Exile on Wall Street

One Analyst's Fight to Save the Big Banks from Themselves

Mike Mayo

• Publisher: Wiley
• Year: 2011
• Print ISBN: 9781118115466
• eBook ISBN: 9781118203668
• Edition: 1
• Topic: Business
• Subtopic: Finance
• Index: Business

An insider points out the holes that still exist on Wall Street and in the banking system

Exile on Wall Street is a gripping read for anyone with an interest in business and finance, U.S. capitalism, the future of banking, and the root causes of the financial meltdown.

Award winning, veteran sell side Wall Street analyst Mike Mayo writes about one of the biggest financial and political issues of our time – the role of finance and banks in the US. He has worked at six Wall Street firms, analyzing banks and protesting against bad practices for two decades.

In Exile on Wall Street, Mayo:

• Lays out practices that have diminished capitalism and the banking sector
• Shares his battle scars from calling truth to power at some of the largest banks in the world and how he survived challenging the status quo to be credited as one of the few who saw the crisis coming
• Blows the lid off the true inner workings of the big banks and shows the ways in which Wall Street is just as bad today as it was pre-crash.
• Analyzes the fallout stemming from the market crash, pointing out the numerous holes that still exist in the system, and offers practical solutions.

While it provides an education, this is no textbook. It is also an invaluable resource for finance practitioners and citizens alike.

Chapter 1

“God’s Work” at the Fed

Unlike a lot of people on Wall Street, I have no pedigree. No Ivy League degree, no prep schools, no internships arranged by a well-placed uncle. In fact, my whole family is a collection of immigrants and outsiders. On my father’s side, my great-grandfather came from Odessa, Russia. In 1905, during the pogroms in that city, his brother was killed by a Cossack guard. My great-grandfather ended up strangling the guard before sneaking out of the country. He arrived in the United States at age thirty-seven, and his last name, Koretzky, was cut down to Kerr. A year later, he was able to arrange for several other family members to get out of Russia, as well, including his son, my grandfather. They entered the United States through Ellis Island in 1906, and for a while the family was so poor that the oldest son had to leave school at age twelve to sell flypaper on the street corners of South Philly.

My mom was raised in an Orthodox Jewish immigrant family in Baltimore, with very traditional values. Her father emigrated from Gomel, then part of Russia, in 1907, also via Ellis Island. Her mother died of cancer when she was just three, and she grew up in her aunt’s house. My mom was an original thinker, into sushi and yoga before either one became fashionable. I often came home to find her upside down, doing a headstand in a corner of the house. My parents split up when I was three years old, and although most people in her family never left the Baltimore area, she settled in Washington, DC. It’s only forty miles away, but it might as well have been a different planet to her family. She worked at the local TV station to support her life as a single mom with three kids. She remarried when I was five, in 1968, to the person she considered her soul mate. My mother and stepdad met at a bridge tournament where they discovered that they both enjoyed the same brand of cheap Scotch.

My stepdad—who raised me along with my mom—also immigrated to the United States, and his story is also that of an outsider. He grew up in Romania in the 1930s, and during his childhood, he watched his country go from a Romanian monarchy, to dysfunctional democracy, to dictatorship, to a Nazi takeover, and then to Communist rule after World War II. When he was seventeen, my stepdad tried to escape from the country, because of violent threats against Romanian Jews.

His goal was to get to Palestine, which was then controlled by the British. He had the equivalent of $350, money he had made by selling cigarettes, gum, and candy on the black market. His first escape attempt failed—he made it across the border to Hungary but was captured by the secret police and sent back to Romania. On his second attempt, he was again caught. On the third attempt, as with my great-grandfather, he had to kill someone in self-defense (in this case, a Romanian guard) in order to finally make it out.

In 1948, he went to Palestine to fight for the Jews’ new homeland. When I was a child, I remember him telling me that he would gladly have given his life if he knew it would have resulted in a Jewish state. That willingness to trade personal sacrifice for patriotic goals really resonated with me. It wasn’t just about getting ahead and taking care of yourself—there were larger principles at work.

Not that this got in the way of his willingness to hustle a little bit. He was street smart and spoke eight languages, in part from his dealings on the black market. For a while, he smuggled watches across the border from Switzerland into Italy. When he later wrote a memoir of this time in his life, he remembered having hundreds of them strapped to his body under his clothes, so many that he ticked like a time bomb.

He served in the Israeli navy and later the merchant marine, and he got into the United States by jumping ship in Florida, later becoming a citizen. By the mid-1960s, he landed in the Washington, DC, area, where he started and ran an aluminum-siding business. He had changed his last name after his escape from Romania; at the time of his move to Florida, he was known as “May’ami,” which was an anglicized version of the Hebrew phrase “to my nation.” In Florida, people called him “Mike Miami,” so he changed his name to Mayo. When I was growing up, every year on the first day of school I had to explain that the last name that I used wasn’t Kerr but Mayo.

My stepdad told me constantly as a kid that World War III with Russia was an absolute certainty. He slept with a handgun by his bed his entire life. I would wake up to hear him screaming profanities at his sales rep, every curse word in the book, demanding that the rep bring in more leads. I was astonished one day to find out that this salesperson was a woman, Vickie, who was good at her job and continued to work for my stepdad for years despite the daily shouting matches.

When he opened a Romanian restaurant with my mother in 1981 called the Vagabond in Bethesda, Maryland, he was comfortable speaking Spanish to the busboys and English to the customers and could hold his own in political discussions with the diplomats who came in. As my mom put it to a restaurant reviewer once, “He can speak, read, sing, and cook fluently in eight languages.” My stepdad did all the cooking at this restaurant, including recipes his mother used to make, and the place once won “Best Duck” in the restaurant section of Washingtonian Magazine. He loved vodka and cigars, and, really, he just loved life. He used to say that he didn’t want to wait to be an alter kocker, which is Yiddish and translates roughly to “old fart,” before he could enjoy himself. Once when he was traveling in France, some people said to him in French—thinking that he couldn’t understand—that his giant cigar looked like a prick. “Yes,” he shot back in perfect French, “but it doesn’t taste like one.”

When it came time for me to pick a college, I went with the University of Maryland for my bachelor’s degree, because the couple of people in my family who had attended college went there. Later I got an MBA at George Washington University at night while working full time. Both schools were good experiences—Maryland’s math department was in the top twenty in the country when I was there; GWU had a respectable business program—but neither one makes the doors fly open on Wall Street.

I know this because my early attempts to get a job there fell flat. I still have the rejection letters, every one of them. Prudential: “We have considered your background and, although it is impressive, we find that our current staffing requirements are not consistent with your objectives and abilities.” Goldman Sachs: “If we do not contact you directly, you can assume that there are no appropriate openings available.” I like looking through this folder of initial rejections, because some of the firms in there don’t exist anymore—Drexel Burnham, Kidder Peabody, Bankers Trust. But at the time I was crushed. I didn’t get one interview.

During this time, I was working at IBM, where I stayed for only a few years, just long enough to realize that a corporate culture like that wasn’t for me. I remember the old-timers wearing lapel pins that showed the number of years they’d been at the company—twenty-five years, thirty years. My friends and I would keep our IBM ID tags on when we went to the bars at night, thinking (incorrectly) that they would impress the ladies.

As the Wall Street rejections continued to pile up, I took a job at the Federal Reserve in Washington, DC, where I first learned to analyze bank deals. The salary represented a pay cut from IBM. I’d be a “GSer,” referring to the government service pay scale, something that everyone in my family had always regarded suspiciously, given their natural mistrust of bureaucrats. I tried explaining that staffers at the Fed aren’t technically in the GS system, but that didn’t cut it. Still, I wouldn’t trade my time there for anything. It was at the Fed that my thoughts on the banking industry took shape and where I learned about the crucial role that objective analysis plays as a check and balance on the sector.

I worked there in the late 1980s and early 1990s. Alan Greenspan was the Fed chairman, but this was before he became a cult figure in the financial markets, and at the time his predecessor, Paul Volcker, had left a lasting impression at the agency. To this day, Paul Volcker is my hero—the six-foot-seven iconoclast who was willing to raise interest rates in the early 1980s in order to stop inflation. That measure led to a necessary but painful slowdown in the economy, with temporarily higher unemployment and interest rates as high as 20 percent. It drew fierce protests—farmers drove their tractors in front of the Fed’s headquarters in the Eccles building on C Street in Washington, and one congressman wanted Volcker impeached—but it successfully ended the stagflation of the prior decade. Volcker was willing to take hard, necessary steps, a rarity for many public figures at that level. When his term ended in 1987, President Reagan would replace him and bring in Greenspan.

Since the financial crisis, history has come back to Volcker. Greenspan’s legacy became tarnished by the 1998 bailout of hedge fund Long-Term Capital Management, which represented a shift in the Fed’s strategy. It signaled to the market that if conditions got bad enough, the Fed would step in to save floundering banks. This strategy carried through to the Internet bubble and post-Greenspan to the crisis in 2007 and 2008, when unusual policy actions protected the banks and others from their own mistakes.

After the latest financial crisis and the real estate debacle, Volcker looks increasingly correct about the need for effective regulation. I respect him most because he never bought into the line—invariably offered by bankers—that regulators should do what’s best for the banks because that will do the most good for the country.

Volcker always took the opposite approach: The goal of the Federal Reserve, and of all outsiders with any kind of oversight role on the financial system, isn’t just to help the banking industry. It’s not to strip away any regulation or constraint and turn Wall Street into a casino. Instead, it’s to ensure that the banking industry remains stable and helps our economy thrive. Volcker was an outsider, and he argued for a big, bold line between the public sector and the private sector that it regulates. Investor and philanthropist George Soros, a friend of Volcker’s, once called him “the exemplary public servant—he embodies that old idea of civic virtue.”

That was his legacy at the Fed when I was there, and we believed that. Civic virtue. Detachment from the companies we were overseeing. Lloyd Blankfein, the CEO of Goldman Sachs, said in a notorious 2009 interview that he thought the firm was doing “God’s work,” and he was promptly ripped to shreds in the press for it. But during my time at the Fed, we genuinely believed that we were performing a valuable public service: protecting the banking system for the benefit of our country. We weren’t getting rich—administrative assistants on Wall Street at the time made more than the average Fed employee—but we were performing a crucial function in the economy and helping the country advance. This was partly a reflection of the times. It was the tail end of the Cold War, when, after all my stepdad’s warnings, World War III had never happened. America had won, and we proved that capitalism was the better economic system. America had a meritocracy that allowed people to rise up through their own talents and efforts. And by harnessing that desire, capitalism could do amazing things. It could direct money to the most productive avenues in order to create wealth and raise living standards. It could transform nations and defeat tyrants. But it needed some checks and balances to function optimally.

My first few months at the Fed were like Marine Corps boot camp. I was part of a class of two dozen wide-eyed junior regulators, meeting daily in a classroom in nearby Foggy Bottom. I learned to write reports that made a clear argument for whether a deal should be approved or not. Don’t hedge, don’t waste anyone’s time. Clarify your argument and substantiate it. In our early training, we got lectures from FBI investigators about fraud—I remember one story about what it was like to nab embezzlers or people running other long-term scams. When you finally arrest them, the FBI investigator told us, they’re almost relieved. “It’s like pulling a knife out of their back,” he said. Another finance expert talked to us about the typical growth rate of banks and how some exceptionally rapid growth in the industry shouldn’t be celebrated but questioned. “If something grows like a weed, maybe it is a weed,” he said. That quote would come back to me when I watched home loans at big banks grow through the roof from the late 1990s to the late 2000s.

More than anything, we were grounded in the basics of bank finance, specifically bank financial statements, which show items differently than the rest of the corporate world. Money is the product that banks sell—loans, deposits, and securities—as opposed to goods and services. Instead of millions of iPods in inventory, you see millions of loans to companies and individuals. In other industries, loans are typically liabilities because as a borrower you’re on the hook to pay that money back. But banks are lenders, meaning that loans are assets. The more loans a bank makes—assuming it has done its homework and reasonably believes that the loans went to reliable, upstanding people who are going to pay them back—the better off that bank is.

As complicated as high-level finance has become in the past decade, at its core, banking is a simple business. Bankers borrow money at a certain interest rate, mostly as customer deposits, then lend it out at a higher rate, and they get to keep the difference. For a long time banks operated on the 3-6-3 rule: Borrow at 3 percent, lend at 6 percent, and be on the golf course by 3 P.M. From the 1940s through the late 1960s, this was the guiding principle. Banks were closer to utilities—very reliable and without big boom-and-bust scenarios. There were some laws in place, like Glass-Steagall, which came about after the 1929 crash and prevented consumer banks and investment banks from being owned and operated by the same company. This ensured that traditional banks, which took relatively limited amounts of risk with customer deposits by making loans, were separate from investment banks, which were using their own capital to take greater risks. Those rules were like governors on a car engine—they helped prevent banks from growing too fast, and they kept the overall industry reasonably safe. They also limited bank returns, which is why bankers wanted them overturned.

When I arrived at the Fed, the country had just gone through the savings and loan (S&L) crisis of the late 1980s—the first financial problem I understood as an adult, though it wouldn’t be the last. In fact, it shows how many banking crises boil down to the same fundamental problems. S&Ls, also known as thrifts, are a narrower form of traditional banks that mostly take deposits from individuals and make loans for people to buy homes. The crisis happened because small local thrifts got too big, too fast, by expanding outside these core areas. The S&L failures cost the taxpayers since their deposits were insured like ordinary bank deposits, meaning that the government paid back depositors when the S&Ls couldn’t.

Ineffective changes in regulation were at the heart of the problem. Thrifts, which were not under direct Fed supervision, were always less regulated than conventional banks, and the rules became even more lax after Congress passed several pieces of legislation in the early 1980s. These greatly expanded the types of loans that thrifts could make and the interest rates they could pay depositors above prior tight interest rate ceilings. If a bank or thrift wanted more deposits, it could offer more interest a...

Table of contents

• Cover
• Contents
• Title
• Copyright
• Introduction: Watering Down the Wine
• Chapter 1: “God’s Work” at the Fed
• Chapter 2: The Big Time—or Something Like It
• Chapter 3: Exile . . . and Redemption
• Chapter 4: The Professional Gets Personal
• Chapter 5: The Crisis
• Chapter 6: The Vortex
• Chapter 7: Citi, Part I: A Long, Sad Saga
• Chapter 8: Citi, Part II: The Plot Sickens
• Chapter 9: A Better Version of Capitalism
• Chapter 10: The Meaning of Life
• Acknowledgments
• About the Author
• Index