“What have I told you since the very first day you set foot in this office? There are three ways to make money in this business. Be first. Be smarter. Cheat. Now I don’t cheat. And although I like to think that we have some pretty smart people in this building, it sure is a hell of a lot easier to just be first.”
“Sell it all. Today.”
Margin Call (2011)
We’re all familiar with the Golden Rule — Do unto others as you would have them do unto you — and I don’t think it’s a stretch to say that its message of reciprocity and empathy is the bedrock of human civilization, certainly of Judeo-Christian thought. As Hillel the Elder said, “What is hateful to you, do not do to your neighbor. That is the whole Torah. The rest is commentary.”
There’s a variation of the Golden Rule — I don’t think it’s a stretch to call it a perversion — that is the bedrock of the business of Money, a business that goes by the shorthand of ‘Wall Street’. This not-so-Golden Rule is the source of pretty much all of the unexpected Bad Things that happen from time to time in markets, where there’s a shock to the system that ‘no one could have foreseen’, like a sudden crash in the price of something or like a run on a bank or an investment firm. That perversion of the Golden Rule is this:
Do unto others as they would do unto you. But do it first.
It’s a perversion of the Golden Rule in two ways. First and most obviously, it’s got that extra sentence about doing the thing before the other guy. But second and less obviously, it’s normative-negative, which is a ten-dollar phrase to say that it’s not talking about doing good things (‘as you would have them do’), but is pretty obviously saying that you should do something that will actively hurt the other guy.
If you’re in the business of Money for more than a nanosecond, you will see this not-so-Golden Rule in action all around you. More to the point, if you want to stay in the business of Money and be successful in the business of Money, you must adopt and live by this not-so-Golden Rule yourself. Seems harsh, I know, but as Hyman Roth so aptly put it in The Godfather, Part II, “this is the business we have chosen.”
And it IS harsh. You can rationalize it by saying that he would have done the same thing to you if the situation had been reversed — and you are almost certainly correct in that assessment! — but the fact remains that YOU are doing the negative thing to the other guy. If you’re a thinking, feeling, non-sociopathic human being you will feel bad about doing that negative thing, but you will also get over it pretty quickly because it is absolutely, unequivocally, 100% the rational thing to do, and if you’ve been entrusted with managing Other People’s Money you have a moral if not legal obligation to do that rational thing despite the blecch feeling you have inside.
The first time I experienced that blecch feeling keenly was in December 2007 when I called our Bear Stearns rep and told him that we had decided to leave Bear Stearns as our hedge fund’s prime broker and we were pulling our money out. A prime broker is basically the ‘bank’ for a hedge fund. They provide lots of services, but the main ones are that they lend you money against the value of your portfolio so that you can buy more stock without using actual cash to go long (bet that the stock price will go up), and they locate and secure the shares of stock that you have to borrow in order to go short (bet that the stock price will go down). In exchange you pay them interest on the ‘leverage’ you used to buy more stock, just like you’d pay interest on a bank loan, and even more importantly from their perspective (and also just like a bank) you ‘deposit’ your stock holdings and some cash with them, which they can use to fund the loans and leverage they’re making available to other clients. It’s arguably the most important counterparty relationship that most hedge funds will have, certainly back then, and it’s a very profitable business for Wall Street investment banks, certainly back then.
What you need to understand is that I didn’t like working with Bear Stearns … I loved working with Bear Stearns. Loved the people, loved the attitude, loved the business terms. Bear Stearns was famously unafraid to take a chance on up-and-comers, both in its hiring of non-pedigreed entry-level employees (preferring, in legendary CEO Ace Greenberg’s words, to hire people who were ‘PSDs’: poor, smart, with a deep desire to be rich) and in its willingness to work with non-pedigreed hedge funds like mine. To be sure, it helped that the larger firm of which my fund was a part was filled with ex-Bear employees, all friends who would vouch for me and my partner. This was back in the day when vouching for someone meant something. It still does, I suppose, but a lot less than it used to. Bear stepped up to be our hedge fund’s prime broker from the very start, putting real time and real effort into a dinky little fund when nobody else would. Yes, they made good money off our business as we grew into a non-dinky fund, but I also owed a personal debt of gratitude to Bear Stearns for taking a chance on us.
And it didn’t matter.
Once I figured out in late fall of 2007 that if we had a nationwide decline in home prices, Bear Stearns faced enormous potential losses in the mortgage-backed securities that they owned, losses big enough to wipe out the entire bank because of their internal leverage on assets – or rather, once I suspected that I had figured this out, because you never know this stuff for sure unless you’re on the inside — then I knew for a certainty that it was only a matter of time before other prime broker clients of Bear Stearns would come to the same suspicion. And once that word got around — that there were doubts and suspicions about Bear Stearns as a counterparty — then I knew for a certainty that what would start as a trickle of clients taking their money out of the prime brokerage ‘bank’ would become a stream and then a river and then … well, then the dam breaks and the investment bank fails and if you’re still there as a prime brokerage client you get really, really hurt.
It didn’t matter if I was right about Bear Stearns and the risks to their balance sheet. I was, but I swear that didn’t matter. What mattered was the not-so-Golden Rule of Wall Street. What mattered is that you must act first when you have even a suspicion of counterparty risk, well before you know for sure whether or not you are ‘right’ about that risk, because everyone else on Wall Street will act first if you don’t. And if you don’t act first, or at least early … if you wait until you’re sure that there’s a counterparty risk … well, you’re screwed.
In December 2007, Bear Stearns still traded for over $100/share. In three months, it was below $5, before finally being taken out by JP Morgan for $10/share in a mercy killing. From suspicions to lights out in three months. Life comes at you fast when the not-so-Golden Rule of Wall Street comes into play. Getting out when we did saved our fund untold hassle and legal tie-ups, gave us the time to move to another prime broker out of strength and not desperation, and set us up for a career-making year in 2008.
Is this sort of run on the bank a self-fulfilling prophecy of doubt and ruin? Yep. If everyone had just kept their prime brokerage account in place would Bear Stearns have survived? Maybe. Do you have a choice but to get out before everyone else does, no matter how much it pains you personally and no matter how much your getting out might accelerate the sad and disappointing outcome? Nope. This is the business we have chosen.
Incidentally, you might wonder if my Bear Stearns rep pleaded with me to keep my money in place. Yes, he did. You might wonder if he was angry when I said that I was out and there was nothing that would keep me in. No, he wasn’t. He was disappointed but he wasn’t angry. He understood the Rule. He knew the score. Absolutely if the situation had been reversed he would have done the same thing.
Why am I telling you this story?
I’m telling you this story because I think that Trump a) recognizes he made a mistake by overplaying the tariff card, b) is sidelining the ideologue pro-tariff crew like Navarro and Miran, and c) is actively looking for off-ramps and de-escalation in the China trade war. I think he may find an off-ramp and de-escalation in the China trade war, and that would be a wonderful thing for the United States and the world.
And it doesn’t matter.
Scary how much this note rings true. Earlier in the month when I had some diminishing hope of a face-saving reversal from Trump I still thought we might be in a worse spot than most Americans realize because of just how much of our wealth was built on our leveraged position as the trustworthy, stable center of the global economic order. Even if there was an about-face from Trump some damage would have already been done, and it would require a re-assertion from Congress of their authority to build back our credibility.
Clearly we are even further from that now. Hard to imagine what the best path forward looks like from here.
A great article. I by coincidence rewatched Margin Call last Friday. My reason was slightly different. I was at an Alternative Investments conference in Toronto a couple of weeks ago. Most of the focus was on Secondaries, Evergreen Structures and Private credit. Secondaries are the resale of illiquid locked up funds, like PE funds with x number of customers. Seemed to be Family Office oriented activity which struck me as a bit of a red flag. Family offices dropping millions into PE funds wanted liquidity all of a sudden. Enough of the for this to be an industry now. Interesting. Evergreen is the packaging of different secondaries into tranches of a fund which is then sold, also to Family Offices. There is a balancing required between the anticipated exit dates for companies in the various tranches and generating consistent cash flow instead of a locked up investments out of the fund. This was also accompanied by Private credit suppliers, people who loan money in place of the banks to companies and people. In a totally unsupervised environment. Private credit was discussing the use of AI to create models more efficiently and maintain the Ever part of the Evergreen fund. It struck me at the time it was just like 2007. I was running a software company that was doing a CRM deal that year with JPM wealth management and was very familiar with the hedge fund world you described. I determined to rewatch Margin Call just to refresh myself on what people said, to compare to the Evergreen private credit pitches I had just heard. It was astonishing how similar the products and the pitches were then and are now. My reason for this response is to point out that there are a lot of things, some we did before and are doing again, which are going to put the chaos today into hyperdrive when they break. And break they will. When I heard what private credit was doing on Main Streets in small towns USA and how it was being packaged…
Thanks for sharing, this is great. The only thing I would add as someone who works on the fundraising side is the concept of the ‘denominator effect.’ As public equities go down, allocations to private equity can become overweight, which then creates a need (requirement) to offload some private holdings. The secondaries market has already existed for a while, but I think the liquidity it provided has been a ‘nice to have’ sort of thing while it could soon become a ‘must have.’ Everything has been humming along fine for the last 15 years while ‘number go up,’ but I wonder if the music is about to stop playing.
This is the whole ballgame here.
At the beginning of the year I had one major goal for my clients, it was to diversify away from US equities. This was not because I had some brilliant foresight into what the future held, rather it was a visceral reaction to a long post by Cliff Asness. Here is the excerpt:
The whole piece is great and it really caused me to interrogate my own priors. So while I laughed at most parts I also found myself having to contend with the reality that I was guilty of one of the crimes he was laying out. So I set out to rectify that.
And how have clients responded to my pitch that maybe they should hold more non-US equities? Did they refuse to listen, swear at me, and yell This is MAGA country as I cowered in fear? Of course not. They followed my advice, as they almost always do, because their goal isn’t some nebulous theory of patriotic investing, their goal is to adequately fund their retirement and maybe have enough left over to help their kids or grandkids get ahead in life. They go where they think the returns are best. If normal mom and pop investors are thinking that way then the tides are going in one direction. My asset allocation is agnostic towards borders, and I consider myself a pretty loyal and patriotic guy. Now imagine what happens when the assets in question are 100x my meager AUM and the patriotism and loyalty dials are turned much lower.
The line out the door is orderly and single file, but only for so long. Tick tock.
What would happen after capital controls to stop capital flight? It’s looking like the next step.
I think one thing old Don has is leverage via the military- it’s all good that Germany asked for their gold back, what happens if Don says no-?
If we also see bankruptcy as a certainty at this point, it is useful to consider Don’s prior bankruptcies and how he managed to stay a relatively wealthy American oligarch for most of his careers regardless of failure or success. I’ve known a particular adage attached has been attached to his banking relationship, “if you owe the bank 1 million, it’s your problem, if you owe the bank 1 billion, it’s the banks problem.”
I also seem to recall his biggest loans originated from Deutsche bank. Maybe that is why he also thinks he can lean on Europeans harder?
So if you think about it from that lens, it actually makes a lot of sense about his strategies- Japan and China own the most government bonds, and Japan has relatively good relationship with US. So he first targets China as the country he wants to isolate and renege his debts unto, while pushing all their allies to either give up their land and float the American debt and subsidize reckless spending by being the 51st states. Why? Because he speaks the language of power, the softer spoken people are treated like fools and the hardliners as enemies.
Now maybe a variant of Ben’s not-so-golden-rule kicks in here, even if the world isolated China and decided to work with the US, since you know that US is going to take advantage of you once they are finished with China- what incentives do you have to follow along?
This strategy could genuinely have worked for him in his business. Just as Elon’s government subsidized pathway to wealth worked for him. But I wonder if there was a few people who knew this strategy wasn’t going to work and made Trump believe he was smart for thinking of it and brave for implementing it when no one else had the courage to do so? Seems like catnip to a man like Trump… Though that could be extrapolating too far.
I paid $20 for this emotional hyperbole after being intrigued by the first half of the post.
“a rush to the exits by every currency counterparty to the United States…”
Get a grip… this post and the comments have me less bearish USD.
Hi Alex, you seem to be saying that something is completely unbelievable.
Have you some info or more thoughts that are missing from the conversation?
Welcome, stranger. I would encourage you to read a bit more here and see if you haven’t perhaps missed a major plot point or two. This place is not like most others, and for good reason.
Alex admire your skepticism! How do you think the US administration will stabilise the situation? I’ll admit I can’t see a path at the moment. Wouldn’t mind your counter view to shore up my blindspots.
That’s it exactly. Great post, DY … thank you!