PDF Summary:Liar's Poker, by Michael Lewis

The cynical view of the financial world says that Wall Street is run by a special breed of traders who exploit investors’ collective fear and greed to enrich themselves however they can, without any care for the havoc they might wreak. In Liar’s Poker, Michael Lewis backs up this opinion with a first-hand account of the pursuit of ill-gotten riches at the Salomon Brothers investment firm during the 1980s. As a Salomon employee, Lewis took part in its wealth-chasing culture and witnessed the start of its downward spiral.

This guide will explore Lewis’s portrayal of Wall Street, the boom and bust of the mortgage bond market, and the rise of junk bond investments. We’ll also take a broader look at the financial world and alternate views showing there’s room for ethics and level-headed investing. We’ll conclude with Salomon Brothers’ troubles in the 1990s, which occurred after this book’s publication.

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Target: Savings and Loans

Right on the cusp of the 1980s, the savings and loan industry suffered a shock that threatened to stop the housing market in its tracks. Lewis says that instead of backing out of the mortgage bond business, Salomon Brothers dove head-first into the market, turning the US government’s plan to bail out local banks into a way to funnel money to itself. According to Lewis, Salomon’s strategy revolved around exploiting the fears of small-town bankers, taking advantage of a crucial tax break meant to help those struggling banks, and turning those banks into the buyers of the bonds created by other banks’ loans.

The ’70s were a time of great inflation. To slow it, the Federal Reserve Bank announced in 1979 that instead of controlling interest rates, it would allow them to fluctuate according to the dictates of the market. The result was that interest rates went up. The housing market faltered since no one wanted to take out home loans at high rates of interest. Lewis explains that savings and loans were suddenly in trouble, since the interest they were paying to savings accounts was greater than the interest they were making on their mortgages that had been written on previous, lower interest rates. These banks needed to sell their mortgages in a hurry, and since it had cornered the mortgage bond market, Salomon was the only buyer.

(Shortform note: The shock to the market that Lewis refers to came as a result of the newly appointed Federal Reserve chairman Paul Volker’s anti-inflationary policies. His practice of reining in the amount of money in the economy while letting interest rates vary resulted in a deep recession that didn’t abate until 1982. Interest rates topped out at 20%, but by slowing the economy, inflation came down from a peak of 14% in 1980 to an average 3.5% for the rest of the decade. Though stocks trended upward during most of this period, high inflation meant that the value of investments shrank in proportion to the diminishing value of the dollar.)

Enter: Ranieri

Enter Lewie Ranieri, head of Salomon Brothers’ mortgage bond trading desk, whom Lewis depicts as the sharkiest shark on Wall Street. Ranieri and his traders took advantage of the fact that most owners of savings and loans had shockingly little understanding of their financial positions or the value of their holdings. Another wrinkle that turned into a pot of gold for Salomon was a tax break passed by Congress in 1981 that would refund savings and loans for their losses. The catch was that those losses had to be on paper, so to prove the amount of their losses, banks had to sell their loans and buy someone else’s. At the time, mortgage bonds were the only way to do this quickly, so Ranieri and his cohorts swooped in like hawks.

(Shortform note: Though Ranieri didn’t invent the mortgage bond, he once again received media attention during the 2008 housing bubble crisis for how he’d been the first to popularize mortgage-backed securities. Ten years after the housing bubble popped, Ranieri expressed regrets for the long-term consequences of turning home loans into instruments of speculation. However, he partially blames the US Securities and Exchange Commission (SEC) for not regulating mortgage-backed securities until it was far too late. Ranieri showed concern for homeowners as home loans became harder to come by, but during the heyday which Lewis writes about, homeowners were merely a source of uncertainty in the mortgage bond market.)

Lewis describes a typical mortgage bond trade like this: A Salomon trader would call Kansas Bank A and offer to buy $1 million in loans for the price of 70 cents on the dollar ($700,000 total). After making the buy, he’d call Georgia Bank B and offer to sell that bundle of loans for 75 cents per dollar ($750,000 total, with a profit of $50,000). Since neither bank knew about the other bank’s transaction, Salomon Brothers’ profits from facilitating the deal were invisible. Salomon traders were schooled in the art of tricking sellers to undervalue their assets while convincing buyers to rate the same products higher. Thanks to the tax break, banks valued their losses and Salomon Brothers reaped the reward.

(Shortform note: To avoid falling prey to the shenanigans Lewis describes, investors must properly valuate their holdings. In The Intelligent Investor, Benjamin Graham warns that stock prices and market mood swings don’t reflect an asset’s actual value and that dips and peaks in the market should be treated with caution. Graham lists specific criteria investors should consider when deciding where to put their capital, such as whether an investment’s assets are greater than its liabilities, its price-to-earnings ratio, and other factors that financial professionals should be able to research and calculate. For the casual investor, Graham recommends an even split between stocks and bonds of large companies with conservative financing.)

As savings and loans got a taste of trading bonds, Ranieri started convincing banks to trade their bonds more frequently, giving them a way to gamble on the market and turn their losses into even greater profits. Whether the banks made money or not wasn’t of any concern to Ranieri, since Salomon skimmed profits off of every transaction. Lewis implies that in essence, mortgage bond traders were like carnival hucksters, convincing every gullible passerby to bet one more dollar on a rigged ring toss game. And it worked—by the middle of the ’80s, Ranieri’s traders were raking in higher profits than anyone else on Wall Street.

(Shortform note: The practice of frequent trading that Lewis says drove Salomon’s profits, though disparaged by experts such as Graham and Warren Buffett, has only accelerated in the age of computers. In Lewis’s later book Flash Boys, he explains how high-frequency trading by automated computer systems negatively impacts regular investors by giving Wall Street firms an unfair, unethical advantage in the market. Beyond that, Lewis argues that high-frequency trading is dangerous. In 2010, unregulated trading algorithms triggered a “flash crash” in which the stock market dropped by 600 points and rebounded in under a minute.)

Mortgage Bonds Decline

Despite Salomon Brothers’ roaring success with the mortgage bond market in the first half of the ’80s, no gravy train runs forever. Beginning in 1986, Salomon’s Wall Street dominance declined. Lewis recounts three separate ways that Salomon Brothers eroded their standing in the mortgage bond market—they allowed other banks to snatch away their best traders, they developed a new financial product that undercut the value of traditional mortgage bonds, and the leaders of Salomon’s mortgage bond department indulged in so much personal excess that Salomon’s executives had to take a stand against them.

As Lewis stated earlier, Salomon Brothers recruited many new traders from the legions of economics students in the 1980s, none of whom had any loyalty to the business. More than that, Salomon restricted their pay for the first two years of employment, regardless of how much money they brought in. This allowed other Wall Street banks to lure them away with higher salaries and bonuses. For young traders, Salomon simply became the place where they went to receive on-the-job training before sailing off to more lucrative positions. Not only did this drain Salomon’s talent, but it also gave away the firm's advantage by transferring its trading strategies and techniques—along with its monopoly in the bond market—into the hands of its rivals.

(Shortform note: To this day, Wall Street investment bankers are compensated with a combination of salaries, commissions, and bonuses. In general, an investment firm will return half its net annual earnings to its executives and traders, divvied up on the basis of individual performance and the returns of a firm’s various divisions, such as government bonds or mortgage-backed securities. In Lewis’s time on Wall Street, salaries and bonuses were often common knowledge and points of competition between traders, but in 2017, New York City passed a law prohibiting investment firms from learning how much potential employees were paid when working for rival banks.)

Lewis writes that besides the steady loss of talent at Salomon, new financial products called Collateralized Mortgage Obligations (CMOs) defused the mortgage bond market by removing the bonds’ volatility that had made them ripe for speculation. Salomon had actually devised these tools themselves to make mortgage bonds attractive to traditional investors. A CMO divided a bundle of mortgages into three or more “tranches” that matured at different rates. Money from homeowners who paid their loans early would go to the holders of tranche #1 until their investment was paid back in full, before rolling payments to tranches #2 and #3. Therefore, tranche #1 was a short-term investment, and tranche #3 was long-term.

Lewis explains that by bringing predictability to mortgage bond payouts, CMOs attracted new investors such as pension funds who wouldn’t have touched unpredictable mortgage bonds in the past. CMOs made mortgage bonds as respectable as corporate and government bonds, but they also normalized the value of those bonds. Because of CMOs, investors now had a better understanding of what mortgage bonds were worth, making it harder for Salomon Brothers’ bond traders to bamboozle their clients as they had in the past. To stay on top of the market, Salomon’s traders kept inventing even more complex and mystifying products that they could hawk to buyers as their next “get rich quick” scheme.

The Next Wave: Collateralized Debt Obligations

The next iteration of asset-backed securities wasn’t created by Salomon Brothers but by its rival firm Drexel Burnham, which we’ll discuss in the next section of this guide. The financial product in question is the Collateralized Debt Obligation (CDO) which collects and restructures high-risk corporate bonds in the same way that CMOs restructure mortgage bonds. First introduced in 1987, CDOs became a tool for bundling subprime mortgages, replacing CMOs during the housing boom that started when interest rates dropped in 2002.

Because of how the loans were repackaged, these CDOs were given AAA ratings—a mark of low risk and high creditworthiness—by leading credit agencies like Standard & Poor’s (S&P), disguising the inherent risk of the loans. When subprime borrowers began defaulting on their loans in 2007, the CDOs based on their mortgages translated those defaults into 2008’s global financial crisis. Because CDOs aren’t traded on public exchanges, the hedge funds, banks, and pension funds that had heavily invested in them were stuck holding the bag.

In The Big Short, Lewis’s book about the subprime crisis, he explains how banks and investors who couldn’t offload their toxic CDOs saw their assets disappear overnight. Despite the lessons learned from the crisis, the grandchildren of Ranieri’s mortgage-backed securities—now called Collateralized Loan Obligations (CLOs)—have made a comeback in the 2020s, leading analysts to worry about another future bubble and collapse.

Exit: Ranieri

Despite their efforts, Salomon’s mortgage bond profits steadily dropped from 1986 to 1987. Lewis writes that because of this, Salomon’s board took a harder, closer look at the behavior of Ranieri’s bond traders. A faction within Salomon’s upper management had a growing distaste for the drunken schoolboy antics of Ranieri’s inner circle and would no longer ignore the way Ranieri and his friends misused company resources. In July 1987, Gutfreund fired Ranieri for reasons that have never been specifically disclosed, and Ranieri’s closest colleagues were also let go over the next several months.

Even with Ranieri gone, his legacy remained. Lewis asserts that because of Ranieri, mortgage bonds had risen from obscurity to become a major source of business on Wall Street. Because of the way Ranieri’s mortgage department had reshaped the culture of Salomon Brothers, and because the firm had let its talent slip away to every other major bank on Wall Street, the cutthroat tactics and backhanded dealings that epitomized Salomon Brothers’ trading floor were now the norm for investment banking in general. Salomon Brothers’ Wall Street dominance continued in spirit, if not in financial fact.

The Good, the Bad, and the Wealthy

Though Lewis writes from a Salomon-centered point of view, the financial profession’s hedonistic behavior and shady dealings aren’t limited to Salomon Brothers alumni. Jordan Belfort’s memoir The Wolf of Wall Street—the basis of the 2013 film—depicts lavish parties, drug use, and outright financial fraud far in excess of anything related by Lewis at Salomon Brothers. In Billion Dollar Whale, Tom Wright and Bradley Hope detail the even more outlandish wrongdoings of Malaysian financier Jho Low, who employed fraud on a global stage to fund parties, gambling binges, and his glamorous lifestyle.

However, it wouldn’t be fair to suggest that everyone in the financial business is characterized by bad behavior. John C. Bogle, founder of the Vanguard Group and author of The Little Book of Common Sense Investing, was praised for his integrity, financial restraint, and support of the common investor. Ruth Porat, former CFO of the investment bank Morgan Stanley before becoming CFO at Google, is known for opening doors for women on Wall Street, fighting against workplace sexual harassment, and helping struggling small businesses in the aftermath of the Covid pandemic.

Warren Buffett, arguably the most successful investor in history, is known for bucking every negative Wall Street stereotype. In The Snowball, his biographer Alice Schroeder writes that Buffett’s humble beginnings led to a humble life, one that was defined by his sense of integrity even after he became the world’s richest man. That integrity would come to Salomon Brothers’ rescue, as we’ll see later in this guide.

The Rise of the Junk Bond

The next investment trend to sweep Wall Street wouldn’t arise from Salomon Brothers but would instead be used against it. These were so-called “junk bonds” that had existed for decades but would be pushed to new heights by Michael Milken, head of the bond department at rival firm Drexel Burnham. Lewis describes how Milken fostered the junk bond craze of the late 1980s and how he used it to fund a wave of hostile corporate takeovers, including one directed at Salomon Brothers.

(Shortform note: Milken’s career was plagued by scandals that escalated throughout the ’80s and beyond. In Den of Thieves, James B. Stewart writes that Milken, who was under constant scrutiny by the SEC, played a key role in a massive insider trading scheme. Shortly after Liar’s Poker was published, Milken pled guilty to fraud and conspiracy, was sentenced to 10 years in prison, and was banned from the securities industry for life. Though he only served two years of his sentence, the SEC fined him in 1998 for allegedly returning to securities work, and they again investigated Milken in 2013 on suspicion that he was continuing to do so. In 2020, President Donald Trump granted Milken a pardon, citing his philanthropic work in later years.)

Junk bonds are issued by companies in poor financial standing as a means to raise capital and keep themselves afloat. These bonds are “junk” because of their high default risk—if the issuing company goes bankrupt, the bondholders are left with nothing. Nevertheless, junk bonds can be attractive because of the high interest rates they offer. Investors who place a lot of money in junk bonds are betting that the profits from the bonds that pay off will be greater than the losses from the bonds that go bust.

(Shortform note: Despite the points Lewis lists in junk bonds’ favor, cautious investment experts say to avoid them. In The Essays of Warren Buffett, Buffett calls out junk bonds as speculative tools driven by the fantasy of easy money and criticizes their very existence for making financial crises worse. Nevertheless, in A Random Walk Down Wall Street, Burton G. Malkiel doesn’t discount junk bonds as an option for young investors with diversified portfolios because of their potential high rewards as well as young investors’ higher tolerance for risk.)

According to Lewis, mortgage bonds and junk bonds were alike in that Wall Street looked down on them as second-rate investments. Like Ranieri with mortgage bonds, Milken ignored Wall Street convention and grabbed as much of the junk bond market as he could. However, unlike Ranieri, Milken saw corporations as businesses, not just customers to be swindled. Using a team of financial researchers, Milken would calculate whether a struggling company was undervalued. If its assets were worth more than its stock price suggested, Milken could argue that its junk bonds weren’t risky and trade them to investors who often made a killing.

(Shortform note: Milken’s valuation strategy is similar to what Benjamin Graham suggests in The Intelligent Investor. Graham, however, is more concerned with stocks. He writes that if the market values a company’s stock less than the actual value of its combined assets, you should buy it because the stock will likely rise in value to reflect the true worth of the business. When it comes to junk bonds, Graham advises against them unless you have the opportunity to acquire them at a deep discount to offset their risk of default.)

By 1987, the junk bond market soared to over $12 billion in transactions as the mortgage bond market continued to falter. Lewis says that Milken needed more junk bonds to sell, so he partnered with a new breed of investor—the hostile takeover king. By identifying businesses whose stock was undervalued, Milken marked targets for potential takeover. He’d finance the purchase of a controlling stake in the company by selling junk bonds to pay for the stock, then when the target company was bought and its leadership ousted, its stock would plummet and its bonds became junk that Milken would trade to finance the next takeover.

(Shortform note: While the general public was mostly unaware of the backroom dealings Lewis writes about, hostile takeovers were headline news. Among the well-known corporate raiders of the ’80s was Carl Icahn, who’s remembered for his hostile takeover of the airline TWA, from which he made nearly $500 million while saddling the airline with a staggering amount of debt. Another was Ronald Perelman, best known for his takeover of Revlon. In The Essays of Warren Buffett, Buffett derides such practices while also raising the issue that a takeover attempt highlights the target company’s failure of responsibility—namely that one of a corporation’s duties is to remain fiscally sound enough to protect its employees and stakeholders.)

Takeover Target: Salomon Brothers

As its profits teetered, Salomon Brothers came within a hair of falling victim to a hostile takeover bid. In September 1987, takeover magnate Ron Perelman (with funding from Milken) moved to grab control of Salomon. Lewis explains why Salomon was vulnerable, the threat Perelman posed to Salomon’s management, and how Warren Buffett came to their rescue.

When junk bonds took off in the latter 1980s, Salomon Brothers kept out of the market, but not for any well-thought-out reason. Lewis says it was mostly because Ranieri sabotaged any attempt by Salomon Brothers to join the junk bond business. Ranieri felt that bonds were his kingdom and that his power would be threatened by any attempt to steer the company away from his mortgage bond turf. As a result, Salomon missed out on participating in the takeover business, and after Ranieri’s firing, the firm was blindsided by Perelman and Milken turning the market against them.

(Shortform note: The reasons Lewis gives for Salomon staying out of the junk bond business suggest that the firm fell prey to valuing expansion over innovation. In Zero to One, Peter Thiel explains that innovation—which he calls “vertical progress”—leads to expanded opportunities and growth, whereas expansion without innovation only leads to competition for resources. Contrary to the attitudes prevalent on Wall Street, Thiel says competition is always destructive because businesses become so embroiled in power struggles that they lose sight of their objectives and make bad business decisions, such as Salomon staying in the mortgage bond game long after it had ceased to be lucrative.)

Buffett to the Rescue

When one of Salomon’s chief investors wanted to sell their shares, Perelman swooped in and made an offer to buy them with funding provided by Milken. Perelman usually fired the managers of the companies he took over, so Gutfreund scrambled to find another buyer to keep his position in the firm. The buyer he found was investor Warren Buffett, but Buffett saved Salomon to make a profit for himself, and he didn’t want shares in the business. Instead, Lewis writes that Buffett loaned Salomon Brothers $800 million so it could buy back its stock, a loan that Salomon would have to repay at 9% interest. Gutfreund’s job as CEO was secure, but the price would be paid by the firm’s shareholders until their debt to Buffett was cleared.

(Shortform note: In Buffett’s biography The Snowball, Alice Schroeder provides a different perspective on why Buffett came to Salomon Brothers’ rescue. In 1976, Gutfreund played a key role in underwriting Buffett’s successful attempt to keep the insurance company GEICO out of insolvency. GEICO would go on to become a key foundation in Buffett’s wealth-building enterprise, and Gutfreund won Buffett’s gratitude and admiration by taking a risk on the GEICO deal when other investment firms wouldn’t lend a hand. When Salomon Brothers came under fire from Perelman, Gutfreund turned to his old friend Buffett, who could bolster Salomon not only with money but also by bringing his sterling reputation to the firm.)

Perelman’s takeover attempt may have been motivated by more than simple greed. Lewis suggests that Milken may have urged the takeover because of his animosity toward Salomon’s CEO Gutfreund, a dislike that Gutfreund reciprocated. Milken’s Drexel Burnham had lured away many of Gutfreund’s former employees, and the rivalry between their two firms was one of the biggest on Wall Street.

(Shortform note: The feud between Salomon Brothers and Drexel Burnham went at least as far back as 1984, when Drexel refused to make high-yield bonds available to Salomon Brothers’ clients so that Drexel could maintain its monopolistic holdings. When the junk bond market collapsed in ’89, Drexel blamed Salomon for tipping off the SEC to Drexel Burnham’s lack of sufficient capital to meet its financial obligations. Drexel Burnham filed for bankruptcy in February 1990—at the time, the largest Wall Street bankruptcy yet—and Salomon Brothers bought the rights to Drexel Burnham’s junk bond business.)

The 1987 “Black Monday” Crash

No sooner had Salomon Brothers evaded one catastrophe when it and the rest of the financial world felt a shock unmatched since the Great Depression. On Monday, October 19, 1987, the global stock market crashed, wiping out trillions of dollars in investments. Lewis explains that the crash occurred at a particularly bad time for Salomon Brothers, how the firm missed its chance to turn losses into gains because of some questionable business decisions, and how some individuals did well in the misfortune.

(Shortform note: In the stock market crash that Lewis got to witness, the Dow Jones Industrial Average dropped over 20% in one day. Because of how the world’s stock exchanges were now tightly linked through computerization, falling prices swept around the world more quickly than in any previous downturn. While there had been warning signs during the previous week that stock prices were entering a difficult time, a combination of computer selling algorithms and investor panic exacerbated the market’s problems, triggering a cascade of stock liquidation that formed the Wall Street equivalent of a “run on the bank.”)

Lewis writes that in the week before what would become known as the “Black Monday” stock market crash, Salomon chose to leap into junk bonds while simultaneously laying off 1,000 employees. Some entire departments were let go, including those in charge of money markets and municipal bonds, with no apparent rhyme or reason. Distrust within the company was at an all-time high, especially since the rank-and-file workers knew that the executives sitting on the board wouldn’t feel any negative effects from the layoffs.

(Shortform note: Distrust between employees and employers is hardly restricted to investment firms, but it was certainly on the rise during the time in which Lewis was writing. Economic historians mark the 1980s as a time when the social contract between companies and their workers went through a dramatic shift. Previously, companies provided high wages and benefits to cultivate loyalty in their workforce, but due to the pressures of global competition, many companies laid off workers to cut costs and replaced them with cheaper sources of labor.)

Before Salomon had a chance to find its new footing, the stock market crash hit like a tsunami. Here, Lewis mentions a curious fact about stocks—when the stock market goes down, the bond market goes up. By firing so many of its bond trading experts, Salomon was left with very few people in a position to take advantage of this flip. One Salomon trader had happened to short the S&P index just before the crash, which luckily recovered a big chunk of wealth, but otherwise Salomon and most of its clients lost entire fortunes in the debacle.

(Shortform note: Lewis doesn’t explain the reason why stocks and bonds rise and fall against each other, but the main driving force is investor emotion. Stocks are seen as a way to make money, whereas bonds are seen as a way to keep money safe. Therefore, when stocks are on the rise, investors sell their bonds to raise capital, driving overall bond prices down. Conversely, when stocks suddenly plummet, investors rush to put their money into bonds, making bond prices go up. That’s not the same as shorting a stock, in which an investor borrows shares in a business whose price he thinks will go down. The investor quickly sells his borrowed stock and then, after it drops, buys it back at a lower price and pockets the difference as a profit.)

There was one silver lining as Salomon Brothers’ stock dropped. Gutfreund, Lewis, and many other staff recognized that their stock was deeply undervalued (just as Milken had known the month before) and took the opportunity to buy their own company’s stock when it was selling at an all-time low. Lewis says that for him, his investment didn’t represent any faith or goodwill toward Salomon Brothers. It was simply a cold calculation toward wealth, which would surely follow when the stock price rebounded. In his heart, Lewis was ready to leave, and though he’d wonder if quitting was a wise decision, he had faith (as of his writing) that the business would do well and continue to make money for years to come.

The Downfall of Salomon Brothers

The future wasn’t as bright for Salomon as Michael Lewis predicted. In 1991, the firm was caught violating US Treasury Department rules for bidding on government bonds. Because Gutfreund had known and hadn’t reported the misdealings to the Federal Reserve or to the company’s board, the Treasury threatened to ban Salomon Brothers from dealing in government bonds, effectively killing the firm. Gutfreund and other executives resigned, and Warren Buffett was thrust into the role of temporary chairman of Salomon’s board.

According to Alice Schroeder in The Snowball, Buffett feared that if Salomon Brothers defaulted on its debts, a global financial crisis would ensue. He begged the government to let the firm continue trading bonds, and in return, he instituted a policy of absolute transparency toward the regulators investigating Salomon’s wrongdoing. When Buffett testified about the scandal before Congress, he took a hardline stance in favor of total honesty and corporate accountability. Salomon’s fortunes briefly rallied in the years immediately after the crisis, but it never regained its prominent position and was later absorbed into Citigroup.