How the 2008 Financial Crisis Changed Wall Street (The Big Short Companion Podcast from Against the Rules)

14:54Lidia Jean Kott:When we come back from the break, Matt Levine and I talk about another consequence of the financial crisis, Bitcoin.

15:08Lidia Jean Kott:I'm back with Bloomberg opinion columnist, Matt Levine. All right, so the first financial consequences is this kind of mini status revolution on Wall Street, where the people who were the top dogs are no longer the top dogs, because the risks moved out of those firms and into other places, and the status goes to where the risk is being taken.

15:28Michael Lewis:And that's a status revolution. It's also like substantively. You get a better financial model. I think so. It's debatable, but I think so. Yeah.

15:36Lidia Jean Kott:Well, what would be the other side? I mean, if you have Apollo and Aries and these places who have long-term funding against their long-term loans, that does seem like a more stable thing than what Goldman was doing or even what Citibank was doing.

15:51Michael Lewis:The main thing that you hear on the other side is that people call those shadow banks, right? Like the banks are very carefully supervised. Not always successfully, but there's a lot of - At least somebody's watching them. There's a regulator who's watching the bank and telling them, don't make that loan. That's too risky, right? Or like in theory, that's happening. With the private credit firms, they can kind of do what they want because they're much more lightly regulated because they don't have the crazy banking funding model, because they're not too big to fail, because their losses aren't socialized.

16:18Michael Lewis:And then, you know, people do worry that leverage is creeping back into the system because it has a habit of doing that, right? private credit firms do get leverage from banks. So it's kind of circulating back into the banking system. And when you move away from private credit, some of the stuff that banks used to do, I read about the basis trade, which is you buy treasury bonds and you sell treasury futures. And it's a very, very, very low risk trade because those are almost the same thing, but they're not quite the same thing. And so people lever that trade up 30 or 100 times. and that used to be a thing that banks do and now it's a thing that like you know the citadels and and millenniums of the world do and you know people definitely look around and say these things are much more lightly regulated than the old banks were and they're running at 100 times leverage that seems risky right like and there are occasions where the basis trade kind of blows up and you know there are academics saying the fed should have to step in when that happens and so So in the long run, you say that you socialize the risk when the banks blow up.

17:23Michael Lewis:But I'm not sure that was what people thought in 2006. I'm not sure people thought that JP Morgan and Citigroup had deposit insurance and Fed access and everything. But Morgan Stanley and Goldman and Lehman and Bayer were investment banks. They were kind of more lightly regulated things. And then it turns out that when they all blow up, the sort of rational thing to do is to socialize the losses, right? But that was not obvious. It's just what happened, right? And so you can imagine that happening again with, you know, if the big hedge funds that have become so central to the financial system find a way to blow themselves up, like, will those losses get socialized?

18:00Lidia Jean Kott:Maybe. When I asked you what the financial consequences are of the crisis and you said the big one you were focusing on was, I didn't think you were going to say what you did say. I thought you were going to say Bitcoin.

18:13Michael Lewis:Yeah, I mean, Bitcoin is, it's hard for me to know how directly Bitcoin is a consequence of the financial crisis. I mean, it's certainly the case that like the Bitcoin white paper references the financial crisis, that it seems like the pseudonymous Satoshi Nakamoto was, you know, upset by the leverage in the banking system and by the socialization of losses in the banking system and wanted a financial system that didn't look like that, that wasn't fractional reserve of banking that wasn't risky, that wasn't based on powerful intermediaries who got government support, but that was peer-to-peer and decentralized and safe.

18:53Michael Lewis:I think that resonated with a lot of people. There's a countercultural element to crypto and Bitcoin where people got into it in part because they didn't trust the banking system. I don't want to overstate that because crypto quickly replicated a lot of the elements of the levered fractional reserve risky financial system, as you well know, right? I mean, if you look at the career arc of Sam Bankman-Fried, like no part of what he was doing was a reaction to the risky financial system in traditional finance, right? Like everything he was doing was recreating that system with crypto.

19:30Lidia Jean Kott:One of the many ironies of crypto is that it seems to be born out of mistrust of institutions and intermediaries. And then it goes and recreates institutions and intermediaries. It requires even more trust than the thing that it's replacing.

19:43Michael Lewis:Because there's like, you know, a thousand people who like are like, oh, I love this thing because it doesn't, you know, replaces trust in intermediaries. And then there's like millions more people who are like, I like this thing because it went up. Right. And then that's like much more, you know, relevant. And then so then you have, you can build a system around that. And And so if people like it because it goes up, then like offer them leverage, right? Offer them a trusted intermediary. And so I think that there is this like cultural connection between crypto and mistrust in the financial system.

20:17Michael Lewis:But that is only a very small part of the actual phenomenon of crypto. The crypto winter that began in the summer before the fall of FTX and ended with the fall of FTX really recreates 2008. Really, beat for beat, this is what happens when you over-lever something. It stops going up, and so then there's nothing holding it up because it's super over-levered, and there's no regulation, and there's a lot of non-transparency about what is backing all of that leverage. I said to you at the beginning, I was not sophisticated enough to understand the risk that Goldman was in when I was at Goldman. I witnessed the financial crisis from inside of Goldman, but I didn't understand it because I was just working my job.

21:04Michael Lewis:But then as I became a financial journalist, I became more of a student of the 2008 crisis. It was so useful and interesting to watch the crypto crisis play out because it truly just relearned the lessons of 2008. And one thing you learn is that it's all the same thing, right? Like a financial crisis, they all look the same, right?

21:25Lidia Jean Kott:But a difference is that in the crypto crisis, that there is no government to come in. Oh, yeah.

21:31Michael Lewis:For a while, there was Sam Bankman free, right? I mean, it was truly like people in crypto were like, well, there's no government, there's no Fed, but there is FTX. Right. So there isn't that backstop. But also, the other big difference is that the reason there's that backstop in 2008 is that there is a widespread and I think pretty justified fear that like a collapse of you know the investment banks the banking system like that subsector of the economy could have like real consequences for the real economy because the banks are the lenders that kind of like you know juice economic growth like one day maybe crypto will be that important to the economy but It wasn't, it's not yet, right?

22:17Michael Lewis:So there's no government bailout because it didn't matter, right? Like all of crypto could go to zero and nothing outside of crypto would be affected by that. You think that's still true now? I think that is 90 % true now. I think that crypto people are working very, very hard to change that, right? I mean, you look at like the integration of stable coins into the traditional financial system. You look at, you know, the crypto treasury companies, like there's this race to integrate crypto into the real financial system. Some of that is because the more you integrate it into the real financial system, the more it goes up today.

22:49Michael Lewis:But some of it is like the more you integrate it into the real financial system, the better your odds of getting a bailout if something goes wrong. You could have like a broad view of crypto that's like crypto is finding the sort of last sucker to buy your crypto assets. And like the U.S. taxpayer being the last sucker is like a really good backstop.

23:08Lidia Jean Kott:That would be sarcasm in case you didn't pick up on it. When we return, we talk about the lessons we should have learned but didn't from 2008.

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26:22Lidia Jean Kott:What lessons do you think we should have learned from the financial crisis that maybe we didn't?

26:30Michael Lewis:I do think that – I have a very conventional view of what happened and what financial crises are, which is that it's short-term information-insensitive leverage on stuff that you think is safe is the dangerous thing, right?

26:46Lidia Jean Kott:Say that again in really plain English.

26:48Michael Lewis:the problem is when you, a bank, whoever, buys stuff that they think is pretty safe. They buy AAA rated mortgage bonds or whatever, right? And they're like, well, this stuff is really safe. So we can fund it by borrowing overnight against it. We can take bank deposits and use it to buy 30-year AAA mortgages because they're so safe. That is the source of all financial crises. Sometimes it's literally bank deposits. That's what a run on a bank is. But in 2008, it's mostly the Goldman's and Lehman's and Bears of the world who are not really taking bank deposits, but who are borrowing very short-term in capital markets.

27:36Michael Lewis:They're thinking, well, we have a big diversified pool of good assets. We're good traders. so it's pretty safe for us to borrow short-term to fund these long-term assets and then like you lose confidence and that short-term funding goes away you have to sell all your assets and you can't sell them or you can only sell them at deeply discounted prices and then you go from saying how great you are and how much money you're making to being bankrupt in hours you know or days like it's an extremely fast catastrophe so there is there is a distinction to be made

28:09Lidia Jean Kott:in this story between the case where the assets actually are safe and people are misperceiving them as unsafe and when they're actually not good at all and people are correct to think that they're not worth what you paid for them.

28:25Michael Lewis:But in the moment, it's very hard for you to, you can't really satisfy people that everything that you own is good. But so, right. The lesson to me is very straightforward, which is that runnable short-term debt is the thing that causes financial crises, can people take their money out? It's not the asset side. People worry a lot about risky stuff. Risky stuff is fine if everyone knows it's risky stuff. What's bad is when you're buying AAA stuff that you think is good that might really be good. What's bad is that there's mark-to-market losses and you have short-term funding and you get blown up.

29:02To me, the thing that the number one lesson to take away is worry

29:06Michael Lewis:about short-term funding. And I think regulators definitely took that lesson. And banks are now much more, we're hard to have much more capital. They have much more liquidity. They're much less short-term funded. But the crypto world didn't learn that lesson. And there are a lot of other places where, the reason the original banking crisis was the sort of successor to the financial crisis is that the original banks had short-term funding. I mean, they had deposits, right? I think people didn't appreciate, it, despite how obvious it seems, people didn't appreciate how short-term the funding of a regional bank actually was.

29:41Michael Lewis:But nowadays, people are much more worried about the asset side, and they're much more worried about, ooh, private credit is investing in risky stuff. And I think that's the wrong place to be looking.

29:52Lidia Jean Kott:If you're looking for the next crisis, where do you think the right place to look is?

29:54Michael Lewis:Oh, I don't know. I don't want to be a crisis monger. I do think that – I want to be clear. I'm not saying this is where the next crisis is. But I do think that the big hedge funds are really interesting, right? The big four, like the multi-strategy hedge funds. They do a lot of the businesses that banks used to do. They're very levered. And they have this profile of like, they're quite safe, right? They have high sharp ratios. They're good at steadily grinding out profits by doing highly levered trades where they're essentially getting paid to take the other side of the market and to provide liquidity to the market.

30:26Michael Lewis:They're very well risk managed. They're very smart. They are the places that train up the best risk takers now in a way that like 20 years ago, that was the banks, right? So all this stuff, like, I'm not saying they're going to have a crisis tomorrow. I'm saying like, that's where a crisis would be, right? They're huge. They're like, you know, they're central to the market. They're highly levered. And all these people, banks, hedge funds, everyone has learned, you know, they were at Goldman in 2007. Like they've learned these lessons, right? But you know, you keep turning the dial a little bit more towards risk and then like there's some chance of things going wrong.

30:59Lidia Jean Kott:Anything else pop to mind when I say financial consequences of the crisis? Consumer Financial Protection Bureau.

31:05Michael Lewis:I mean, that's over. I don't know. I would put that in the category. A broad sociological consequence of the financial crisis is that the big banks lost status. Now you can go to Congress and say, banks should not be able to charge overdraft fees. Everyone's like, oh yeah, those banks, they suck. It's easier to regulate banks just generally. Banks have less of an ability to get what they want. I think that is probably a consequence of the crisis. When you look at the CFPB's mandate, it has almost nothing to do with the financial crisis. There is this nexus of giving people mortgages they can't afford is both a bad consumer banking practice and a contributor to the financial crisis.

31:56Michael Lewis:That's an important overlap. But most of what the CFPB is doing is fining banks for doing things that probably improve the stability of the banking system by extracting money from consumers. The CFPB is a consequence of the crisis in the sense that people were mad at banks. And so it was a lot more tenable to do things to regulate or punish banks. But that just sort of ended for political reasons.

32:23Lidia Jean Kott:So I wanted to pick your brain on just this subject. And I think it sounds like I picked your brain clean, unless there's something else you would like to say.

32:30Michael Lewis:I'm a little interested in stable coins. I mean, like stable coins are sort of a way to take risk out of the financial system. Like instead of having your money at a bank, which could invest it in weird stuff, you have your money in this thing, a stable coin that basically invested in treasury bills, right? One thing that I write about a lot is that banking has become narrower. And what that means is that on the one hand, the institutions that do risky investing are now increasingly funded with long-term locked up equity type funding. So private credit firms raise equity to make loans rather than using deposits.

33:04Michael Lewis:And then on the other side this the like depository stuff is invested in safer shorter term stuff and so like classically that's money market funds where like you put money in money market fund they put it in like treasury bills you get interest and instead of them lending out your money long term they're just doing something very safe with it and increasingly like stable coins are becoming that right and so like this is like a crypto incursion into the traditional financial system but also people So a lot of people, politicians, crypto people really like it, right? Because it does seem like a safer and more direct way to hold your money than holding it in a bank, which might be making, you know, buying mortgage scaries with it.

33:45Michael Lewis:I will tell you who doesn't like it. My impression is that who doesn't like it is the Fed, right? Because like the Fed likes the traditional banking system, right? They like the ability to transmit monetary policy through bank reserves, right? There is this worry that we're undermining the banking system by moving a lot of what would have been deposits into something else, money market funds and stable coins. There's an article at Bloomberg about how stable coins are potentially an existential threat to regional banks. Because regional banks, they get deposits from companies depositing your paycheck, and then they use that to like run their business making loans.

34:25Michael Lewis:And if stable coins become a good payment mechanism and companies just say, I'll give you a stable coin instead of like a direct deposit in your bank account, then like JP Morgan will be fine. Like they'll do a stable coin. It'll be fine. Right. But like a lot of regional banks are going to have trouble because the banking system for so long was the sort of sleight of hand of like, we take deposits that you think are super safe and we use them to make risky investments. And if that's going away, then it's an existential crisis for some number of banks. And is that going away because of 2008? Like a little bit.

34:58Michael Lewis:You can draw that line, right? Like the mistrust in the banks and like the understanding that banks take risks with your money, like it was sort of like, you know, brought back to the forefront by the 2008 crisis. And so some of like the stablecoin stuff and the narrower banking stuff really is downstream of that. I mean, I had never heard of the term narrow banking until 2008, right? Like it became a thing after 2008. People said, this whole system of we take short-term money and we use it to make risky bets just became a lot more suspicious.

35:29Lidia Jean Kott:Can you imagine a world where there are no banks?

35:32Michael Lewis:People imagine a world where there are no banks all the time. I mean, not exactly. They imagine a world where your deposits live in stable coins, in treasury bills, in reserves at the Fed, in US dollar digital currency where you don't have to have a bank. The Fed keeps track of your account for you. And then how do you get a mortgage? Well, a lending club gives you a mortgage or a private credit firm gives you a mortgage or an insurance company gives you a mortgage. Apollo gives you a mortgage. One thing that Apollo does is they run annuities. And an annuity is like, we'll give you a fixed cashflow for 30 years.

36:10Michael Lewis:That's the other side of a mortgage. It makes total sense for Apollo to say, we're going to make mortgages on one side and we're going to do annuitism on the other side and they're going to cross perfectly. I think it's pretty easy to imagine a world without banks. It's very hard to imagine the transition. To go from the world of banks to a world without banks would be really difficult for a lot of people.

36:31Lidia Jean Kott:But if it happens and if that's the path we're on and that narrow banking is just a step on the path to no banks, people will tell the story how it all may have kind of just started with the financial crisis.

36:43Michael Lewis:I think if that happened, I put a very low probability of that happening. But if it happened, yes, I think clearly the financial crisis would be the great catalyst for it. Because like, by the way, I mentioned stable coins, like stable coins grow out of Bitcoin, right? Bitcoin grows out of the financial crisis, right? Like the sort of like great flourishing of mistrust in the financial system can lead to a lot of consequences. And I think we're like, you know, partly down the road to those consequences.

37:05Lidia Jean Kott:That was Bloomberg Opinion columnist Matt Levine. Next week, we're wrapping up this Big Short Companion series by talking with two people whose political careers got their starts with the financial crisis. Because the crisis changed more than just finance. It changed politics, too.

37:27Matt Levine:Against the Rules, the Big Short Companion is hosted by Michael Lewis. It's produced by me, Lurie Jean Cott, and Catherine Girardot. Our editor is Julia Barton. Our theme was composed by Nick Bertel. And our engineer is Hans Dale Shi. Special thanks to Nicole Optenbosch, Jasmine Faustino, Pamela Lawrence, and the rest of the Pushkin Audiobooks team. Against the Rules is a production of Pushkin Industries. To find more Pushkin podcasts, listen on the iHeartRadio app, Apple Podcasts, or wherever you listen to podcasts. And if you'd like to listen ad-free and learn about other exclusive offerings, don't forget to sign up for a Pushkin Plus subscription at pushkin.fm slash plus or on our Apple show page.

38:16Matt Levine:And you can get the big short now at pushkin.fm slash audiobooks or wherever audiobooks are sold.

38:32Lidia Jean Kott:Every Sunday we cover the latest tech news on This Week in Tech. Hi, this is Leo Laporte inviting you to join me. And this week's panel, Gary Rivlin, Pulitzer Prize winning author of AI Valley. Molly White, Wikipedia editor and the creator of Web3 is going just great. And car guy Sam Abul Samet. Sam has some opinions on the brand new Ferrari Luce. Molly's mom has some opinions on Google's new search page, and Gary has some thoughts about the Pope. That and more this week on Twit. You'll find it at twit.tv and wherever you get your podcasts. The right window treatments change everything. Your sleep, your privacy, the way every room looks and feels.

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