like, but she hasn’t told me. By the time I’m through I have picked out nine suits. Now I have to do what I hate most—stand around and fit all these fucking things. While I’m doing this, Lizzie takes my credit card and says she’s going to pay. But she comes back with three slips. ‘What’s this?’ I ask her. She’d bought nine suits, fifteen ties, and twenty-four shirts with monograms and a bunch of these little things here [he points to the hankie]. I’d been euchred.”

  Not entirely. He found ways to foil his appearance-conscious advisers. Most of his new suits were three-piecers, which by some miracle of justice went out of fashion immediately after he bought them. Anyway, Ranieri never really wore his new clothes. One trader remembers, “He’d come in every morning with his vest slung over one shoulder and his tie slung over the other.” And there was no chance whatsoever Ranieri would permit his new look to interfere with the down-to-earth image he projected to his clients. The new clothes became a clever foil for his old self.

  Jeff Kronthal recalls being out to dinner with Ranieri and a client of Salomon Brothers when Ranieri spilled soup on his new thin tie and shirt. “He was pissed off and cursing. He said that if they let him wear his wide ties, it would have only ruined the tie and not the shirt.” Before a trip to see another client, the State of Alaska, it was pointed out to Ranieri, who wore only a suit, that since it was March, he might need an overcoat in Alaska. He gave his American Express card to Liz Abrams, who bought him an eight-hundred-dollar Chesterfield at Brooks Brothers. Off went Ranieri to Alaska, resplendent not only in a relatively new suit but in a brand-new overcoat. However, between the forty-first floor and Alaska he lost his shoes. He replaced them, apparently duty-free. He met with the client in his eight-hundred-dollar overcoat and a nineteen-dollar pair of bright orange imitation stack boots with heels six inches high. It was a great act, perhaps the best on Wall Street.

  You couldn’t put your finger on why, when two seemingly equal people sat in the same trading position, one made twenty million dollars, and the other lost twenty million dollars. John Meriwether, Liar’s Poker champion, was the Salomon trading manager who came nearest to perfection in spotting future trading talent. Yet even he erred. He once hired a man who panicked whenever he lost money. One day the man, finding himself in a hole, broke “They’re out to get me, they’re out to get me,” he shouted over and over until someone hustled him off the trading floor.

  You couldn’t always put your finger on losers, but you knew talent when you saw it. Howie Rubin had it. Of all the traders, Rubin displayed raw trading instinct. Lewie Ranieri calls Rubin “the most innately talented young trader I have ever seen.” The other traders say he was the trader most like Lewie Ranieri. One trader remembers that “Lewie would say he thought the market was going up, and buy a hundred million [dollars’ worth of] bonds. The market would start to go down. So Lewie would buy two billion more bonds, and of course, the market would then go up. After he had driven the market up, Lewie would turn to me and say, ‘See, I told you it was going to go up.’ Howie had a little of that in him, too.”

  Rubin joined Salomon Brothers in the fall of 1982 from the Harvard Business School. What interested everyone most about Rubin, from Ranieri on down, were the years he had spent counting cards (memorizing the cards that had been dealt and calculating how it affected the odds) at a blackjack table in Las Vegas. A Harvard graduate who counted cards was a rarity: a synthesis of the old Salomon and the new.

  In 1977 Rubin was a chemical engineer fresh out of Lafayette College working for an Exxon refinery in Linden, New Jersey. He made $17,500 a year, which at the time he thought was good money. “After six months I was bored,” he says. “After a year and a half I was really bored.” What do you do if you are a bored chemical engineer in Linden, New Jersey? You watch TV and drink beer. Flipping channels one night, Rubin and a college friend ran across a “Sixty Minutes” piece about a man who made his living counting cards in blackjack. “Shit, if he can do it, how tough can it be?” said Rubin. He read three books on the subject and moved to Las Vegas. In two years in Las Vegas he parlayed $3,000 into $80,000. “The tough part wasn’t breaking the system; the tough part was not getting tossed out of the casinos,” he says. By the time he left, every casino in town carried his photograph; he would wear disguises to sneak past the security guards. When, eventually, he became bored with counting cards, he enrolled in Harvard. He learned that there was such a job as trading bonds from his more worldly classmates. He knew immediately, he says, that it was his calling.

  Rubin found the prepayment game he played with discount mortgage securities similar to counting cards. “Blackjack is the only non-independent outcome game in the casino. What happens in the past affects what will happen in the future. There are actually times when you have a statistical advantage, and that is when you make the big bets,” he says. At Salomon he had the advantage of superior information about the past behavior of homeowners, and only when he had this edge did he make the bets. What’s more, he says, the trading floor at Salomon Brothers felt like a Las Vegas casino. You made your bets, handled risk, in the midst of a thousand distractions. To feign indifference before the blackjack dealer in the casino while he memorized every card that was dealt, Rubin engaged a neighbor in conversation and drank gin and tonics. At Salomon Brothers he traded bonds while being hollered at by six salesmen, eating a morning cheeseburger, and watching Ranieri hold a Bic lighter under the balls of a fellow trader.

  In his first year out of the training program, 1983, Rubin made $25 million. The several-hundred-million-dollar question that has never been answered by the management of Salomon Brothers was first raised by Howie Rubin: Who really made that money, Howie Rubin or Salomon Brothers? In Rubin’s view it was Howie Rubin. In John Gutfreund’s view it was Salomon Brothers. Gutfreund felt the firm created the opportunity for Rubin and therefore deserved the bulk of the rewards. Gutf
reund’s view, of course, prevailed. The first two years out of the training program Howie Rubin, like all trainees, was placed in a compensation bracket. In his first year he was paid $90,000, the most permitted a first-year trader. In 1984, his second year, Rubin made $30 million trading. He was then paid $175,000, the most permitted a second-year trader. He recalls, “The rule of thumb at Harvard had been that if you are really good, you’ll make a hundred thousand dollars three years out.” The rule of thumb no longer mattered. In the beginning of 1985 he quit Salomon Brothers and moved to Merrill Lynch for a three-year guarantee: a minimum of $1 million a year, plus a percentage of his trading profits.

  Who could blame him? Certainly not his fellow traders. They understood. You didn’t ask a trader to squeeze every last penny out of a market for Salomon Brothers, train him to exploit the weakness in others, and then expect him to roll over and purr at bonus time. At the end of each year the people on the Salomon Brothers trading floor dropped whatever they were doing for a period of several weeks and traded their careers. What are they paying me? What are they saying to me about my prospects? How much money can I get from another firm? There was even a game—much like Liar’s Poker—played by traders against the firm. Wolf Nadoolman calls it “How to be paid three hundred and fifty thousand dollars a year and pretend to be upset about it. (By the way, I was very good at it. Really fabulous).” The point of the exercise was to inform the firm that maybe, just maybe $350,000 would suffice this year. But next year, if it didn’t pay your properly, you’d be doing a runner. You might be bluffing. Then again you might not.

  John Gutfreund, although himself a trader by training, did not grasp the contradictions inherent in his compensation system. The unprecedented profits in the mortgage market strained the Salomon Brothers spoils system as it had never been strained before. Gutfreund’s attitudes took their final shape in the days when the firm was a partnership. Loyalty could then be pretty much taken for granted. In a partnership a trader was required to keep a substantial portion of his wealth in the firm. If he left the firm, he lost a fortune.

  That system ended when Gutfreund sold the firm to Phillips Brothers, the commodities trader, in 1981. Now, a peach-fuzzed youth (from Gutfreund’s perspective) would emerge from the firm’s training program, be sent to chase a new opportunity in the mortgage market, reap tens of millions of dollars in profits, and then demand a cut of what he had produced. Gutfreund had no intention of paying anyone “a cut.” He entertained a notion that X was enough, and his notion was rooted in an era when paying a million dollars to a second-year trader was unthinkable. And, anyway, Salomon Brothers, not Howie Rubin, had made that twenty-five million dollars trading.

  Gutfreund openly criticized what he considered the overweening greed of the younger generation. In 1985 he told a reporter from Business Week as he waved his hand magisterially over his employees on the trading floor: “I don’t understand what goes on inside these pointy little heads.” His hypocrisy was noted and resented by the mortgage traders. It was easy for Gutfreund to say money didn’t matter. He paid himself more than any chief executive on Wall Street. And he had already made his fortune by taking forty million dollars out of the sale of the firm to Phillips Brothers. His attitude—as well as those of other old partners—toward the firm changed once he had cashed in his chips. He and others ceased to view Salomon Brothers as a instrument of wealth creation and began to treat it as an instrument of power and glory, a vast playground in which they could be the bullies.

  Gutfreund especially seemed to revel in the playground’s growth. He loved to point out that Salomon was the world’s most powerful investment bank, with three billion dollars in capital. He took obvious pleasure from the concept of being a “global” investment bank. Offices opened and expanded in London, Tokyo, Frankfurt, and Zurich. The firm, which had employed two thousand people in 1982, had six thousand people by 1987.

  All this can be attributed, one supposes, to a healthy desire to remain competitive. However, many of the mortgage traders argue that growth for growth’s sake reflected glory upon John Gutfreund. Often he would point out that Salomon Brothers carried eighty billion dollars of securities on its books overnight, every night. He would follow this observation by saying that, in asset size, Salomon Brothers was “the largest commercial bank in the world” and “one of the forty largest countries in the world.” As one (Jewish) mortgage trader said in response, “C’mon, John, you’re not talking the Netherlands; you’re talking about a bunch of Jews who are leveraged.”

  The concept that he presided over no more than Jews with leverage was as alien to Gutfreund as the Netherlands. Salomon Brothers, where he was boss, was bigger than that. By the commutative property of executive grandeur, John Gutfreund was bigger than that. Howie Rubin, on the other hand, didn’t really figure, except as a cog. He could be replaced by another trainee. The traders thought of Gutfreund’s system as a bad trade. The upside was to stay at Salomon, and if the firm continued to prosper, the trader could hope to be repaid for past performance. The downside was that the firm ceased to be profitable and the trader’s best years were wasted.

  Therefore, Howie Rubin took the three-million-dollar contract from Merrill Lynch in March 1985 and became a legend in his own time. Word of Rubin’s coup filtered back into our training program, and he was spoken of by people who had never met him. “Did you hear what Howie Rubin got at Merrill?” people asked. Rhetorically, of course, since everyone knew. The Howie Rubin legend drew into mortgage trading people who planned to leave just as soon as they got their three-million-dollar contracts elsewhere. A whole new attitude toward working at Salomon Brothers was born: Hit and run.

  And that is how Salomon Brothers, and the mortgage trading desk in particular, became a nursery for the rest of Wall Street. Corporate, government, and mortgage traders streamed out of the place in ever-increasing numbers, to the point where, one day, a senior corporate bond salesman said he was thinking about moving to Merrill Lynch because he knew more people there. The mortgage department was hit the hardest by the phenomenon. From the point of view of other firms, Salomon mortgage traders were cheap at any price. They provided entry to an enormous market from which a firm was otherwise excluded. They were often paid, therefore, far more than they expected.

  The reductio ad absurdum of the phenomenon was Ron Dipasquale. In 1984, Dipasquale was, as one trader says, “a third-string mortgage trader.” He had moved out onto the trading desk from the back office and hadn’t much experience trading when Merrill Lynch called and offered him a million dollars a year guaranteed over two years. He was to be its new head of mortgage trading (he in fact preceded Rubin). While it is true that Dipasquale later distinguished himself as a trader, at the time he knew next to nothing. Merrill Lynch discovered its mistake about a week too late. Dipasquale had his contract in hand. He was given a seat in the back office of Merrill Lynch until his contract expired, whereupon he returned to a standing ovation at Salomon. Hail the conquering hero! Precious few traders were invited to return to Salomon after they had jumped ship, but Dipasquale was made an exception. His move, to his superiors, was a practical joke played on Merrill Lynch.

  Howie Rubin wasn’t a joke. The strangest thing about his departure was his reluctance. He claims he nearly turned down the Merrill Lynch offer. But once he had decided to accept, he didn’t dare turn up at Salomon Brothers to reveal his plans, for he knew how easily he could be persuaded to stay. He wanted to stay. He had hoped to have a career with Salomon Brothers. “I couldn’t have been happier there,” he says. What he loved most about the place, he says, is: “All you had to do was trade.” So instead of making an appearance, he telephoned Mortara, who suggested they meet for lunch at the South Street Seaport.

  Even mortgage traders couldn’t chose their moments of self-revelation. Rubin remembers crying as he spoke with Mortara and Kronthal, while they sat on the curb outside the seaport. “It was like leaving a family,” he says. Far from trying to persuad
e Rubin to remain at Salomon, his superiors made it clear they understood. Howie Rubin, quite simply, had been bought. From that fate no trader was immune. It could just as easily have happened to Mortara or Kronthal (though their price tags would have been higher). Mortara now says, “Look, I tried to be a good corporate citizen while I was there, but I think the people who participated in the development of the mortgage market were victims or at least severely penalized by the Salomon Brothers compensation system. Their pay was way out of line with their production.”

  It was an odd tragedy. All parties suffered, yet it was difficult to generate a whole lot of pity for any of them. The mortgage department had made a fortune in 1984, while the firm as a whole had not done well. The traders, therefore, were not paid according to what they produced. Considering their feelings about the rest of the firm (fuck ‘em!), the idea of having to nurse others inn bad years did not sit well. After Rubin’s departure, Tom Kendall, Steve Baum, and top salesman Rick Borden took the million dollars offered each of them by the Farmers Savings Bank in Davis, California. Steve Roth and a new mortgage trader named Andy Astrachan took million dollars, probably much more, offered Mike Milken at Drexel Burnham.

  All of a sudden three of the four most profitable mortgage traders were gone (Roth, Baum, and Rubin). The fourth was Andy Stone, who in 1984 had made seventy million dollars trading fifteen-year mortgages called, because of their short maturities, Midgets, Gnomes, and Dwarfs. In the middle of 1985 Stone received a call from Merrill Lynch, which offered to double his pay. Stone declined. “I thought I would be at Salomon until I was fifty years old,” he says. Like Rubin, he didn’t want to leave the mortgage department family. “Then Merrill asked me what it would take. They said everybody has his price,” he says. Assuming that Merrill would balk, Stone said his price was four times his 1984 paycheck. Instead “they said OK.” And so it was done. Stone had accepted a guarantee sweeter than Rubin’s, to join his buddy Howie as co-head of mortgage trading at Merrill Lynch. At that point Salomon Brothers panicked. Ranieri and Mortara asked Stone to reconsider his move over the weekend. Since they were like family, he did.