Matt Levine runs the “Money Stuff” newsletter, one of the most irreverent and informative guides to the absurdities of the financial world. He is an experienced journalist covering Wall Street, and is also one of the few people in the press who can both understand and explain complicated economic issues! Our own Sparky Abraham and Lyta Gold spoke to Levine in New York City about Ponzi schemes, sociopathy, insider trading, and Martin Shkreli…
SPARKY ABRAHAM: Sometimes you talk about the relationship of doing well or being profitable as a trader in finance versus being a good salesman, which is kind of like being a magician. One of the things you’ve said is that making money as a hedge fund manager is kind of secondary to the primary measure of success as a hedge fund manager, which is whether you can get people to invest in a hedge fund.
LYTA GOLD: To get them to believe that you’re good at this.
MATT LEVINE: Well, it’s a constellation of things. One thing is you need to go to people and say: “Give me money, I’m good at this.” Another thing you have to do is you have to be clever about how you keep their money, because there is a range of terms for hedge funds. One thing to do is say “Give me money, and if you ever want it back, you’ll have it back with 10 days notice.” Another thing is to say “Give me your money, and if you ever want it back, you have to give me a year’s notice, and I’ll give you a quarter of your money each year after that. Or I’ll raise a public vehicle in the Netherlands or whatever, and you can give me money, and then if you want to get your money back you can sell it to someone else.” If you do that, that’s partially a marketing thing, but mostly a legal obstruction. If you do that, and then you lose a lot of money, like half your money, you still have the other half. Whereas if you’re a regular hedge manager and you lose half the money, the people take out the other half. So it’s not just like having a nice smile and a firm handshake. There’s an intellectual endeavor to keeping their money, which is totally separate from investing well.
LYTA: There’s almost a possible Robin Hood thing. Like taking rich people’s money and saying, “Oh no, it’s disappeared, it’s gone to these secret places.” You could benefit regular humans.
MATT: No one’s done that. Oddly!
LYTA: Maybe someone should. I guess you’d probably get in trouble.
MATT: Well the attributes that make you good at this aspect of the hedge fund manager job, and the attributes that make you want to distribute the money…
SPARKY: Another thing you write about a lot, which is a little bit related to this, are the scammers.
MATT: I love scammers! I want to distinguish here. There’s a world of high finance that has the real intellectual content and has norms that are not necessarily intuitive to the average person or the average prosecutor. And so those norms will sometimes be surprising when they’re exposed. But then separately there are just pure thieves, who’re usually not at big banks—not never, but usually these are just thieves who run weird Ponzi schemes that are funny.
LYTA: Ponzi schemes are so great. Why do people keep doing them?
MATT: Because they keep working.
LYTA: It’s amazing that they work. I just love it.
SPARKY: Why do they keep working?
MATT: Because the stuff is hard, because the people are not financially literate, because people have a series of psychological biases. My favorite scheme is not the Ponzi scheme. I’m not going to name a particular thing; it’s a concept that’s called, it has different names—“the prime bank scam” is a pretty common name for it. Those words don’t really mean anything. There’s a phenomenal book by Guy Lawson called Octopus, which is the best scam book. So the prime bank scam, the pitch is so simple: There is a market that the big banks use to trade paper, commercial paper, prime loans, prime paper, or prime bonds.
SPARKY: These are made-up names.
MATT: Just whatever. Sometimes it will coincide with the name of a real thing. It doesn’t matter; it’s all made-up shit. The banks trade this stuff secretly in trillion dollar increments. And I can give you access to that market and you can come in and trade these “prime bonds.” The basic thing is just like the Nigerian Prince scam or anything else: I just need a little bit of money. But the pitch is that there is a secret world that is outside of your knowledge, and I’m inviting you into that secret world. It’s like Hogwarts. It’s such a primal human feeling of “I am not special, somewhere the special people are doing special things. Now I have been invited to be a special person, and I deserve it. And so I’m going to make a billion dollars trading prime bank loans.” Why does that keep working? Why do people read Harry Potter? It’s just such a basic archetype.
LYTA: People know that Harry Potter isn’t real though. So you’ve got people being pulled into thinking that this is the real thing.
MATT: But it’s like all of human—what is the Trump phenomenon, if not like, “I’ve taken the Red Pill”?
LYTA: It’s a lot like YouTube conspiracy theories.
SPARKY: Forbidden knowledge.
MATT: There’s some secret knowledge out there that I have, and now I’m special. And the Prime Bank scam is like that, and what’s amazing about Octopus is the first half of it is the story of Sam Israel, who starts as a hedge fund manager, and it becomes a Ponzi scheme. He’s a hedge fund manager who loses some money and he says, “Well, I’ll just make it back by lying to people,” and then he just ends up running a Ponzi scheme. And it’s a common story. The second half of the book is him saying, “I really need to make up this money” and some guy comes to him and says the banks trade these prime bank loans at night. And he’s like, “I’ll look into this.” And they totally run this scam on him. They run the scam on the hedge fund manager who still has tens or hundreds of millions of dollars that he hasn’t lost, which he then loses on the Prime Bank scam. No one knows who they are. These guys disappear. They take [Israel] to a bank at night. It’s like The Sting where they rent an office and change the sign. They take him to a bank at night, and they say they only trade at night. The one guy who’s in on [the scam] lets them in, and they turn on one computer so he can watch the terminal’s lights blink. And then he goes “Sure, here’s a billion dollars.” And then it gets even crazier. It’s amazing because it’s not just the poor idiots. It’s a whole range. I think everyone wants magic to exist. This guy’s a hedge fund manager; he knows these things aren’t real, or he should.
SPARKY: I mean that’s the crazy thing that took me a while to realize, that Ponzi schemes are not just like individual old rich ladies who are getting caught up in this stuff. Actually, that was sexist; not just old rich people.
LYTA: I’ll allow it. You won’t be fired into the sun today.
MATT: Ponzis are in some ways less interesting than the Prime Bank scams. If you look at Bernie Madoff, that trick is kind of straightforward. He’s a pillar of the community, and he’s promising low stable returns. And people were like, alright I’ll take low stable returns. Because Bernie Madoff was a big respectable guy running a big market-maker, and he was just running a Ponzi scheme, and all these big respectable people gave him all their money. Most Ponzis are stupider than that; they say they’ll give you high investment returns, and most people say, I like high investment returns.
SPARKY: I don’t mean to totally turn this sad, but the Octopus story is kind of sad too.
MATT: Of course it is! It’s terrible.
LYTA: I like octopuses though.
SPARKY: I do love octopuses; I have cephalopod paraphernalia—that’s a squid. [pointing to a squid sticker on his laptop] But, so I didn’t actually read Octopus, but I know there’s a book called Scarcity that’s sort of about the cognitive effects of being under stress about resources. Obviously the guy you’re talking about, Sam Israel, he wasn’t under stress about resources in the same way that the book talked about, which is people with very, very low incomes with high costs, but you can kind of see the same thing. One of the things that happens is sort of like tunnel vision, and you kind of lose your ability to see under stress.
MATT: Sure, [Israel] was under a ton of stress because he was running a Ponzi scheme. One reason I’m interested in scammers is because they’re funny, but it’s also rare, not never, but it’s rare that you really look at them and they’re pure sociopaths. “I’m gonna rip people off.” Not never; actually a fair number of them. But a lot of them, it’s much more like you think you’re good, you have one bad quarter; some combination of it doesn’t fit with your self-conception, and you feel shame in front of your investors. So you’re going to move a few things around, and then it just snowballs, and then you can’t just admit the lie. “What am I gonna do?” And then it just snowballs into going to banks at night and doing the Prime Bank scam. But at each step along the way you can sort see how [the scammer] did that, and it ends up in a terrible place.
SPARKY: Can you think of any examples of the more sociopathic kind?
MATT: Martin Shkreli is a fascinating case because he’s such a famously bad guy. He clearly has some sort of personality issues. But leaving aside the drug prices which is arguably sociopathic—there are people who defend it.
LYTA: Those people are sociopaths.
MATT: Leaving aside the threats on Twitter and all the crazy stuff—
SPARKY: Wu-Tang album, which I feel was actually an unforgivable act.
LYTA: Oh yeah, war crime.
MATT: Yeah, well they were going to sell it. Most of the bad stuff they did. He was just the buyer.
SPARKY: That’s true. That was on the Wu-Tang Clan. I mean I’m not going to say he was just the buyer but yeah.
LYTA: He was shitty once he got it.
MATT: He’s terrible in most ways, but just focusing on the stuff that he was charged and convicted of criminally, which was just a series of quite Ponzi-like activities… He ran a hedge fund, and he basically lost everyone’s money. And then he lied to them about it. He was like, well I’m just putting your shares into this other hedge fund. And then he lost their money again.
LYTA: Fucking failsons.
MATT: And then he’s like, I’ve redeemed you into these shares of this company that I started. And that company was a wild success, and they all made back all their money! It’s really weird. Leaving aside the fact that his company was a wild success, which was really surprising, not how these things usually end, and he still goes to prison for it. Usually you go to prison when the third thing is also a failure. Leaving that aside, it’s plausible that he wasn’t actually stealing the money; he’s actually investing it and losing it, and then just lying about it. The narrative of every step was sort of understandable. Filtered through his abrasive personality, it’s still kind of there; he’s still doing the same thing as every other Ponzi scheme. The more sociopathic—I hate to—
SPARKY: You don’t want to single out the sociopaths?
MATT: There’s an elephant in the room of a person who has recently been criminally charged with fraud, and who there’s been a lot of discussion about that person being a sociopath. I just don’t know; I just don’t want to comment on that.
SPARKY: That’s fair. But I actually don’t know who the elephant in the room is. So maybe I’ll go back.
LYTA: Do we mean sociopath as someone who literally has no ability to make moral choices, someone with a mental illness, or do we mean somebody who is just acting in an extremely shitty way?
SPARKY: I’m not really a fan of talking about people as sociopaths no matter what they might have done or what their motivations might have been.
MATT: I don’t actually think Martin Shkreli is a sociopath; I think he’s got a weird and abrasive personality, some of which is an act, some of which he thought would be helpful to him in some way.
SPARKY: An act which arguably may have worked for him in some ways.
LYTA: Fun fact about Martin Shkreli: He went to high school with a friend of mine. Knew him, he was always a total douchebag apparently, but my friend ended up going to his 24th or 25th birthday party. Shkreli had just made his first big bunch of money, and they rented a penthouse for the party, and he swaggers into his party with his arms around two blonde babes. He thought he was really hot shit.
SPARKY: Did that ever stop being his attitude?
LYTA: I don’t think so, but it’s pretty remarkable to see was doing a job that was rewarded. He was only doing it poorly because he lost all those people’s money.
MATT: Eventually he made it back.
SPARKY: So the fact that Martin Shkreli ended up going to jail is kind of interesting because he didn’t really lose all these people’s money in the end. We’ve been having conversations between ourselves about how there’s a kind of knee-jerk reaction even among people who might tend more toward prison abolition-type views to be ok with punishing white collar criminals.
MATT: Absolutely. I find it discouraging… I’m not a big believer in putting people in prison if it can possibly be avoided. And I think that there are a lot of people who are like, we should not put nonviolent first-time offenders in prison, and then there are people who are like, “Actually we should go way beyond that and significantly reduce prison for repeat and violent offenders,” and then there are people who are like, “every nonviolent first-time offender who insider-trades”—the most ridiculous minor crime—”should go to prison for 30 years.” I really think the evidence is so overwhelming that every time we move to create harsher punishments for some thing—because we see rich white people who have done that thing and we want them to not get away with it—every time that happens it leads to increased incarceration for poor people of color. That’s like a universal law. So when people are like, “oh, I’m a prison abolitionist, but all white-collar criminals should go to prison,” that means low-income mortgage brokers who are not the people making billions of dollars are going to prison for financial crimes. Always, always, always, always, always, means that. It’s such a clear rule and disappointing tactically to say we should put more white-collar criminals in prison. Like, “Martin Shkreli should go to prison and only him.” No, it doesn’t work that way. Separately from the utilitarian effects, it’s bad to cause harm to people. The value of causing harm to white-collar criminals is so purely expressive. It’s not deterrence, because you don’t need to be put in prison for eight years to deter insider trading. You can ban them from the securities industry. You don’t need to do it to incapacitate them. There’s no rationale for it except that we as a society like to express our anger at white collar criminals, and that is a terrible rationale.
SPARKY: We talked about this on a bonus episode for the Current Affairs podcast, and personally this is part of the reason why I really loved working the CFPB, because it kind of felt like being a prosecutor, but we didn’t put anybody in jail. The worst we could do to you is take the money that you made by doing the thing you did.
MATT: You should definitely take the money. I don’t mean that white-collar crimes should run rampant. You should not put people in prison if you can avoid it.
SPARKY: But one of the questions that we had that we didn’t really have any way to know what the answer even could possibly be is something like—I think there’s a lot of evidence out there that really long prison sentences don’t work as a deterrent for particularly violent crime. But with a lot of white-collar crimes, sometimes it seems like something that’s a little bit more cost-benefit weighed by people.
MATT: So two things: One is, yes sure, these are rational actors. Two, it seems to me, I could be wrong, but for me personally, the deterrent effect of a little bit of prison is quite high. I don’t want to go to prison at all, not even a little bit. I would sacrifice a lot to not go to prison for a month. And I don’t know if that’s universal. People can say, “Oh two years and I’ll come out rich?”
SPARKY: I don’t believe those people at all.
MATT: No. You say that. They’re wrong. They may genuinely believe that.
SPARKY: Yes, I believe them that they believe it. I don’t believe that if they knew what prison for two months was like…
MATT: So that’s one thing. The other thing—this is going to be controversial—
LYTA: Say it.
MATT: If you look at the thing that is called white-collar crime, a lot of it is questions of interpretation. So there are people who are insider trading who are often harder to deter because they’re not sophisticated people.
SPARKY: I got a good tip; I’m going to go.
MATT: The big recent insider trading case that upended the law was this Newman case where this hedge fund manager employed analysts who called investor relations people at companies and talked to them. The investor relations people, their job was to talk to hedge fund analysts. And then the hedge fund managers asked around, “what stocks should I invest in?” The analysts said this stock. And then the managers buy the stock. And then the prosecutors said when those analysts talked to those investor relations people, that was a crime. But also, when the hedge fund managers heard from the analysts that the stock would go up, that was a crime too, because they must have known the information was too good. You look at that, and you’re like, maybe. But this is not sociopath evil geniuses who are like, “Haha now I have the keys to the vault.” This is a series of interpretations and cues that to some extent feels like after-the-fact criminalization. It’s not all white-collar crimes that are like that. There are other cases I’m interested in where bond traders were lying to customers about the prices they paid for bonds. That’s bad.
SPARKY: I mean the guy was manipulating his chats.
LYTA: That’s clever. Good work!
MATT: It’s terrible, but you talk to those people and they’re like, well I was 22, I came to this bank, the people who were successful, powerful people at this big well-respected bank, and they said, here’s what you do: Tell them you paid 90 and then charge them. That’s how they were trained, and they didn’t know any better. And so they’re deterrable, but each headline is typically about prosecutors pushing the law a little bit, so how would they have been deterred if they didn’t know it was illegal? I don’t know; that’s not always true but it’s often true. That’s especially true in insider trading.
LYTA: Because at a certain point nobody could ever talk to anybody else about this at all. If you’re going to take it to the absolute extreme.
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