Three more sell orders came flashing in. Beside me, Joe was talking in all directions-"Hit! Buy! Lift! Ten million up! Where are you on the follow?" He was a trading machine and on that day he was at his best. Everyone was shouting now, the salesmen and the traders, and millions of dollars were changing hands, darn near all of them in the same direction: outward. There was nothing we could do except buy and hope that Jane knew what she was doing. You've heard of the trenches. I was in there. Right above me, the sellers were circling, trying to get in line for a landing, like big pa.s.senger jets in a stack somewhere above JFK.

I dropped Delta's price again, to 13, and still the sell orders came in. I guessed the ratio of sellers to buyers was about ten to one. I got hit immediately for another seven million. Larry on the phone bought around $5 million worth. Then Terence, the best salesman I had, bellowed at me, "I got a buyer at fifteen, five up. You want to let some fly right here?"

This was the only buy so far. It was the only lift I'd had all day. Way to go, Terence Way to go, Terence. I took it. Then I dropped the price once more, to 12. Two more huge sell orders came in, and we bought yet again.

Sitting right next to me, Jane said quietly, "We're stealing them, Larry, we're stealing them. Stay focused. They're worth fifty-two cents, trust me."

I trusted her because she knew the reality, not the far-removed fury of the investors and traders. She knew about the lines of gleaming aircraft, the value of the Delta fleet, their name, their reputation, the jet fuel problem that was strangling them, and the murderous debt. But above all she understood that bankruptcy would allow them to regroup, and she knew there was an intrinsic value to those bonds beyond the debt and into the future. Jane could probably have run the airline, and here she was right next to me, telling me to buy at the lowest possible price, telling me I was stealing them as I blasted away at the Lehman balance sheet in this outrageous spending spree.

When the dust finally cleared, Joe and Larry had bought $95 million face-value worth of Delta bonds, I'd bought $40 million, and Peter Sch.e.l.lbach had bought $60 million. When we added all the orders up, the tally when you include those bonds we already owned was about $350 million, buying all the way down to 12 cents, from outfits like Putnam and Fidelity.

There's an old traders' rule: never sell your holdings on a day of bad news. Stay away from the exit door while the mob is trying to get through. Because there's sure to be a bounceback, just as soon as the panic-stricken sellers have all run for their lives.

When the phones finally went quiet, Alex Kirk returned to his office. Jane said jauntily, "Don't worry about it. We're golden." And I sat down for the first time in an hour to a.s.sess the situation.

Four of the seven biggest air carriers in the United States were now operating in Chapter 11-that was half the pa.s.senger seats in the nation being operated by bankrupt airlines. They'd only recently recovered from the aftermath of 9/11. And now here was Lehman Brothers with a huge holding in Delta's bonds, and I couldn't help wondering how long it would take to climb back to the value Jane so confidently forecast. If she was right, we'd probably make the biggest one-day profit in the history of Lehman. If she was wrong ... let's not even go there.

The one person in all of the corporation who believed implicitly that Jane was correct was Larry McCarthy. One of the most fearless traders ever to work on Wall Street, he would hear no word against her a.s.sessment of the Delta situation; indeed, working in concert with Joe Beggans, he'd bought $95 million worth of the airline's bonds. He was keenly aware that it might be months before the price rose to the levels Jane predicted. But he was sure of our position. And like all true gamblers, he was sure that his luck was running strong. As a matter of fact, he kept buying all through the next month, whenever an opportunity came up.

The situation at Delta did not really improve. Unrest in the Middle East continued, and the pilots were threatening to strike, which would blow Delta's normal operations apart and cut off their cash flow, their lifeblood. But Larry was adamant. "It's what Jane says. Those bonds are worth a lot more than twelve cents on the dollar. They got f.u.c.king Boeings, hundreds of 'em, parked all over Georgia."

It's difficult to grasp the size of the gamble Larry was involved in, just as it's difficult to grasp the type of man Larry was-his astuteness, the speed of his calculations, and the depth of his nerve. You'll have to take my word for it: there was nothing ordinary about him. Larry McCarthy had stepped straight out of a scene from The Cincinnati Kid The Cincinnati Kid. He had a nose for victory and an instinct for trouble. And when he scented the former, there was no shaking him off.

I'll tell you just one story about McCarthy, and then you'll know precisely what manner of man held those Delta bonds. He and I used to go gambling together. I suppose it was in our blood; there are a lot of guys like that on Wall Street, cold and determined with the firm's cash but addicted to the chase, calculating the odds, the risk-to-reward ratio. I guess we're all junkies for the thrill of being right, of winning, always winning. Anyway, later in the fall of 2005 we decided to go up to the Mohegan Sun casino in Connecticut for a couple of days. After dinner at Michael Jordan's Steak House, we headed for the tables for some blackjack.

I settled into a modest corner where the stakes were around $50$100. McCarthy went to $100$500, a spot he had occupied many, many times before. But by any standards you'd have to say the cards were not running for him. He slogged it out, going head to head with the dealer, but nothing could change his luck. After two hours he'd blown a very large hole in $75,000. An hour later he'd lost $100,000. The dealer was pulling seven-card 21s and never busting.

Three times I saw Larry double down on a 10 and then pull a 10, only for the dealer to hit 21. The pressure was relentless, the bad luck apparently endless. But McCarthy never flickered, never stopped smiling, never stopped wisecracking his way through the evening. Never once did he lose his cool, laughing cheerfully with the pit bosses and the dealers, who knew, to a man, that the cards had turned against him before he even started.

After four hours he had blown out $165,000. Nothing had gone right, nothing had been even reasonable. But Larry stayed positive, once handing the c.o.c.ktail waitress a $500 tip. Finally I took him aside and told him, "Come on, buddy, this is a disaster. I've calculated your losses. You're down a hundred and sixty-five thousand. Let's call it a night."

I'll never forget his reply. He stared at me hard and said, "This is all about staying positive, old pal. Most people quit in life when they're just three feet from the gold. But you got to be there with the big bucks, for the turn. Because it always turns. Remember that. Everyone has good luck. Everyone has bad luck. Just don't stampede for the f.u.c.king exit when there's a minor setback. Trust me, it's gonna turn, and that's when you want to be there." And then he told me to call the pit boss and get another $100,000. He was playing on, and his credit was good. I just shook my head at the sheer guts of the man.

Both on the trading floor and in the casinos, most guys run for the hills when things aren't going their way. Bad negative att.i.tudes, whiners and complainers. But not Larry. On the trading floor and at the tables, he was always Captain Cool, waiting patiently, lying in wait for his moment.

He asked us to give him a little room. Then he collected his $100,000 and took over the whole table, all six slots. They roped off the area, except for him and me, and he started with $2,500 on each hand-that's $15,000 on each round against the dealer. That gave him a very slight advantage, because there was no one else playing, catching the good hand. I watched him win a few, then lose a few.

And then suddenly the dealer busted two hands in a row for the first time in close to five hours. Larry hauled back $15,000. Then he pulled nothing less than a mind-blower. He gestured to the pit boss and requested permission to up the table max from $5,000 a hand, $30,000 a table. "Let's get this baby up to ten thousand," he said. "Sixty thousand a table."

The pit boss nodded.

Larry proceeded to pile on his $1,000 chips, ten each on all six slots. The cards were not pretty. His best was a 16, but the dealer's cards were worse. There was a six, but when the second card turned, it was the dreaded five. This meant if she drew a face card she'd have 21, and Larry would be down another $60,000.

The dealer, still under 17, had to go again. Almost thirty people crammed together outside the ropes, watching this fight to the finish, holding their breath. The dealer turned the card. It was a three, which made 14. Larry never blinked. The dealer turned again, an ace, for 15. Larry stared straight ahead. The dealer turned once more and pulled yet another ace. That was still only 16.

This was sensational. But the dealer had to turn again. And it was as if the entire casino had come to a halt. The pit bosses had moved in and were standing watch with the crowd. c.o.c.ktail waitresses stopped serving, and a kind of telepathy swept around the gaming room. It was as if everyone was aware of the t.i.tanic struggle between the casino's ace dealer and Larry McCarthy from Wall Street, with $60,000 riding on the turn of a card.

I watched the dealer gulp and then reach for the shoe, selecting the card. For a split second, the hand that covered that card paused, and then flipped it over to reveal the queen of spades. Dealer's bust-26.

After five hours, Larry's luck had finally turned. He leapt to tackle me, taking both of us right off our stools, into the velvet ropes, and onto the floor in front of all the spectators, both of us laughing fit to die.

When we finally climbed back to our feet, Larry just said, "Okay, guys, let's play some cards." He swapped the $1,000 orange chips, the "pumpkins," for the $5,000 "gray ladies" and placed two of them on each spot-another $60,000 hand. And when the cards came up they were devastating for the dealer: four blackjacks and two 20s for Larry, against the dealer's pitiful 17.

In thirty-five minutes, Larry had come back from the dead to be $25,000 in front. "Remember this," he said. "You've seen for the past four hours the best part of this game, and the very best part of life. When things can't get any worse, they always do, and when they can't get any better, they always do."

What he said was true. I'd watched this man get beat over and over again, and then I watched him ride his luck all the way back. When we walked out of there two hours later, he was $475,000 in front. I saw it with my own eyes. I think for the first time, I finally understood why Larry McCarthy was a full-blooded legend of Wall Street and why his name would live for a long time.

On the way out, he told me one more truth, as applicable in the market as it was at the table. "Never blow your powder too early," he said. "Start nice and slow, nice and low. Get the feel of the market, get centered, make sure you got a ton of ammunition, and don't quit too early. Never do that. When they're running against you, keep going, because they're gonna turn. And the split second they make that turn, hit it, buddy, hit it real hard. Because that's when you're gonna f.u.c.king win." win."

Which was all very well, until we returned to the office the next day only to see that Beazer, the home builder we'd shorted so ferociously, was chugging upward yet again. With all of its thousands and thousands of suspect mortgage holders and all of its debt, the market didn't care. Beazer rode up to $82 against our short position of $75. The sons of b.i.t.c.hes were killing us. That morning we dropped another $2 million, which made $4 million altogether. Christ, we were losing $600,000 a point.

"Where's Babay? Where the f.u.c.king h.e.l.l's Babay?" Never had I seen Captain Cool so angry. He'd searched the entire floor, raging from one section to another. Most people were too scared to laugh. Larry decided to take it on the chin and take the short off, just to stop the hemorrhaging. Never before had I seen him go against his own instincts that severely. Jesus, if he'd done that at Mohegan it would have cost him $600,000 personally.

And still Karim Babay never showed. Once more Larry searched the floor, and when he came back he was even more angry-angry with himself for losing his nerve, furious at Karim, who was not there to offer words of encouragement and advice, and incandescent at Beazer Homes, which had the temerity to defy every form of known logic.

Words failed him. Any vestige of humor he had left had flown the coop. And with an outrageous display of brute strength he reached up, ripped the computer screen from its mounting, and hurled it to the floor, obliterating it in a shower of gla.s.s and electronic sparks. The noise was amazing, and of course it was too much for a lot of the younger traders, who started to crack up at the temporary disintegration of Captain Cool.

But Larry was not sorry. He leaned down, picked up the shattered monitor, raised it above his head, and once more hurled it downward, blasting the frame asunder, with sparks and gla.s.s once more flying every which way. Then he turned to face the crowd, and suddenly the anger seemed to drain right out of him. At last he chuckled, raised his fist into the air, and shouted to the cheering traders, "f.u.c.k 'em, right?" The roar of applause almost took the roof off the building.

Right then Beazer jogged up another 50 cents. "Screw 'em," said Larry. "We'll get 'em back on the way down."

That 'ole dog, he could still hunt.

But not everything was going wrong. In fact, hardly anything was. And several weeks later we stood back and watched Calpine go down in flames. The clean-as-air energy corporation vindicated every last word Christine Daley had ever uttered about them. They crashed under the overwhelming burden of their own debt and made a few headlines on November 29 when their stock price lost 57 percent of its value after they fired their CEO and founder, Peter Cartwright, and their CFO, Bob Kelly, who Christine had said could dance through raindrops without getting wet.

The stock drop was not in fact that serious, since it had already plummeted from its high of $58 to $1.25, but now it had lost another 71 cents, which more or less wrapped it up. I've never been exactly certain of the amount of money we made from that cla.s.sic short, which we'd leveled at the corporation based on the words of one of the great Wall Street researchers. But it was, by all accounts, close to $100 million.

On Tuesday morning, December 20, Calpine filed for Chapter 11 in the U.S. Bankruptcy Court in New York. It was the eighth largest in history. They'd gone down under that ma.s.sive debt, now $22.5 billion. The news flashed on all of our Bloomberg terminals, and I traded over $100 million in Calpine bonds that day, having been short $50 million face. It gave me my first-ever $5 million profit day. Larry and Joe Beggans were short $175 million.

I talked to Christine later that day, the day of her great triumph. And like a true researcher, she was slightly preoccupied with a historical fact. How could it be, she wondered, just a few years after the Enron catastrophe, that a crazily overleveraged U.S. corporation, in complete denial of its untenable position, could keep right on pulling off questionable accounting moves, one after the other? And from her perspective the fact that she had spotted it while no one else seemed to care made it worse. You rarely find such a realist who is also ultimately such a purist. But Christine Daley was that person. She had watched from afar and her a.s.sessment was that Calpine executives were attempting to pull the wool over investors' eyes, and she'd contemptuously dismissed all that as a smoke screen. It was the pure darned wrongness of the evasions, the half-truths, the exaggerations, the unfairness to investors. That's what had gotten to her. That's why she was so unforgiving in her a.s.sessment of that corporation. Just the G.o.dd.a.m.ned lack of truth in their dealings with stockholders.

I felt I'd been with Christine from the start, since Calpine had been the topic of our very first conversation on my first day at Lehman. And I will always remember her astute determination. Just as I will always consider it a privilege to have known her.

7.

The Tragedy of General Motors "I am ninety-nine percent certain," said Christine, "that General Motors is going bankrupt. It's not even a car company; it's a health care provider with an auto manufacturer on the side."

THE NEW YEAR came howling out of the northwest in 2006, and we struggled to work every morning, the sun not yet up. Huddled into our top coats and fur hats, chins tucked down into our scarves, feet encased in galoshes, we made our way along the icy sidewalks, jumping slush puddles. Manhattan, winter-bleak, shouldering its way into the new day. came howling out of the northwest in 2006, and we struggled to work every morning, the sun not yet up. Huddled into our top coats and fur hats, chins tucked down into our scarves, feet encased in galoshes, we made our way along the icy sidewalks, jumping slush puddles. Manhattan, winter-bleak, shouldering its way into the new day.

Yet once we'd fought our way into the warmth of our building, there were smiles on the faces of the traders in our little corner on the floor. There was even a smile on the face of the elusive Scarlet Pimpernel of the research department, Karim Babay-they seek him here, they seek him there ...

In faraway California, slumbering on the warm banks of the Delta, Beazer Homes had just copped it. Their stock peaked in the first couple of days of the year at around $82.50, then began a relentless dive to where it belonged, losing $20 initially, then heading for $40 and then ultimately almost to zero, complete with its gigantic debt, and all of its dicey mortgage holders.

That January, the determined Larry McCarthy steamed back in and initiated a new short position on Beazer and was quickly on his way to a super $10 million profit as the stock finally plummeted. For one split second, I thought he was going to hug Karim for joy. And I never once noticed even one computer terminal in any danger whatsoever.

We were, at that time, in what some people regarded as a Goldilocks economy-a relaxed and calm state of affairs when everything moved gently and, like Goldilocks, we were keeping the three bears at bay. The first sign that Mama Bear was about to spill the porridge came in late January 2006 when David Rosenberg, chief economist for Merrill Lynch, suddenly came out and announced that existing home sales had started to collapse in October, three months previously, when they were down 36 percent compared to October 2004. That was the steepest decline in ten years, he noted.

Collapse. Down. Decline. Those words should have been time bombs in our fourth-floor mortgage sector, as if someone had yelled "Satan!" in the Sistine Chapel. But they were not. They were ignored.

And Rosenberg wasn't finished yet, not by a long shot. He reminded everyone that the U.S. housing boom had been built on cheap credit, mostly financed by the shadow banks. In 2005, 43 percent of all first-time home buyers had put zero money down. This figure had risen from 27 percent in 2003. Whatever was happening was looking kind of popular, the way free houses often are.

Rosenberg, echoing Mike Gelband six months before, added that 35 percent of all 2005 mortgages had been of that highly dicey, buy-now-pay-later variety-the ARMs, negative amortizations, and interest-only loans, not to mention the truly shaky no-docs issued to the $400,000-a-year bus drivers. For the first time in years, unsold inventories of U.S. homes were ratcheting higher. And he pointed out that the more than three hundred shadow banks in the United States amounted to little more than a steroid distribution center, funded by Wall Street's creation, the collateralized debt obligation. (Today CDOs sound uncannily like the product of a snake-oil salesman: cure your ills, cure your depression, cure every d.a.m.n thing.) cure your ills, cure your depression, cure every d.a.m.n thing.) I, along with every other member of our group, could not shake off the feeling of disquiet that a price drop in the real estate market, which sparked off any form of negative home equity, would not be a pretty sight. It was a source of near-wonderment to me that hardly anyone else could see that the U.S. economy and the stock market were being pumped up by a credit bubble the size of the planet Saturn-that's nearly ten times bigger than the Earth, 235,000 miles in circ.u.mference, not including the moons and rings.

Even Time Time magazine, that bastion of reality, was swept along by the bulls. In that very same January, they mentioned that the "big-spending U.S. consumers" being fed low-priced products from China had spurred worldwide growth of over 4 percent for the second year running, the strongest two-year growth period in three decades. "And there's more good news to come," said magazine, that bastion of reality, was swept along by the bulls. In that very same January, they mentioned that the "big-spending U.S. consumers" being fed low-priced products from China had spurred worldwide growth of over 4 percent for the second year running, the strongest two-year growth period in three decades. "And there's more good news to come," said Time Time. "The world economy is on track to enjoy another b.u.mper year in 2006 as this twin American-Chinese engine continues to power ahead." Those forecasts emerged from a discussion among economists that Time Time brought together at the World Economic Forum in Davos, Switzerland, that month. brought together at the World Economic Forum in Davos, Switzerland, that month.

And many of the world's financial big-hitters went with the flow. "The outlook is basically for another Goldilocks kind of year," stated Laura D. Tyson, at the time dean of the London Business School and a former chairman of the President's Council of Economic Advisers.

I can state categorically that in our group there was not one person-not Alex Kirk, Michael Gelband, Richard Gatward, Larry McCarthy, Joe Beggans, Pete Hammack, Jane Castle, nor Christine Daley-who agreed with one word of that, Time Time magazine or not. We all thought this Goldilocks bulls.h.i.t was running on borrowed time, and that Lehman should be shorting its backside off, to compensate for the wrath to come. Especially when it smacked into the fourth floor. Not to mention the thirty-first. magazine or not. We all thought this Goldilocks bulls.h.i.t was running on borrowed time, and that Lehman should be shorting its backside off, to compensate for the wrath to come. Especially when it smacked into the fourth floor. Not to mention the thirty-first.

Just consider the dark warnings issued by these prophets in our group: Kirk called the "steroid problem" in the property market before anyone; Gelband laid it on the line to the mortgage guys before anyone else at Lehman understood the figures; McCarthy jumped on and acted upon every one of the warnings, believing them to be accurate; Castle could see the airlines collapsing at least a year in advance; Daley called the demise of the energy t.i.tan Calpine more than a year in advance; Hammack called the demise of one of the biggest publicly quoted home builders and mortgage giants in the country, and Babay supported him, almost ending up wearing a computer terminal as a New Year's party hat. We weren't on anyone's bandwagon; in fact, we put the wheels on the friggin' thing. And none of us bought Goldilocks. We didn't even buy the porridge.

And while Time Time was printing its issue and Tyson was forecasting, there were yet more ominous signs in the housing market. Perhaps the only person outside our team worth listening to was Warren Buffett, who remarked on the growth cycle, not just of real estate, but of anything: "You always have three I's. First, the innovator, then the imitator, then the idiot." Right on, Buffy Here came the idiots, going for construction, piling into the hideously swollen gargoyle of the Florida real estate market. More than 27,000 condominiums were recently completed in Miami, with permits pending for 50,000 more. In the ten years prior to that, only 9,000 condos were built in the whole of greater Miami. And of course there was the automatic response there always is at the top of an out-of-control bull market-in this case, was printing its issue and Tyson was forecasting, there were yet more ominous signs in the housing market. Perhaps the only person outside our team worth listening to was Warren Buffett, who remarked on the growth cycle, not just of real estate, but of anything: "You always have three I's. First, the innovator, then the imitator, then the idiot." Right on, Buffy Here came the idiots, going for construction, piling into the hideously swollen gargoyle of the Florida real estate market. More than 27,000 condominiums were recently completed in Miami, with permits pending for 50,000 more. In the ten years prior to that, only 9,000 condos were built in the whole of greater Miami. And of course there was the automatic response there always is at the top of an out-of-control bull market-in this case, There are between 75,000 and 100,000 retirees a day flooding into Florida There are between 75,000 and 100,000 retirees a day flooding into Florida. Yeah, right, trying to keep up with the death rate.

In company with Peter Sch.e.l.lbach, I stared down at the figures for the southern construction boom. "There's always reasons at the top why we're going higher," he said. "And there's always reasons at the bottom why we're going lower. But this has got to be a top."

Aiding and abetting in this dizzying rampage around the top of the mountain were Lehman Brothers' two in-house write-'em-up, knock-'em-out mortgage brokerages, BNC and Aurora. Neither of them showed any signs of applying the brakes. These were outfits that fed on the optimism, nurtured the expansive ambitions of our mortgage team, and joined in the universal celebration of the boom times which would never end. They never even spoke to us, never even knew us, as we never really knew them.

In the first quarter of 2006, BNC was lending more than $1 billion a month. Aurora, the Alt-A market specialist, was right up there in the top three in this market for no-down-payment mortgages, which was in the process of growing from $190 billion to $400 billion in under three years. And of course this meant they had to keep growing, faster, faster, faster.

We all knew this meant their standards must be dropping. When there is heavy pressure to grow, those standards always drop. Mortgages that didn't meet the proper company requirements were surely being approved. They'd already dispensed with borrowers having to prove anything, either income or a.s.sets.

It had to be risky, and we were the corporate experts on trouble, identifying it whenever and wherever it lurked. Anyone wanted our opinion, we'd give it: we'd research the shaky area, and come up with a reason to either go short or forget it. Distress was our game. We'd have blown the whistle on BNC and Aurora a long time before anyone else did. That was our business, even in this bust-the-rules, make-the-sale Wild West real estate market of 2006.

The truth, unhappily, was that for Lehman's mortgage guys it wasn't about the loan. It was about getting the parts (mortgages) for their securitizations. Even if money was lost on a mortgage, no one cared. They made the money up tenfold on the securitization process. And, with the help of the ratings agencies, they thought they had the risk all figured out, as they packaged and sold the CDOs. If there was a high risk attached to any given security, a higher interest rate was paid.

The least risky securities carried that AAA seal of approval by the credit-rating agencies. The problem emerging, in the opinion of our group, was that all of the loans carried about ten times more risk than the agencies thought. Some of the ratings, we suspected, had been issued on the south side of ridiculous. And every time we looked at the consumer spending charts or the mortgage origination chart, there grew a sneaking suspicion that we were somehow on the verge of the greatest debt binge in the history of global finance. Worse yet, it was emanating from the United States of America.

Starting in 2001, when Alan Greenspan dropped interest rates to 1 percent, the chart that tracks U.S. consumer debt as a percentage of income suddenly broke out, upward. It showed an alarming rise from the acceptable average of between 95 percent in a recession and 85 percent in boom markets. But now, in early 2006, it was on a relentless ascent, driving through 135 percent and still rising.

But perhaps the most thoroughly alarming of all the charts we studied, week in and week out, was the one that tracked the amount of debt Wall Street had repackaged, rebranded, rerated, and remarketed. We now called them RMBSs, CDOs, CLOs, and G.o.d knows what else. But they really were only debt, U.S. consumer and U.S. corporate debt. The chart showed that in the year 2000, the number was $1 trillion. In 2005, the number was $2.7 trillion. That's in the new modern language you need to describe a pile of $100 bills 475 miles high. Which is, by the way, beyond the pull of gravity.

Alex Kirk, Peter Hammack, and Ashish Shah, our global managing director, the a.n.a.lysis king of structured credit derivatives for the entire firm, were in no doubt. Lehman's foreign sales of these securitizations, especially to Europe, were astronomical, up 600 percent in six years. Every month we sold them more. And our relationships with banks and funds in Asia were often stronger. We were selling them securitized debt like lottery tickets.

Globalization-we darn near invented it, and we were quick to praise it: the global economy, the security of the banking brotherhood, the the global economy, the security of the banking brotherhood, the interdependence, the global safety in numbers interdependence, the global safety in numbers. Someone estimated that 23 percent of all Wall Street's revenue stream for the last three years flowed out of securitization sales.

I had a different perspective. Globalization was when a financially strapped subprime mortgage holder in Stockton suddenly defaults, dumps his house keys in the mailbox, and then vanishes-and the $300,000 default shows up on the balance sheet of a side-street bank in Shanghai, Singapore, Tokyo, or London. That's Globalization with a big G G. G.o.d help everyone if the default number ever went high, into, say, the thousands.

This was plainly a beginning. Our group had identified beyond any reasonable doubt that this thing was about to turn bad. There were trouble spots throughout U.S. industry, and the world was exploding with derivatives-the intangible financial products that Warren Buffett first described as "weeds priced as flowers" and later branded "financial weapons of ma.s.s destruction."

Have you ever noticed how, both in life and in corporations, one small piece of economy with the truth often leads to full-blooded deceit and then a copper-bottomed southern-fried lie? And following right behind that lie, you usually find a real shady area, a kind of no-man's-land where no one goes, not even in discussion with each other. We had one of those at Lehman. A deep dark secret. Matter of fact, it was the deepest and darkest you could get. Its name was Grand Cayman.

For there, in that sun-drenched Caribbean paradise set 170 miles south of the western end of Castro's Cuba, Lehman, in company with several other investment banks, held a controlling hand over a succession of hidden trusts. And, being Wall Street, they were awarded a truly fancy t.i.tle that no one could possibly understand: qualified special purpose ent.i.ties, or QSPEs. (Throw in the word international international, and you could have been talking about any subject, in any place, at any time on earth. Obfuscation, thy name is Wall Street.) And in those QSPEs they stored money, bonds, derivatives, and CDOs-all of which had the glorious advantage of never appearing on corporate balance sheets. They were "selling" the CDOs to the trust and reporting the sale as profit on the Lehman balance sheet. This could be regarded as somewhat eccentric, since they were effectively selling the d.a.m.n things to themselves.

Altogether, the Grand Cayman connection provided three big advantages to a firm like Lehman Brothers, which was trying desperately to compete with the biggest banks on Wall Street. The first was entering false profits from the "sale" onto the balance sheet. The second was receiving all the coupon payments from the derivatives they still held in the trusts. The third was that the Financial Accounting Standards Board (FASB) required them only to put aside 3 percent of capital, a tiny amount, to cover any losses in an offsh.o.r.e trust.

This 3 percent requirement was the highly controversial Rule 140, written in 2000, and the one Enron broke most spectacularly on its way to universal disgrace. They could not come up with the 3 percent when asked by the government, despite claiming to have made huge profits. That 3 percent brought them down: they were forced to admit insolvency and file for bankruptcy. In 2003 FASB attempted to raise the threshold to 10 percent, but the banks reacted with fury, arguing about the major impact such a rule would have on them. The banking lobby had not been so up in arms since Bill Clinton first declined to sign the Gla.s.s-Steagall repeal into law nearly ten years previously. Citigroup had ma.s.sive holdings offsh.o.r.e, and their comptroller almost had apoplexy. He publicly stated on behalf of the global giant that Citi would be "significantly impacted" if the rule was changed to require 10 percent. Citigroup estimated they would have to raise $20 billion in fresh cash, which was a measure of the extent of their offsh.o.r.e, off-the-record, off-the-hook, off-balance-sheet holdings on the Caribbean island of dreams-sorry, schemes. In late 2003, after intense political pressure, FASB backed down, thus proving that the Securities and Exchange Commission was definitely still asleep, allowing Wall Street to careen forward, unchecked, unregulated, and unaccountable. Wall Street, of course, knew the SEC was still asleep, and, generally speaking, hoped to h.e.l.l it would stay asleep.

This lack of regulatory oversight allowed Lehman Brothers to continually visit the short-term commercial paper market and borrow more and more money-ma.s.sive amounts, billions of dollars-always pledging their new toys as collateral. You'd have thought someone might have yelled "Stop!" or "Basta!" "Basta!" or or "Arret!" "Arret!" or or "Achtung!" "Achtung!" or even "Holy s.h.i.t!" because the toys were bought with borrowed money. And those toys were time bombs despite their fancy names: RMBS, CDO, CLO, CMBS. It was like an arms race of leverage on Wall Street, and it all started with the demise of Gla.s.s-Steagall, the firewall that had kept the mighty commercial banks separate from the ambitious, fleet-footed investment houses. But now they were legally together, with one bank outdoing the next, pushing the leverage envelope, borrowing on an unprecedented scale, getting rid of the evidence that said they couldn't afford it. And there was no way for anyone accurately to measure the risk. or even "Holy s.h.i.t!" because the toys were bought with borrowed money. And those toys were time bombs despite their fancy names: RMBS, CDO, CLO, CMBS. It was like an arms race of leverage on Wall Street, and it all started with the demise of Gla.s.s-Steagall, the firewall that had kept the mighty commercial banks separate from the ambitious, fleet-footed investment houses. But now they were legally together, with one bank outdoing the next, pushing the leverage envelope, borrowing on an unprecedented scale, getting rid of the evidence that said they couldn't afford it. And there was no way for anyone accurately to measure the risk.

But the battle to reform Rule 140, involving some members of the government and the Wall Street heavies-the guys who came up with the big political contributions-was developing into a knockdown-drag-out contest. And with a presidential election not so far away, the bankers were punching way above their weight.

The issue was truly simple: leverage. If a new rule came in that forced the banks to haul their billions down the Cayman beaches and back to Wall Street, all h.e.l.l might break loose. Because they would no longer be dealing with 3 percent offsh.o.r.e. They'd be looking at a domestic 10 percent holdback, to cover U.S. losses, standard procedure in banks throughout the nation since the Revolutionary War. This would have the obvious effect of depleting the balance sheets. Not only was holding back capital unacceptable emotionally, but most of the banks simply did not have it-especially Lehman, which was now leveraged thirty to one. If that rule was changed, the U.S. government might have to face up to a rash of bankruptcies in the financial capital of the world. Alan Greenspan was plainly wary of damaging the banking system with regulations and controls while the game was still in progress. But the risks and the leverage kept right on piling up.

The regulators continued to delay, never imposing the stricter rules, which would bring the inevitable deleveraging-the only way to slow down a market like this. They had let the gra.s.s grow four feet high because they were afraid of damaging the lawn.

Once more utilizing my perfectly astounding grasp of events aided by hindsight, I have to say that none of this was obvious at the time; not even to the line of crystal b.a.l.l.s that decorated the desks of my group at Lehman. But it was one giant SEC procrastination, fueled by an overriding sense of not wishing to face the harsh discordant music of deleverage, which means getting smaller fast.

At that time, however, Ashish Shah and I did speak about the situation and concluded that there was a clear danger the way everyone was dragging their feet about disclosure of off-balance-sheet a.s.sets. It plainly could not last. Somehow it would have to come to light.

Looking back, it's clear the revenues were always what really mattered in the secretive boardrooms of Manhattan. Because those revenues mean bigger bonus pools, and that meant more money for the partners, very flashy houses in the Hamptons, beautiful cars, and fine art collections. Wasn't life absolutely great?

For all of us, the bonus pool was of paramount importance because the bonus represented most of our income. That's how we were paid. We also were paid half of our compensation in our own corporate stock. And everyone knew the inevitabilities of life. We had to earn the money to keep the profits and the stock high. Otherwise we were all spinning our wheels financially. Many of us were naturally far less ruthless than others, and many of us had a clear moral code about what was right and what was clearly wrong, but we were all working at the very sharp end of Wall Street, and making money was our game.

We were all more or less on the same salary. It was the bonus that made the difference. For instance, I needed to make $20 million for the firm to earn $1 million in bonus for myself. And I strived to do so, writing up my order book with immense diligence every day, recording the wins, recording the losses. Right next to me, the vastly experienced Larry McCarthy had a huge pool of money to play with because of his track record and length of service. Therefore he would always earn more than I could until I could increase my own money pool by making winning trades and building my own track record. It was always about money, nothing else.

I had an excellent first year, and I read somewhere that the average Wall Street bonus was almost 250 percent bigger than the average salary for all nonfinancial jobs in the city. Since 2003, thanks to the derivatives, our total compensation had increased by 49 percent. Which, when you stop to think about it, is on the high side. But that's what it was all about-record leverage, record bonuses.

In a sense, when any of us took a position, we were putting not only the firm's money but also our own bonuses on the line, our own personal wealth and annual income. This, I a.s.sure you, is apt to concentrate the mind. None of us takes lightly any position in the market, long or short. And when we do, it takes real courage. The same applied to the researchers, those hard-eyed corporate detectives upon whose words the traders depended.

Thus, in that cold New York January of 2006, everyone sat bolt upright and paid attention when Christine Daley made an observation about General Motors, once the world's largest automaker, and still employer of around 266,000 people in thirty-five countries. "I am ninety-nine percent certain," said Christine, "that General Motors is going bankrupt. It's not even a car company; it's a health care provider with an auto manufacturer on the side."

Of course, GM's troubles had been around for many years, and forecasts of doom were not earth-shattering items of news. But Christine Daley's business was to identify major problems in major corporations, and when she spoke up professionally, it was to recommend that Lehman Brothers invest millions of dollars in a short position. And this time it was on the Detroit car giant.

In her opinion, General Motors could not live. She cited their huge retiree health care and pension program, which covered more than 1.1 million people and entailed a total obligation of $56 billion, which the corporation could not possibly go on supporting. GM, said Ms. Daley, was engulfed by its obligations. She spoke of those now notorious GM job banks, possibly five thousand strong, where GM workers who had been laid off sat around in vast cafeterias reading and still received $30 an hour. She spoke of continuing problems with union cooperation, of GM's 2005 loss of $8.6 billion. She argued that every move GM made was creating long-term devastation for bondholders. She actually considered that if GM did not get rid of GMAC, their car financing and mortgage corporation, they might be gone by Christmas. Her last and final warning involved the burgeoning commodities market, fueled by the fact that China, in the run-up to the Olympics, appeared to want all of the world's steel, iron, rubber, zinc, and G.o.d knows what else. Commodities, in Christine's view, were going through the roof, and GM needed those commodities but could not possibly pay the price. "That," she said, "will finish them." She was planning, she noted, to make a presentation in March to the entire fixed-income division, and expected to demonstrate that this was indeed the time for one of the most almighty short positions Lehman had ever taken.

The GM stock price was already down below $19, and as a group, we elected to take a gamble on Christine's logic. We made some initial short positions in GM stock, starting out at $20, a.s.suming the market would immediately notice the problems that were slowly strangling the auto manufacturer. But the stock instantly jumped up $2 and we covered our position-that's trader-speak for "all bets are off." We waited for the rally to end and then went back in, shorting GM at $24, expecting a quick sell-off. It never happened. GM went to $27.

Then Forbes Forbes magazine came out with a sad and melancholic examination of the company, headlined "The Tragedy of General Motors." It was as if Christine Daley had stood at the elbow of the author. The conclusions were identical: how could the Detroit colossus possibly continue? Nothing could have spelled out the plight of GM with more d.a.m.ning and sorrowful evidence. This was no witch hunt. This was a shrewd and professional a.s.sessment of the situation, and it was delivered by a national magazine upon whose word great judgments were made, right down to who was the richest person in the country. Forbes had a voice, a big, booming voice that, when it issued a warning, would surely be heard. magazine came out with a sad and melancholic examination of the company, headlined "The Tragedy of General Motors." It was as if Christine Daley had stood at the elbow of the author. The conclusions were identical: how could the Detroit colossus possibly continue? Nothing could have spelled out the plight of GM with more d.a.m.ning and sorrowful evidence. This was no witch hunt. This was a shrewd and professional a.s.sessment of the situation, and it was delivered by a national magazine upon whose word great judgments were made, right down to who was the richest person in the country. Forbes had a voice, a big, booming voice that, when it issued a warning, would surely be heard.

We went back in and placed the trade for a third time, shorting the stock at $27, confident the high debt load would finally drive it down. GM went to $31. Again we covered our position and bailed out, and that evening we caucused with Christine Daley, who thought the world must have gone mad. She was apologetic, angry, and slightly embarra.s.sed.

But we had all forgotten one thing-the stock market in 2006 was not a normal stock market. It had an element of death-defying bravado about it, a prolonged denial of the obvious. Under the weight of $32 billion worth of debt, deteriorating cash flow, and insurmountable obligations, General Motors stock soared to $32. We at Lehman could have caught a very nasty cold, several million dollars' worth, and the old bonus sheets would have taken a full-blooded hit from this runaway Humvee.

But we were accustomed to an iron form of discipline, always prepared to take the hit before it grew into something serious. In this case we had covered three times, getting out and suffering only minor damage, limiting our losses. Alex Kirk pulled Larry and me aside and said "the market can stay irrational a lot longer than your trading ledgers can stay solvent. Cover the GM now." That's the way of the professional. Only a d.a.m.n fool takes a position for a specific reason and then marries it when it goes the wrong way. You have to get out the instant it goes wrong, and the road to h.e.l.l is paved with those who did not do so.

I mention this as one of the great shining examples, way beyond the derivatives, of a market that did not want to hear bad news and could not understand potential danger of leverage in the system. It was a pure one-way transmission. Wall Street was listening for calm seas calm seas, record profits, best-ever growth, joy, wealth, prosperity record profits, best-ever growth, joy, wealth, prosperity, and b-o-o-o-o-n-u-u-s b-o-o-o-o-n-u-u-s. Anything less was essentially out of the culture.

And there was nowhere, repeat nowhere, on the planet Manhattan where this hyperoptimism, this self-aggrandizing, preening success story, applied in greater measure than at Lehman Brothers, the sorcerers of securities. When we shorted GM and were proved temporarily a bit hasty, there were those in the firm who nodded wisely at the obvious folly of our little group of pseudo-pessimists who could not understand the reality of modern investing.