Diary of a Very Bad Year Chapter 8 - Time to Step Back
This is part of my series retelling Diary of a Very Bad Year. Today we’re covering Chapter VIII.
It’s July 2, 2009. The Dow sits at 8,280. Unemployment is at 9.5%. And HFM is doing something he hasn’t done in a decade. He’s going on vacation. A real one.
But before he leaves, he and the interviewer cover a lot of ground. Crime. Punishment. The death of investment banks. And why people who blow up billions still get hired.
Phone Booths of Rome
HFM’s last real vacation was in 1998. His girlfriend had an academic conference in Rome. He tagged along. Should have been great, right?
Nope. That was the week Russia got its IMF bailout and all hell broke loose. HFM had big positions in Russia. So his vacation in Rome turned into a tour of Roman phone booths. Calling the office from one payphone after another, trying to figure out what was happening to his trades.
His girlfriend wasn’t happy. His boss wasn’t happy. He wasn’t happy. The only winner was the hotel that got paid for a room he barely used.
After that, HFM swore off long vacations. His logic was simple: skip vacations now, retire earlier, relax then. He admits this was probably a bad strategy. Ten years later he’s burned out.
So now he’s taking a whole month off in July. He set up Microsoft Outlook rules to auto-delete most incoming emails. He told everyone to contact someone else. He’ll read the arts section and sports. That’s it.
150 Years for Bernie Madoff
The conversation shifts to Bernie Madoff, who just got sentenced to 150 years in prison. HFM’s take: “As an investor, I’ll take the under on that. He’s not Yoda.”
But the philosophical question behind the sentence is interesting. People at HFM’s desk debated it. Some said 150 years is way more than most murderers get. That’s true. But HFM points out that Madoff’s fraud destroyed trust at the exact moment trust was already in short supply. The damage was enormous and hard to measure.
And here’s the thing. Madoff had a perfectly good market-making business. He didn’t need to run a Ponzi scheme. He chose to. That makes it more twisted than a crime of passion.
HFM makes a sharp observation about how finance people judge punishment. It depends entirely on whether they can imagine themselves getting accused of something similar. Nobody in finance can imagine running a Ponzi scheme, so everyone says throw the book at Madoff. But when the Enron guys at Merrill got charged for helping set up shady accounting structures? Suddenly a lot of bankers got nervous. They’d done deals that looked a little like that. Their compliance departments approved those deals. And the line between “aggressive but legal” and “criminal” felt too thin for comfort.
That’s where you get the hatred for people like Eliot Spitzer, the former New York attorney general. Finance people felt he was criminalizing failure, going after things that looked too close to normal business.
Wall Street’s “Recovery”
The financial sector is making money again in mid-2009. But HFM is careful about what that actually means.
Goldman Sachs is hiring. Average compensation is $700,000. But HFM notes the mean is misleading. A few people make $10 or $50 million, and a bunch of people get normal salaries. The average tells you nothing useful.
And the profits aren’t coming from the same places that created the bubble. The old windfall businesses from 2005-2007 are gone. What’s happening now is that basic brokerage functions are profitable again because so much competition was wiped out. Spreads are wider because markets are volatile. It’s not a return to the old party. It’s a different business making money for different reasons.
HFM also says bluntly that a lot of pre-crisis GDP was an illusion. Financial sector profits were unsustainably high. Those paper profits reversed into huge losses. Going forward, GDP will be lower. Not just slower growth. A lower level, period. Easy credit had supercharged everything, and those customers who couldn’t really afford things are just gone.
The LTCM Cautionary Tale
The interviewer brings up Long-Term Capital Management, the famous hedge fund that blew up in 1998. HFM knows them well. His boss used to lecture the team about why they couldn’t produce LTCM-level returns. Then LTCM blew up and nobody mentioned them anymore.
The real story HFM wants to tell is about what happens after you blow up. John Meriwether founded LTCM. Before that, someone working under him at Salomon Brothers got the firm caught in a Treasury auction scandal. After LTCM collapsed, Meriwether started a new fund called JWM. That fund had some good years, then blew up again in 2008.
HFM’s frustration is clear: how many times do you get to blow up before you lose your license to manage money? The incentive structure is broken. Hedge fund managers get a big cut of the upside but it’s not their money on the downside. The only things that could fix this are either requiring managers to invest a lot of their own money, or having real penalties for spectacular failure.
Instead, what happens is the opposite. A guy blows up and someone hires him saying “he’s learned an expensive lesson” or “he’s proved he’s a risk-taker.” HFM’s response: yes, he’s proved he’s an irrational, crazy risk-taker.
He breaks down the ways people blow up. Some are writing flood insurance without realizing it. They make money most years, then a crisis hits and wipes them out. Some grow beyond their expertise and get into businesses they don’t understand. Some are just coin-flippers who got lucky.
And the top executives who get fired from failed banks? They golf. Or they go to private equity firms where their name opens doors for fundraising. Nobody’s crying for Jimmy Cayne playing bridge after Bear Stearns collapsed. Though HFM notes that many of these guys lost more than people think. Their compensation was mostly in stock that became worthless.
The Death of Investment Banks
The most striking part of this chapter is the roll call at the end. The interviewer reads a list of banks that gathered in 1998 for the LTCM bailout: Bankers Trust, Bear Stearns, Chase Manhattan, Goldman Sachs, J.P. Morgan, Lehman Brothers, Merrill Lynch, Morgan Stanley Dean Witter, Salomon Smith Barney.
HFM goes through them one by one. It’s brutal.
Bankers Trust got caught in a derivatives scandal, took losses in Russia, got bought by Deutsche Bank. Bear Stearns is now part of JPMorgan. Chase bought J.P. Morgan. Lehman? “There’s a smoking crater where Lehman Brothers used to be.” Merrill got bought by Bank of America in what their CEO called a shotgun wedding. Goldman and Morgan Stanley survived but converted to bank holding companies, which means they’re regulated like commercial banks now. Salomon was absorbed by Citigroup.
HFM’s conclusion: the pure investment bank doesn’t exist anymore. They’re either bought, blown up, or converted. It’s a fundamental change in how Wall Street works. These institutions had been around for generations. And in about a year, they all disappeared or transformed into something different.
Maybe new ones will form eventually. But for now, the era of the independent investment bank is over.
Previous: Chapter VII - Life After the Crisis
Next up: Chapter IX Part 1 - Farewell