Category Archives: Books

The following is an excerpt from Liar’s Poker by Michael Lewis. Liar’s Poker is a semi-autobiographic novel of Michael Lewis while working as a bond salesman at Solomon Brother’s during the 1980s.

Interestingly, Michael Lewis never intended for Liar’s Poker to contain any techniques or knowledge applicable to investing or trading, but I believe there are some great lessons contained in the book. The key takeaways are:

1. The market tends to overreact to significant events, and it pays to be a contrarian.
2. Analyze and act on secondary and tertiary effects to significant events quickly before the market becomes aware of them.

Alexander was unique, the closest thing I met to a master of the markets, which, I’m now convinced, no man really is. He was twenty seven, two years older than I, and had been with Salomon Brothers for two years when I arrived. He had grown up trading a portfolio of securities. He recalls making a killing in the stock market while in the seventh grade. At the age of nineteen he lost ninety-seven thousand dollars on U.S. treasury bill futures. He was not, in other words, a normal child. Once he learned to ride his gains and cut his losses, he never looked back. What he lost in t-bills, the made back several times in gold futures.

Alexander knew how to exploit the world’s financial market. What’s more, as a salesman he knew how to sound as if he knew how to exploit the world’s financial markets, and he had the same effect on other men in our little world as sirens have on sailors. Within months after he moved from London and onto the forty-first floor in new York, he had been discovered by a handful of managing directors who wanted to know what to do with their own money. You’d have thought they’d be comfortable making their own investment decisions, but they weren’t. Each day they’d ask Alexander for advice. To get it, however, they had to stand in line behind Alexander’s clients and me. Alexander was a salesman, but like all the very best salesman, he had the instincts of a trader. His customers – and his bosses – simply did whatever he told them to.

Alexander had a knack for interpreting events around him. The most impressive aspect of this was its speed. When news broke, he seemed to have already planned his response. He trusted his nose completely. If he had a flaw, it was that he lacked the ability to question his own immediate reactions. He saw the markets as a tightly woven web. Yank on one filament in the web, and the other filaments had to move, too. He therefore traded in all markets. The bonds, currencies, and stocks of France, Germany, the United States, Japan, Canada, and Britain; the markets in oil, precious metals, and bulk commodities – all interested him.

The luckiest thing that happened to me during the period I spent at Salomon Brothers was having Alexander take me into his confidence. We met when I replaced him in London. For two years prior to my arrival, he had worked for Stu Willicker and beside Dash Riprock. When we met, he was returning to New York, to be a bond salesman on the forty-first floor. There was no reason for him to watch over me. Except for the mango tea which he required me to smuggle in bulk to him from Paris, there was nothing in it for him. It was a genuinely selfless act, which I recount only because at the time it seemed so incredible. It was as if he had bought hares in my future and were determined to make the trade come right. We spoke at least three times each day and as often as twenty. The conversations during the first few months consisted of his talking and my asking questions.

My job was a matter of learning to think and sound like a money spinner. Thinking and sounding like Alexander were the next best thing to being genuinely talented, which I wasn’t. So I listened to the master and repeated what I heard, as in kung fu. It reminded me of learning a foreign language. It all seems strange at first. Then, one day, you catch yourself thinking in the language. Suddenly words you never realized you knew are at your disposal. Finally you dream in the language. It seems odd now to to think of dreaming of moneymaking schemes. But it didn’t seem terribly out of the ordinary when I woke up one morning thinking that there was an arbitrage available in Japanese bond futures. That morning I looked into the Japanese market, saw that it was indeed the case, and wondered why I had dreamed of it, since I couldn’t recall having ever spoken of the subject. Gobbledygook to you, perhaps. A second language to me.

Many of the trades that Alexander suggested followed one of two patterns. First, when all investors were doing the same thing, he would actively seek to do the opposite. The word stockbrokers use for this approach is contrarian. Everyone wants to be one, but no one is, for the sad reason that most investors are scared of looking foolish. Investors do not fear losing money as much as they fear solitude, by which I mean taking risks that others avoid. When they are caught losing money alone, they have no excuse for their mistake, and most investors, like people, need excuses. They are, strangely enough, happy to stand on the edge of a precipice as long as they are joined by a few thousand others. But when a market is widely regarded to be in a bad way, even if the problems are illusory, many investors get out.

A good example of this was the crisis at the U.S. Farm Credit Corporation. It looked for a moment as if Farm Credit might go bankrupt. Investors stampeded out of Farm Credit bonds because having been warned of the possibility of accident, they couldn’t be seen in the vicinity without endangering their reputations. In an age when failure isn’t allowed, when the U.S. government had rescued firms as remote from the national interest as Chrysler and the Continental Illinois Bank, there was no chance the government would allow the Farm Credit bank to default. The thought of not bailing out an eighty-billion-dollar institution that lent money to America’s distressed farmers was absurd. Institutional investors knew this. That is the point. They people selling Farm Credit bonds for less than they were worth weren’t necessarily stupid. They simply could not be seen holding them. Since Alexander wasn’t constrained by appearances, he sought to exploit people who were. (The occupational hazard of his role was an ugly elitism; you begin to think everyone else is stupid.)

The second pattern to Alexander’s thought was that in the event of a major dislocation, such as a stock market crash, a natural disaster, the breakdown of OPEC’s production agreements, he would look away from the initial focus of investor interest and seek secondary and tertiary effects.

Remember Chernobyl? When news broke that the Soviet nuclear reactor had exploded, Alexander called. Only minutes before, confirmation of the disaster had blipped across our Quotron machines, yet Alexander had already bought the equivalent of two supertankers of crude oil. The focus of investor attention was on the New York Stock Exchange, he said. In particular it was on any company involved in nuclear power. The stocks of those companies were plummeting. Never mind that, he said. He had just purchased, on behalf of his clients, oil futures. Instantly in his mind less supply of nuclear power equaled more demand for oil, and he was right. His investors made a large killing. Mine made a small killing. Minutes after I had persuaded a few clients to buy some oil, Alexander called back.

“Buy potatoes,” he said. “Gotta hop.” Then he hung up.

Of course. A cloud of fallout would threaten European food and water supplies, including the potato crop, placing a premium on uncontaminated American substitutes. Perhaps a few folks other than potato farmers think of the price of potatoes in America minutes after the explosion of a nuclear reactor in Russia, but I have never met them.

But Chernobyl and oil are a comparatively straightforward example. There was a game we played called What if? All sorts of complications can be introduced into What if? Imagine, for example, you are an institutional investor managing several billion dollars. What if there is a massive earthquake in Tokyo? Tokyo is reduced to rubble. Investors in Japan panic. They are selling yen and trying to get their money out of the Japanese stock market. What do you do?

Well, along the lines of pattern number one, what Alexander would do is put money into Japan on the assumption that since everyone was trying to get out, there must be some bargains. He would buy precisely those securities in Japan that appeared the least desirable to others. First, the stocks of Japanese insurance companies. The world would probably assume that ordinary insurance companies had a great deal of exposure, when in fact, the risk resides mainly with Western insurers and with a special Japanese earthquake insurance company that’s been socking away premiums for decades. The shares of ordinary insurers would be cheap.

Then Alexander would buy a couple of hundred million dollars’ worth of Japanese government bonds. With the economy in temporary disrepair, the government would lower interest rates to encourage rebuilding and simply order the banks to lend at those rates. Japanese banks would comply as usual with their government’s request. Lower interest rates would mean higher bond prices.

Also, the short-term panic could well be overshadowed by the long-term repatriation of Japanese capital. Japanese companies have massive sums invested in Europe and America. Eventually they would withdraw those investments, turn inward, lick their wounds, repair their factories, and bolster their stock. What would that mean?

Well, to Alexander, it would suggest buying yen. The Japanese would buy yen, selling their dollars, francs, marks, and pounds to do so. The yen would appreciate not just because the Japanese were buying it buy because foreign speculators would eventually see the Japanese buying it and rush to join them. If the yen collapsed immediately after the quake, it would only further encourage Alexander, who sought always to do the unexpected, that his idea was a good one. On the other hand, if the yen rose, he might sell it.

Each day Alexander called and explained something new. After several months of struggling I began to catch on. When Alexander hung up, I would call three or four investors and simply parrot what Alexander had just said. They would think me, if not a genius, then at least astute. On the basis of what I told them, they put money on the line. They made handsome profits, just like the investors to whom Alexander spoke. Soon they were calling me. Before long they wouldn’t speak to anyone else but me. That would do whatever I, meaning Alexander, told them to do. This would soon prove very valuable.

-Liar’s Poker, pp. 172 – 177.

Liar’s Poker is one of the classic Wall Street texts. Read the reviews of Liar’s Poker on Amazon.