Steve Eisman: We are delighted to bring you this bonus podcast with the legendary Steve Eisman, portrayed in The Big Short as one of the early identifiers of trouble in the mortgage market in the run-up to the great financial crisis. I sat down with him in a live session late last month to discuss reflections on the last crisis, thoughts on what might be a current one, and what it means to be portrayed by Steve Carell on screen. Please enjoy my conversation with Steve Eisman.
Steve: Welcome, Steve. We are delighted to have you. I saw you speak at a panel, a fireside chat at a recent RIA forum, and was intrigued by not only your insights from your time navigating the financial crisis and its depiction, infamously or famously in the Michael Lewis Big Short movie. And there was a lot of discussion of that, but I was even more intrigued by what that experience has taught you and the insights it’s given you into today’s situation when at least if the pundits had it right, we would’ve been facing a similar recession by now, but yet we have not. So what I’d love to do, we’ve got about 20, 25 minutes of your time and we will have time for questions if anyone has any. I just wanna take you through a few questions that you’ve already seen and we will end with asking you a little bit about whether the movie made any impact on your life or not, so we don’t have to go into that from the very beginning. So first of all, can you just give us a minute on your origins, how you started out in finance and how that took you both to shorting CDOs but to the place we are today?
Speaker C: Well, I was a lawyer a very, very long time ago, and I was a terrible one because I’m not a detail-oriented person, and I was a corporate lawyer. And unbeknownst to me, that the best thing you can have as a characteristic to be a good corporate lawyer is to be detail-oriented. So I was a round peg in a square hole. So I managed to get a job as a junior analyst at Oppenheimer on the sell side. Eventually I got promoted to being the financial services analyst there. I did that from ’92 through 2000. It was a wonderful experience to learn about everything. One of the groups that I actually covered ironically back then was the first generation of subprime mortgage companies. I don’t know if anybody here remembers a company called The Money Store. That was one of them. And ’98, for reasons that are not important, they almost all went bankrupt. And people like to say, “Oh, Steve, you’re such a genius. You saw it coming.” I don’t know about that, but I was a little bit better prepared than everybody else because in 2002, when the second generation of subprime mortgage companies came public, They were basically all run by the same guys, and I mean guys, and same guys. And I figured, you know what, this is a tragedy in 3 acts. I’ve already seen the 3 acts. This is just Act 1. Wake me up when Act 3 is coming and, and we’ll talk. So it wasn’t so much that I predicted it, as I like to say, I was waiting for it. Now, when I had these thoughts occur to me, I I didn’t, didn’t realize how big the industry was going to become. By 2006 and ’07, that was the shocking part that I didn’t foresee. So when I knew it was going to blow up, it had gotten to such a size, I realized that the ramifications of it for literally planet Earth were a lot bigger than I could ever have imagined.
Steve: And just before we get into the drama of that whole breakdown, so just in terms of your family origins are interesting. So both your parents were brokers, which may have been unusual back then for both mother and the father to have been brokers. Would you say growing up discussing stocks around the table, discussing investments around the table, did that influence your investment approach, your investment beliefs, maybe tolerance of risk at all?
Speaker C: Probably did. I mean, all that risk that maybe some people would find difficult to deal with, I sort of grew up with. So, you know, some people might think that’s abnormal, but to me it was normal. So, you know, my tolerance for that type of stuff is just probably better than most just because I grew up in that type of environment.
Steve: So moving then to the CDO short opportunity in ’08, you mentioned having seen some of this play out before, but what was it that you think led you to see something that others hadn’t besides this prior financial experience? And how did that play out? And how much pain did you have to stomach before realizing that you were right?
Speaker C: Well, the way I got into the whole ABS CDO short was just that on the equity side, we were short a whole bunch of subprime mortgage companies. They were relatively small. The cost of borrow was exorbitant. They were extremely illiquid. In some cases, the cost of borrow was 20%. I’m not even exaggerating. And they were very illiquid and you couldn’t even get size. So we were looking for other ways to do it. Then when we realized that by shorting the lowest of the stack on a securitization, you were in effect almost— you were kind of shorting the equity itself, but the cost was only 3% as opposed to 20%, that this was a way you could really do something that you really believed in and in size. And that’s why we did that.
Steve: And maybe then walk us through a little bit of those months, those days.
Speaker C: Well, let me first— you asked a question about how long did you have to wait? You know, in our business, as you know, being too early is the equivalent of being wrong. And there’s certainly been many times in my career where I’ve been too early. This was one time in my life my timing was impeccable. I only began doing this at the tail end of 2006. The thing really began to fall apart at the beginning of 2007. Maybe I waited 3 months. It wasn’t exactly a lot of pain.
Steve: And of course, we can all go back now and watch the movie and watch the dramatization. But how accurate do you think that depiction was in terms of your position versus the crowd, people getting on board? What was that period like? Were you the lone trader or a bandwagon effect?
Speaker C: Well, there were a few members of what I like to call the financial services hedge fund mafia that were involved, but very few. The whole fixed income world thought I was crazy. I remember I had a— this is a wonderful meeting. I had a meeting with the head of Assetback Research at Bear Stearns came into our office and he was positive, we were negative. And I said, “Okay, just please explain to me why you’re positive.” And he says, “Well, since World War II, housing prices in the United States have never gone down on a national basis.” And I said to him, “Is that like a law of physics or maybe an accident of history?” And he basically thought it was almost a law of physics. And people just, they were so used to making so much money in fixed income world in this product, it was just unimaginable to them that it could ever change. It also helped me that I hated these companies. I thought they were doing things to people that was so socially detrimental, it was borderline evil, and I wanted them to fail. So there were a lot of reasons why I was really all in. Investing can be emotional at times.
Steve: So did you realize great joy? Then to witness their demise. How did that play out as a—.
Speaker C: Well, let’s talk about 2 years. So in 2007, where most of this played out on the fixed income side, that was joy. In 2008, when planet Earth almost burned, the analogy I like to draw is Noah, as in the Noah. So when Noah builds the ark and it starts to downpour, and his family is safe, but people are screaming and drowning outside. Noah’s content that he’s safe, but he’s not happy people are dying. That’s what 2008 felt like to me.
Steve: And then the aftermath. Did you participate in the ’09 rally and the aftermath? What was that like?
Speaker C: We did. I mean, not as much as the market, but we did. We turned probably around April, which was probably about a month late. We did pretty well that year. The funny thing about ’09 was in 2009, this is pre-Dodd-Frank, pre-new regulations for the banks. So the Fed’s pumping in tons of money, fixed income trading is huge, and Wall Street has basically a last hurrah. 2009 was the last time, in my view, that traditional financial companies had any important role in the markets. Today, they’re basically just utilities to me.
Steve: Okay, so let’s talk then about today and where we have got to, I suppose, because this clearly, you know, things have changed in terms of the landscape of financial services. But yet we still had the specter of the regional banks and SVB and First Republic, etc. So what is your take on that? Are we fighting the last war? We’re trying to fight a weight’s war and not taking our eye off the risks that are there today.
Speaker C: So let’s backtrack for a second. So in the last several decades, there have been several what you— I would call debacles. There was long-term capital, there was a financial crisis, there was a couple of others, and then Silicon Valley. And every time the people who were involved, who were about to lose a lot of money, start screaming and yelling, please Federal Reserve, bail us out because otherwise the world’s going to end. Now, that was true in ’08, but it wasn’t true any other time. Silicon Valley is a regional bank. It’s not a small regional bank, but it’s not a systemic issue. I would not have done what the Federal Reserve did. I would’ve done a variation of it. I would’ve let Silicon Valley collapse. I would’ve let the depositors eat it because after all, they’re masters of the universe, venture capitalists. They don’t believe in regulation. And now, the first time that they’re in trouble, they say, “Please bail us out.” I wouldn’t have bailed them out. I would’ve, however, guaranteed deposits of everybody else. That way you would’ve avoided moral hazard and shown that people will suffer pain. But obviously nobody called me, so they didn’t do that, as I like to joke. Believe me, nobody ever calls me, not that I ever expect them to. And what I would say about the new regulations, it’s an example of what I like to call the generals fighting the last war. War. So what was the problem in ’08? The problem in ’08 was too much leverage and too much risky stuff on the balance sheet. And so Daniel Tarullo, who became Vice Chairman of Financial Supervision, did 3 things. He reduced leverage of the banks by more than half. He made them reduce, call it cut off the tails of risk of the stuff that they did. So the balance sheets, even within the leverage, were less risky. And then for the large banks, and he could only do this for the large bank, he created massive liquidity requirements, meaning you had to have an unbelievable percentage of your assets in very short-term treasuries. And those are the 3 things he did. Now, unfortunately for the Silicon Valleys of the world, those liquidity requirements did not apply to them because they were below the threshold. So, one of the reasons why the large banks that not buy a lot of long-term bonds, not that they didn’t buy any, but just not that much relative to their size. They didn’t buy a lot of long-term treasuries was because they couldn’t. They had to have too much of their liquidity in short-term instruments. They didn’t have the ability to do that. Those rules didn’t apply to Silicon Valley. They bought a whole bunch of long-term bonds. They were underwater, and their depositors fled because they were all basically all the same depositors. They were venture capitalists who couldn’t raise money anymore. They had to pull money out of the bank. If that’s the problem, then the solution isn’t really more capital, because God knows the banks have plenty of capital. The solution is impose the liquidity requirements that you’ve imposed on the large banks onto all the other banks. That’s the obvious solution. But for whatever reason, they didn’t do that. And so now they’re increasing the capital requirements of the large banks and the midsize banks. It’s not even clear at this point that they will impose harsher liquidity requirements on the midsize banks. So again, it’s an example of the generals fighting the last war, but because of that, it makes the whole sector uninvestable.
Steve: The whole financial sector uninvestable.
Speaker C: What I would call traditional banks, the traditional parts of the— I’m not talking Visa and MasterCard, obviously. Visa’s fine. I’m talking about traditional Bank of America, Goldman Sachs, Morgan Stanley, M&T Bank, all those institutions that people have in the past liked to own, you can’t own. It’s pointless.
Steve: So let’s look at lessons learned, positive lessons learned from that crisis, but, you know, maybe more swift intervention where it really matters and where it’s the right kind of intervention and maybe lessons that haven’t been learned. And part of that, what are the laws of physics today that people think are now just a truism that maybe need to be questioned? Some conventional wisdom, maybe it’s tech now, Where we think it’s a low— Well.
Speaker C: I still think there’s less of this because Amazon, Google, Meta have been such unbelievable companies. People are constantly searching for the next one. And so when something that goes public that’s sexy, that has very high revenue growth but no earnings, people say, aha, this is it, pile in. And you know, but how many Googles and Metas and Nvidias of the world really are there? Who makes it to the finish line? Not that many. Most fail. So you get this enormous volatility in these, I would call hypergrowth companies because they treat it like a lottery ticket until it’s not a lottery ticket. That’s where there’s some interesting investing opportunities show up because when it becomes clear that it’s not necessarily a lottery ticket, but maybe it’s a real business like solar, for example. So solar, if you go back, 2 years ago. We’ll just pick on one company, Enphase. So Enphase, I remember at some point during COVID was about 80, and then solar became this incredibly hot space. It was treated like tech, tech, tech, tech, tech. It’s all you need to know. Growth, growth, growth, growth, growth. And it went to over 300 and now it’s 120. And why is it 120? Part of the reason is that Enphase sells components for residential solar panels, which is a fine business. But most individual people, when they put a solar panel and a battery on their roof, finance it. Well, when rates are zero, easy to finance. When it’s going to cost you now 8 to 9% to finance, not so easy to finance. So all of a sudden, an industry that saw very high revenue growth for years is actually experiencing, dare I say it, Negative revenue growth. Shocking. Now, that doesn’t mean it’s not a real business. There is a real business over the next several years in the whole solar space, which is something that I’m pretty involved with. But I don’t have to worry that there are raving lunatics in the stock who are hoping that the stock’s going to go from 10 to 3,000 in a day. This is where you get to do real homework and do some real valuation analysis and meet the companies and beat the crap out of them. You can eliminate the crap part of the REIT podcast. Actually, don’t leave it. It’s kind of funny. But you get my point. This is where real investing starts to come in. So I enjoy that.
Steve: And let’s take that to the broader infrastructure sector, because just to give you some context, we have been adding infrastructure into our model portfolios now for about 18 months, 2 years. Some of it was an inflation hedge. Some of it was a pure diversifier. Some of it was to get away from the pure MLP allocation. To just have a broader— MLPs.
Speaker C: I get a migraine when someone says the word MLPs.
Steve: Well, tell us why, because we’re aligned in that respect. But, you know.
Speaker C: I ran my last financial services hedge fund and ended in 2014, and I joined Newberger. And at the time, Newberger, for reasons that are not important, there are a lot of PMs that had a lot of positions in energy and MLPs. So I started to do a lot of work on MLPs. I started to realize this is a very weird animal because you’ve got a GP often who’s public and you’ve got an MLP that’s also public and it’s run by the same people. GP and the MLP are run by the same people. Whatever money the MLP makes, the GP takes a 50% scrape. I remember— and they’re very levered, The corporate structure is bad and the dividend coverage wasn’t great. I remember I called a friend, a sell-side analyst who I was friendly with who covered the space. I said to him, “Let me ask you something. How many stocks do you cover?” He said, “Six.” I said, “If you had a clean sheet of paper and you could create the perfect MLP GP situation, leave aside whether the tax documents and stuff, what would the structure look like? Forget about who has the best pipes.” He says, “Well, no GP, MLP. It would just be one.” He said, “The coverage of the dividend, the dividend would be, let’s say, half the cash flow and debt-to-EBITDA would be less than 4.” He had a whole list of things of that would be the perfect company. I said, “How many companies do you cover?” He said, “60.” “How many does that apply to?” He said, “2.” Now, the industry’s better now, but back then they were kind of crazy. I remember In 2016, when the group collapsed, there was an MLP GP group that came in. The dividend yield was 12% at the time. And I swear to God, it’s 2016. I could tell you where I sat in the room. This was a seminal moment for me on this group. And they came in and they were talking about how they were going to be spending less on building pipes because cost of capital is higher. And so I raised my hand, I said to the CEO, Your dividend yield is 12%, but your GP takes a 50% scrape of your earnings. So really, your cost of capital is not 12%, it’s 24%. What pipe on planet Earth could you build that would give you an IRR in excess of 24%? And he looks at me and he goes, he just starts to mumble. I’m thinking, this guy’s off his rocker. Clearly, the problem was these guys were just incentivized to build. That’s how they were paid. One of my favorite sentences that I ever made up— I have a few gems, but only a few. One is incentives trump ethics every time. That was really the problem with the MLP group. Now, it’s a different group today. It’s mostly corporations and a lot of it’s different, so it’s investible. Back then, it was an appalling structure.
Steve: We’ve only got a few minutes left, but you like infrastructure today. You mentioned solar. What else would be the maybe 3 big reasons why you like infrastructure as an asset class today? And what do we expect it for? Yield or just for good diversifying solid returns?
Speaker C: I’m not looking for yield. I’m looking for very good, maybe I think much better than solid returns. I’m actually looking for revaluation. You’re talking about $1.2 trillion of money that’s going to be spent by the federal government on greenification, on shoring, various parts of energy tax credits, wind, solar. It’s got a lot of tentacles to it. It goes from companies that design highways to traditional industrial companies, to aggregates, cement, to some sexy things in tech, to some greenification things. Solar is completely out of favor right now, but I think sometime next year will be become very reinvestible again. Anybody wants to follow up, we can talk. And then there’s the, what I call the newfangled toy decarbonization, which is very much in its infancy. I think this is gonna be a very, very, very exciting story for 10 years, probably a very solid investible story for 5 to 7.
Steve: And I know you’re not a macro strategist, but where do you think we are in terms of the interest rate cycle? And going from here, recession, no recession, soft landing, hard landing, election year coming up. How do you see the market conditions playing out based on having seen a few cycles yourself already?
Speaker C: Well, let me have a little humility here. I mean, one of the reasons why I was prescient in 2007 and ’08 is because back then one of my real areas of expertise was analyzing loan credit quality. And I’m very data-driven, and there was sufficient data out there to see that consumer credit was imploding, and that was going to have a major impact on the economy. I wasn’t looking at interest rates. I wasn’t looking at PPI, CPI, ISM. I wasn’t involved. I was focusing on this one data point, 70% of the US economy is consumer. The consumer is going to implode. End of story. Now, it’s much, much more complicated. The consumer’s in very good shape. People have jobs. Whatever layoffs we’ve seen is at the high end in terms of tech and Wall Street. It’s not General Motors, people are trying to get a 30% raise. This is like the revenge of the middle class versus 2008 and ’09. At this point, I can’t— look, I’m not an economist. I can’t see a recession where everybody has jobs. It’s hard to imagine at this point. And sometimes you read in the paper that consumer credit quality is beginning to deteriorate. That’s fair, but consumer credit quality has never been this good in anyone’s life. Lifetime. So when you’re coming across delinquency and loss levels that are what I would call subterranean, the fact that they’re starting to normalize is hardly something to be crying about. So look, it’s pretty amazing that the Fed has raised rates this much and the economy hasn’t slowed yet. Maybe that’s partially due to the fiscal stimulus. I’m not sure. My answer to your question is everybody should have a little be a little humble about this so far, because so far everybody’s been wrong, and some people have been wrong in multiple directions.
Steve: I think your dad’s quote you shared with us in the pre-meeting was, what, “Peacock today, feather duster tomorrow.”.
Speaker C: Yes, and my addition to his quote was, he said, “Peacock today, feather duster tomorrow,” and then my addition is, “And hopefully peacock again.”.
Steve: Phoenix from the ashes. The silly question around The Big Short, did that make a difference in your life? A little bit more high profile.
Speaker C: One thing that I really enjoyed was I, after the movie, I hired an agency to get me speeches all over the world. This was a really good gig. You know, they paid me a little money, they paid for my travel. I got to go all over the place, see the world, make speeches. People would, you know, I’m a pretty good public speaker, hopefully, as you could all see, and people would give me a nice round of applause, and that was really enjoyable. And I’ve gotten to speak at a lot of colleges, which has been a really enjoyable thing. I’ve mentored some people. I’ll brag here a little bit. During COVID I was out on the North Fork on Long Island, and there was a young man who had just graduated from college. He couldn’t get a job because obviously it was COVID. He was the guy who gave you the tee time at the public golf course that I played on. So I said to him, listen, if you’re interested, I’ll teach you. I’ll teach you how to do Wall Street. So I taught him for a year. He’s at JPMorgan now. So that was a thrill.
Steve: And what is it, just as a closing then, what would be those takeaways you share when you’re doing a college, say, I don’t know if it’s a commencement ceremony or what type of a ceremony, but what would be the things you would want a college graduate to know? Maybe one who wants to go into Wall Street or not?
Speaker C: So I’ve gotten that question a lot. And what I always say is that Warren Buffett likes to say, pursue your passion. I actually disagree with that to a degree. The reason why I disagree with it is, listen, your passion could be opera, but if you can’t sing, you ain’t getting the job. My theory is pursue your aptitude. What I mean by that is, I mean, I remember in high school, I was half decent at most subjects, but no genius. I had friends who were geniuses in history and English, but couldn’t add. Then I had friends who were geniuses in sciences and math, but could write a sentence. It had nothing to do with intelligence. It had to do with what they were naturally gifted at. Everybody’s different. So, you know what I tell people who want to pursue any career, whether it’s Wall Street, figure out what your aptitude is. Are you an idea generator? Are you a detail-oriented person? Are you comfortable with math? Are you more comfortable with stories? There’s a whole list. There are online tests you could take to figure it out. Are you empathetic? Are you not empathetic? Are you personable so you could be an investment banker, or do you not like to talk to people so don’t be an investment banker? Try and pursue the career, whether it’s Wall Street or not, that uses your aptitude strengths as opposed to your aptitude weaknesses. Because if you go into a career where you’re weak in all the aptitudes that require success in that career, you’re going to leave banging your head against the wall. And it’s not because you’re not smart, it just doesn’t come naturally to you. That’s what I tell anybody who asks.
Steve: Well, Steve, thank you for the reminder around the humbling effect of markets. It’s something we feel every day. I’d like the audience to know that there was no money changed hands for the speech, that you were gracious to answer my request to come here and speak with us. I hope you’ll do it again.
Speaker C: As you can see, we had— I’d be happy to.
Steve Eisman: This podcast is for informational purposes only and should not be construed as investment advice, and all views are personal and should not be attributed to the organizations and affiliations of the host or any guest.
Steve Eisman: We are delighted to bring you this bonus podcast with the legendary Steve Eisman, portrayed in The Big Short as one of the early identifiers of trouble in the mortgage market in the run-up to the great financial crisis. I sat down with him in a live session late last month to discuss reflections on the last crisis, thoughts on what might be a current one, and what it means to be portrayed by Steve Carell on screen. Please enjoy my conversation with Steve Eisman.
Steve: Welcome, Steve. We are delighted to have you. I saw you speak at a panel, a fireside chat at a recent RIA forum, and was intrigued by not only your insights from your time navigating the financial crisis and its depiction, infamously or famously in the Michael Lewis Big Short movie. And there was a lot of discussion of that, but I was even more intrigued by what that experience has taught you and the insights it’s given you into today’s situation when at least if the pundits had it right, we would’ve been facing a similar recession by now, but yet we have not. So what I’d love to do, we’ve got about 20, 25 minutes of your time and we will have time for questions if anyone has any. I just wanna take you through a few questions that you’ve already seen and we will end with asking you a little bit about whether the movie made any impact on your life or not, so we don’t have to go into that from the very beginning. So first of all, can you just give us a minute on your origins, how you started out in finance and how that took you both to shorting CDOs but to the place we are today?
Speaker C: Well, I was a lawyer a very, very long time ago, and I was a terrible one because I’m not a detail-oriented person, and I was a corporate lawyer. And unbeknownst to me, that the best thing you can have as a characteristic to be a good corporate lawyer is to be detail-oriented. So I was a round peg in a square hole. So I managed to get a job as a junior analyst at Oppenheimer on the sell side. Eventually I got promoted to being the financial services analyst there. I did that from ’92 through 2000. It was a wonderful experience to learn about everything. One of the groups that I actually covered ironically back then was the first generation of subprime mortgage companies. I don’t know if anybody here remembers a company called The Money Store. That was one of them. And ’98, for reasons that are not important, they almost all went bankrupt. And people like to say, “Oh, Steve, you’re such a genius. You saw it coming.” I don’t know about that, but I was a little bit better prepared than everybody else because in 2002, when the second generation of subprime mortgage companies came public, They were basically all run by the same guys, and I mean guys, and same guys. And I figured, you know what, this is a tragedy in 3 acts. I’ve already seen the 3 acts. This is just Act 1. Wake me up when Act 3 is coming and, and we’ll talk. So it wasn’t so much that I predicted it, as I like to say, I was waiting for it. Now, when I had these thoughts occur to me, I I didn’t, didn’t realize how big the industry was going to become. By 2006 and ’07, that was the shocking part that I didn’t foresee. So when I knew it was going to blow up, it had gotten to such a size, I realized that the ramifications of it for literally planet Earth were a lot bigger than I could ever have imagined.
Steve: And just before we get into the drama of that whole breakdown, so just in terms of your family origins are interesting. So both your parents were brokers, which may have been unusual back then for both mother and the father to have been brokers. Would you say growing up discussing stocks around the table, discussing investments around the table, did that influence your investment approach, your investment beliefs, maybe tolerance of risk at all?
Speaker C: Probably did. I mean, all that risk that maybe some people would find difficult to deal with, I sort of grew up with. So, you know, some people might think that’s abnormal, but to me it was normal. So, you know, my tolerance for that type of stuff is just probably better than most just because I grew up in that type of environment.
Steve: So moving then to the CDO short opportunity in ’08, you mentioned having seen some of this play out before, but what was it that you think led you to see something that others hadn’t besides this prior financial experience? And how did that play out? And how much pain did you have to stomach before realizing that you were right?
Speaker C: Well, the way I got into the whole ABS CDO short was just that on the equity side, we were short a whole bunch of subprime mortgage companies. They were relatively small. The cost of borrow was exorbitant. They were extremely illiquid. In some cases, the cost of borrow was 20%. I’m not even exaggerating. And they were very illiquid and you couldn’t even get size. So we were looking for other ways to do it. Then when we realized that by shorting the lowest of the stack on a securitization, you were in effect almost— you were kind of shorting the equity itself, but the cost was only 3% as opposed to 20%, that this was a way you could really do something that you really believed in and in size. And that’s why we did that.
Steve: And maybe then walk us through a little bit of those months, those days.
Speaker C: Well, let me first— you asked a question about how long did you have to wait? You know, in our business, as you know, being too early is the equivalent of being wrong. And there’s certainly been many times in my career where I’ve been too early. This was one time in my life my timing was impeccable. I only began doing this at the tail end of 2006. The thing really began to fall apart at the beginning of 2007. Maybe I waited 3 months. It wasn’t exactly a lot of pain.
Steve: And of course, we can all go back now and watch the movie and watch the dramatization. But how accurate do you think that depiction was in terms of your position versus the crowd, people getting on board? What was that period like? Were you the lone trader or a bandwagon effect?
Speaker C: Well, there were a few members of what I like to call the financial services hedge fund mafia that were involved, but very few. The whole fixed income world thought I was crazy. I remember I had a— this is a wonderful meeting. I had a meeting with the head of Assetback Research at Bear Stearns came into our office and he was positive, we were negative. And I said, “Okay, just please explain to me why you’re positive.” And he says, “Well, since World War II, housing prices in the United States have never gone down on a national basis.” And I said to him, “Is that like a law of physics or maybe an accident of history?” And he basically thought it was almost a law of physics. And people just, they were so used to making so much money in fixed income world in this product, it was just unimaginable to them that it could ever change. It also helped me that I hated these companies. I thought they were doing things to people that was so socially detrimental, it was borderline evil, and I wanted them to fail. So there were a lot of reasons why I was really all in. Investing can be emotional at times.
Steve: So did you realize great joy? Then to witness their demise. How did that play out as a—.
Speaker C: Well, let’s talk about 2 years. So in 2007, where most of this played out on the fixed income side, that was joy. In 2008, when planet Earth almost burned, the analogy I like to draw is Noah, as in the Noah. So when Noah builds the ark and it starts to downpour, and his family is safe, but people are screaming and drowning outside. Noah’s content that he’s safe, but he’s not happy people are dying. That’s what 2008 felt like to me.
Steve: And then the aftermath. Did you participate in the ’09 rally and the aftermath? What was that like?
Speaker C: We did. I mean, not as much as the market, but we did. We turned probably around April, which was probably about a month late. We did pretty well that year. The funny thing about ’09 was in 2009, this is pre-Dodd-Frank, pre-new regulations for the banks. So the Fed’s pumping in tons of money, fixed income trading is huge, and Wall Street has basically a last hurrah. 2009 was the last time, in my view, that traditional financial companies had any important role in the markets. Today, they’re basically just utilities to me.
Steve: Okay, so let’s talk then about today and where we have got to, I suppose, because this clearly, you know, things have changed in terms of the landscape of financial services. But yet we still had the specter of the regional banks and SVB and First Republic, etc. So what is your take on that? Are we fighting the last war? We’re trying to fight a weight’s war and not taking our eye off the risks that are there today.
Speaker C: So let’s backtrack for a second. So in the last several decades, there have been several what you— I would call debacles. There was long-term capital, there was a financial crisis, there was a couple of others, and then Silicon Valley. And every time the people who were involved, who were about to lose a lot of money, start screaming and yelling, please Federal Reserve, bail us out because otherwise the world’s going to end. Now, that was true in ’08, but it wasn’t true any other time. Silicon Valley is a regional bank. It’s not a small regional bank, but it’s not a systemic issue. I would not have done what the Federal Reserve did. I would’ve done a variation of it. I would’ve let Silicon Valley collapse. I would’ve let the depositors eat it because after all, they’re masters of the universe, venture capitalists. They don’t believe in regulation. And now, the first time that they’re in trouble, they say, “Please bail us out.” I wouldn’t have bailed them out. I would’ve, however, guaranteed deposits of everybody else. That way you would’ve avoided moral hazard and shown that people will suffer pain. But obviously nobody called me, so they didn’t do that, as I like to joke. Believe me, nobody ever calls me, not that I ever expect them to. And what I would say about the new regulations, it’s an example of what I like to call the generals fighting the last war. War. So what was the problem in ’08? The problem in ’08 was too much leverage and too much risky stuff on the balance sheet. And so Daniel Tarullo, who became Vice Chairman of Financial Supervision, did 3 things. He reduced leverage of the banks by more than half. He made them reduce, call it cut off the tails of risk of the stuff that they did. So the balance sheets, even within the leverage, were less risky. And then for the large banks, and he could only do this for the large bank, he created massive liquidity requirements, meaning you had to have an unbelievable percentage of your assets in very short-term treasuries. And those are the 3 things he did. Now, unfortunately for the Silicon Valleys of the world, those liquidity requirements did not apply to them because they were below the threshold. So, one of the reasons why the large banks that not buy a lot of long-term bonds, not that they didn’t buy any, but just not that much relative to their size. They didn’t buy a lot of long-term treasuries was because they couldn’t. They had to have too much of their liquidity in short-term instruments. They didn’t have the ability to do that. Those rules didn’t apply to Silicon Valley. They bought a whole bunch of long-term bonds. They were underwater, and their depositors fled because they were all basically all the same depositors. They were venture capitalists who couldn’t raise money anymore. They had to pull money out of the bank. If that’s the problem, then the solution isn’t really more capital, because God knows the banks have plenty of capital. The solution is impose the liquidity requirements that you’ve imposed on the large banks onto all the other banks. That’s the obvious solution. But for whatever reason, they didn’t do that. And so now they’re increasing the capital requirements of the large banks and the midsize banks. It’s not even clear at this point that they will impose harsher liquidity requirements on the midsize banks. So again, it’s an example of the generals fighting the last war, but because of that, it makes the whole sector uninvestable.
Steve: The whole financial sector uninvestable.
Speaker C: What I would call traditional banks, the traditional parts of the— I’m not talking Visa and MasterCard, obviously. Visa’s fine. I’m talking about traditional Bank of America, Goldman Sachs, Morgan Stanley, M&T Bank, all those institutions that people have in the past liked to own, you can’t own. It’s pointless.
Steve: So let’s look at lessons learned, positive lessons learned from that crisis, but, you know, maybe more swift intervention where it really matters and where it’s the right kind of intervention and maybe lessons that haven’t been learned. And part of that, what are the laws of physics today that people think are now just a truism that maybe need to be questioned? Some conventional wisdom, maybe it’s tech now, Where we think it’s a low— Well.
Speaker C: I still think there’s less of this because Amazon, Google, Meta have been such unbelievable companies. People are constantly searching for the next one. And so when something that goes public that’s sexy, that has very high revenue growth but no earnings, people say, aha, this is it, pile in. And you know, but how many Googles and Metas and Nvidias of the world really are there? Who makes it to the finish line? Not that many. Most fail. So you get this enormous volatility in these, I would call hypergrowth companies because they treat it like a lottery ticket until it’s not a lottery ticket. That’s where there’s some interesting investing opportunities show up because when it becomes clear that it’s not necessarily a lottery ticket, but maybe it’s a real business like solar, for example. So solar, if you go back, 2 years ago. We’ll just pick on one company, Enphase. So Enphase, I remember at some point during COVID was about 80, and then solar became this incredibly hot space. It was treated like tech, tech, tech, tech, tech. It’s all you need to know. Growth, growth, growth, growth, growth. And it went to over 300 and now it’s 120. And why is it 120? Part of the reason is that Enphase sells components for residential solar panels, which is a fine business. But most individual people, when they put a solar panel and a battery on their roof, finance it. Well, when rates are zero, easy to finance. When it’s going to cost you now 8 to 9% to finance, not so easy to finance. So all of a sudden, an industry that saw very high revenue growth for years is actually experiencing, dare I say it, Negative revenue growth. Shocking. Now, that doesn’t mean it’s not a real business. There is a real business over the next several years in the whole solar space, which is something that I’m pretty involved with. But I don’t have to worry that there are raving lunatics in the stock who are hoping that the stock’s going to go from 10 to 3,000 in a day. This is where you get to do real homework and do some real valuation analysis and meet the companies and beat the crap out of them. You can eliminate the crap part of the REIT podcast. Actually, don’t leave it. It’s kind of funny. But you get my point. This is where real investing starts to come in. So I enjoy that.
Steve: And let’s take that to the broader infrastructure sector, because just to give you some context, we have been adding infrastructure into our model portfolios now for about 18 months, 2 years. Some of it was an inflation hedge. Some of it was a pure diversifier. Some of it was to get away from the pure MLP allocation. To just have a broader— MLPs.
Speaker C: I get a migraine when someone says the word MLPs.
Steve: Well, tell us why, because we’re aligned in that respect. But, you know.
Speaker C: I ran my last financial services hedge fund and ended in 2014, and I joined Newberger. And at the time, Newberger, for reasons that are not important, there are a lot of PMs that had a lot of positions in energy and MLPs. So I started to do a lot of work on MLPs. I started to realize this is a very weird animal because you’ve got a GP often who’s public and you’ve got an MLP that’s also public and it’s run by the same people. GP and the MLP are run by the same people. Whatever money the MLP makes, the GP takes a 50% scrape. I remember— and they’re very levered, The corporate structure is bad and the dividend coverage wasn’t great. I remember I called a friend, a sell-side analyst who I was friendly with who covered the space. I said to him, “Let me ask you something. How many stocks do you cover?” He said, “Six.” I said, “If you had a clean sheet of paper and you could create the perfect MLP GP situation, leave aside whether the tax documents and stuff, what would the structure look like? Forget about who has the best pipes.” He says, “Well, no GP, MLP. It would just be one.” He said, “The coverage of the dividend, the dividend would be, let’s say, half the cash flow and debt-to-EBITDA would be less than 4.” He had a whole list of things of that would be the perfect company. I said, “How many companies do you cover?” He said, “60.” “How many does that apply to?” He said, “2.” Now, the industry’s better now, but back then they were kind of crazy. I remember In 2016, when the group collapsed, there was an MLP GP group that came in. The dividend yield was 12% at the time. And I swear to God, it’s 2016. I could tell you where I sat in the room. This was a seminal moment for me on this group. And they came in and they were talking about how they were going to be spending less on building pipes because cost of capital is higher. And so I raised my hand, I said to the CEO, Your dividend yield is 12%, but your GP takes a 50% scrape of your earnings. So really, your cost of capital is not 12%, it’s 24%. What pipe on planet Earth could you build that would give you an IRR in excess of 24%? And he looks at me and he goes, he just starts to mumble. I’m thinking, this guy’s off his rocker. Clearly, the problem was these guys were just incentivized to build. That’s how they were paid. One of my favorite sentences that I ever made up— I have a few gems, but only a few. One is incentives trump ethics every time. That was really the problem with the MLP group. Now, it’s a different group today. It’s mostly corporations and a lot of it’s different, so it’s investible. Back then, it was an appalling structure.
Steve: We’ve only got a few minutes left, but you like infrastructure today. You mentioned solar. What else would be the maybe 3 big reasons why you like infrastructure as an asset class today? And what do we expect it for? Yield or just for good diversifying solid returns?
Speaker C: I’m not looking for yield. I’m looking for very good, maybe I think much better than solid returns. I’m actually looking for revaluation. You’re talking about $1.2 trillion of money that’s going to be spent by the federal government on greenification, on shoring, various parts of energy tax credits, wind, solar. It’s got a lot of tentacles to it. It goes from companies that design highways to traditional industrial companies, to aggregates, cement, to some sexy things in tech, to some greenification things. Solar is completely out of favor right now, but I think sometime next year will be become very reinvestible again. Anybody wants to follow up, we can talk. And then there’s the, what I call the newfangled toy decarbonization, which is very much in its infancy. I think this is gonna be a very, very, very exciting story for 10 years, probably a very solid investible story for 5 to 7.
Steve: And I know you’re not a macro strategist, but where do you think we are in terms of the interest rate cycle? And going from here, recession, no recession, soft landing, hard landing, election year coming up. How do you see the market conditions playing out based on having seen a few cycles yourself already?
Speaker C: Well, let me have a little humility here. I mean, one of the reasons why I was prescient in 2007 and ’08 is because back then one of my real areas of expertise was analyzing loan credit quality. And I’m very data-driven, and there was sufficient data out there to see that consumer credit was imploding, and that was going to have a major impact on the economy. I wasn’t looking at interest rates. I wasn’t looking at PPI, CPI, ISM. I wasn’t involved. I was focusing on this one data point, 70% of the US economy is consumer. The consumer is going to implode. End of story. Now, it’s much, much more complicated. The consumer’s in very good shape. People have jobs. Whatever layoffs we’ve seen is at the high end in terms of tech and Wall Street. It’s not General Motors, people are trying to get a 30% raise. This is like the revenge of the middle class versus 2008 and ’09. At this point, I can’t— look, I’m not an economist. I can’t see a recession where everybody has jobs. It’s hard to imagine at this point. And sometimes you read in the paper that consumer credit quality is beginning to deteriorate. That’s fair, but consumer credit quality has never been this good in anyone’s life. Lifetime. So when you’re coming across delinquency and loss levels that are what I would call subterranean, the fact that they’re starting to normalize is hardly something to be crying about. So look, it’s pretty amazing that the Fed has raised rates this much and the economy hasn’t slowed yet. Maybe that’s partially due to the fiscal stimulus. I’m not sure. My answer to your question is everybody should have a little be a little humble about this so far, because so far everybody’s been wrong, and some people have been wrong in multiple directions.
Steve: I think your dad’s quote you shared with us in the pre-meeting was, what, “Peacock today, feather duster tomorrow.”.
Speaker C: Yes, and my addition to his quote was, he said, “Peacock today, feather duster tomorrow,” and then my addition is, “And hopefully peacock again.”.
Steve: Phoenix from the ashes. The silly question around The Big Short, did that make a difference in your life? A little bit more high profile.
Speaker C: One thing that I really enjoyed was I, after the movie, I hired an agency to get me speeches all over the world. This was a really good gig. You know, they paid me a little money, they paid for my travel. I got to go all over the place, see the world, make speeches. People would, you know, I’m a pretty good public speaker, hopefully, as you could all see, and people would give me a nice round of applause, and that was really enjoyable. And I’ve gotten to speak at a lot of colleges, which has been a really enjoyable thing. I’ve mentored some people. I’ll brag here a little bit. During COVID I was out on the North Fork on Long Island, and there was a young man who had just graduated from college. He couldn’t get a job because obviously it was COVID. He was the guy who gave you the tee time at the public golf course that I played on. So I said to him, listen, if you’re interested, I’ll teach you. I’ll teach you how to do Wall Street. So I taught him for a year. He’s at JPMorgan now. So that was a thrill.
Steve: And what is it, just as a closing then, what would be those takeaways you share when you’re doing a college, say, I don’t know if it’s a commencement ceremony or what type of a ceremony, but what would be the things you would want a college graduate to know? Maybe one who wants to go into Wall Street or not?
Speaker C: So I’ve gotten that question a lot. And what I always say is that Warren Buffett likes to say, pursue your passion. I actually disagree with that to a degree. The reason why I disagree with it is, listen, your passion could be opera, but if you can’t sing, you ain’t getting the job. My theory is pursue your aptitude. What I mean by that is, I mean, I remember in high school, I was half decent at most subjects, but no genius. I had friends who were geniuses in history and English, but couldn’t add. Then I had friends who were geniuses in sciences and math, but could write a sentence. It had nothing to do with intelligence. It had to do with what they were naturally gifted at. Everybody’s different. So, you know what I tell people who want to pursue any career, whether it’s Wall Street, figure out what your aptitude is. Are you an idea generator? Are you a detail-oriented person? Are you comfortable with math? Are you more comfortable with stories? There’s a whole list. There are online tests you could take to figure it out. Are you empathetic? Are you not empathetic? Are you personable so you could be an investment banker, or do you not like to talk to people so don’t be an investment banker? Try and pursue the career, whether it’s Wall Street or not, that uses your aptitude strengths as opposed to your aptitude weaknesses. Because if you go into a career where you’re weak in all the aptitudes that require success in that career, you’re going to leave banging your head against the wall. And it’s not because you’re not smart, it just doesn’t come naturally to you. That’s what I tell anybody who asks.
Steve: Well, Steve, thank you for the reminder around the humbling effect of markets. It’s something we feel every day. I’d like the audience to know that there was no money changed hands for the speech, that you were gracious to answer my request to come here and speak with us. I hope you’ll do it again.
Speaker C: As you can see, we had— I’d be happy to.
Steve Eisman: This podcast is for informational purposes only and should not be construed as investment advice, and all views are personal and should not be attributed to the organizations and affiliations of the host or any guest.
