Chapter 2

GAMBLING ON WALL STREET

“In a world that’s changing quickly, the only
strategy guaranteed to fail is not taking risks.”

—Mark Zuckerberg

People like me are wired to crave risk. We thrive at the limits.

After making millions by taking risks in commodities, my late friend Steve Fossett found that he was unhappy to be working all the time, so he pushed the limits in aviation, sailing, and adventure, breaking more than one hundred records.

Sir Edmund Hillary literally pushed through a crack in an ice-covered rock, crawling out the other side to become the first man to summit the highest point on earth, despite the fact that his boots were frozen solid on the morning of his ascent in 1953, and no one in recorded history had ever reached the top of Mount Everest.

It’s no accident that men and women who embrace risk, surmounting obstacles and setbacks that few others could survive, continually seek new and greater challenges. But the most successful ones are not purely adrenaline junkies or sensation seekers. The latest research shows that they all rely on “meticulous preparation, avoidance of unnecessary risks, and the ability to remain unperturbed by acute peril.”1

If you are one of us, you’ll agree that taking risks has a way of making life worthwhile.

When, like me, you find yourself skiing an Olympic run in the Dolomites, feeding herring to hungry sharks on the bottom of the Caribbean, or investing your hard-earned money in ways that would keep the fainthearted awake all night, then you know you’re always happiest when you seize the opportunity to take risks.

That’s where the dividing line is. When something makes your heart start pounding from the adrenaline coursing through your veins, does it make you want to hide beneath the covers or do it again?

For me, taking risks has been a way of life. As an investor, it’s made me money. As a person, it’s resulted in an adventurous life, constantly expanding to new horizons.

A love of risk is built into our brains. Those of us with neurological profiles showing unusual levels of self-control and low reactivity to stress also tend to have an innate orientation toward high achievement.2 Combining risky activities with a standard of high achievement is a recipe for dramatic success.

Successful risk taking is free from emotion. No one is more adamant about that than Alex Honnold, the first climber to free solo El Capitan in Yosemite. He swears he can’t make the climb if he’s emotional: “If I even get an adrenaline rush, it means that something has gone horribly wrong.”3 In business or adventure, it can be fatal to get swept away by feelings and impulses. My mentor at Bear Stearns, Ace Greenberg, always said that if you can’t calculate the risks with a cold eye, you have no business investing your money.4

Done properly, taking risks is not about being reckless. It’s about making a series of well-informed bets. To succeed at high-risk ventures requires the discipline to wait until right moment, then act with boldness and precision. As J. Paul Getty once said, “If you want to make money, really big money, do what nobody else is doing… buy when everyone else is selling and hold until everyone else is buying.”

When research, preparation, and experience inform your choices, the risk is less, but it’s never been easier to take a shot at investing with little to no preparation. All you need is a phone or a computer and some cash to wade right in, oblivious to the fact that all over the world, thousands of very smart, very experienced, totally dedicated people with an almost unlimited information flow are devoting themselves to selling overpriced investments to you and to buying underpriced investments from you.

In other words, when you’re just starting out, your biggest risk is you!

But even after years spent learning to shrewdly and effectively assess risk-reward ratios on a sprawling range of investments, some risks are impossible to anticipate.

I have to agree with the remark by Nobel Prize–winning physicist Niels Bohr that “prediction is very difficult, especially if it’s about the future.”

The outcomes of operational change, for instance, are particularly hard to anticipate. When an enterprise must change management, product, or processes, predicting the future requires great humility.

No matter how many years of experience any of us have under our belts or how much we’ve learned from decades of investments, we’re still vulnerable to the biggest danger of all: simply making a mistake.

Today, I consider investment error to be my biggest risk. The possibility of buying the wrong thing at the wrong price or selling at the wrong time, despite my best efforts at preparation, is always smiling in the shadows, waiting for just the right moment to turn things upside down. But that’s life.

As Ace knew, the important thing is to get in the game. “You can’t behave so cautiously that you’re not really in the game. You have to get involved in lots of deals. You hope they’re all winners, but if you’re not losing money on some, it means you’re not taking chances, you’re not working hard enough.”5

Don’t take risks unless you crave them. But if you do, go all in.

BURNHAM & CO.

You’ve got to stand on the shoulders of risk-taking giants.

Fresh out of Harvard Business School, I proudly left home for my first day of work on Wall Street in my brand-new, bright-green 1962 Volkswagen convertible, thanks to a 100 percent loan. The sun was shining, the top was down, and I couldn’t get the smile off my face.

As I pictured it, I was going to get down to business and start earning the big bucks from the moment I arrived. It didn’t quite work out like that.

Looking back on it now, I marvel at the risks I took in those early years. Despite having the largest student loan debt in my graduating class, I uprooted my family from Boston and moved them all the way to New York City. Both the United States Army and the powerhouse company Gillette Razor made me promising offers; instead I walked away to take a chance on a small brokerage firm called Burnham & Co. To top it all off, as a graduation present to myself, I bought a shiny new car the color of money.

“I’ve got so little to lose,” I told myself, laughing. “I might as well go all out.”

Maybe my timing could’ve used a little work, but my instincts were good. Burnham & Co. would one day become one of the biggest success stories in the history of the securities industry—before its spectacular fall. It grew to become one of the largest junk-bond investment banks in the world. Today it no longer exists.

Few ventures have ever been more unlikely to succeed. Born with a silver spoon in his mouth, Isaac Wolf Burnham II started out as a messenger boy in his uncle’s Wall Street firm, making twenty dollars a week. In the depths of the Depression in 1935, when so many other brokerage firms were failing, Burnham decided to open his own firm. He needed $100,000 but only had $4,000, so he asked his grandfather Isaac Wolf Bernheim if he could borrow $96,000.

His grandfather knew something about taking risks and beating the odds. The Bernheim Bros. distillery he founded in 1848 had survived Prohibition and grown into an empire that still thrives today.6 He gladly took a risk on his grandson, lending him the money and probably admiring his spunk—but not without adding a clause to his will insisting that Isaac repay the loan.7 And that’s what Isaac did after he used the money to start Burnham & Co.8

Isaac changed the name from Bernheim to Burnham for the same reason Issur Danielovitch changed his name to Kirk Douglas. Anti-Semitism was so unabashed in the late nineteenth century that many Jewish immigrants claimed to have forgotten their names when they reached Ellis Island.

“Your name is?” the registry clerk would ask.

“Fargesn!” (“Forgotten!”) the immigrant would say in Yiddish, as if he didn’t know his own name. Not understanding Yiddish, the clerk would nod and write down “Ferguson” and wave them in. It was as if a new family line had been born of forgetting.

When I knew him, “Tubby” Burnham was considered to be one of the industry’s most cautious managers, but a brilliant strategist. The combination served him well. His caution made him take the time to develop one of the finest securities research departments on Wall Street. As a result, Burnham knew before anyone else that the stocks in the rest of the world were going for far lower prices than American stocks. Before long, he had built a niche in foreign securities.

Just before I arrived, Burnham & Co. had decided to expand into investment banking. That made a lot of sense to me. As I saw it, the research could provide high-quality leads and basic information on a number of industries that hotshots like me in the investment banking group could use to run around making a bunch of deals and securing our fortunes.

Little did I know that mergers and acquisitions are among the most demanding of all business activities. No one can do it straight out of graduate school. At the time I had never even seen the process firsthand, so I couldn’t begin to imagine the layers of complexity, much less all the intricacies of finance, economics, law, taxes, government policy, and psychology that were required to make it work.

Unfortunately, Burnham put a man of very modest intellectual capacity in charge of the investment banking operation, a man named Robert Linton. When he was hired at Burnham & Co. in 1946, he was their eighth employee. He started as a runner, rushing stock certificates to Wall Street firms, and would eventually work his way up to CEO.9 (It was Linton who would preside over the bankruptcy of the firm years later.)

To the very end, he was known for a steady—one might say stultifying—style. In 1977 a rival banker would disdainfully characterize him as a man who had persistently been “married to the same lady for twenty-five years, has had the same secretary for twenty-two years… has a fourteen-year-old dog,” four children and “lives quietly in Rye.”10

In my view, Linton combined mediocrity with arrogance, a toxic blend. It should’ve been a warning to me that Linton not only had been put in charge of investment banking, but that he was also the head of the margin department (the accounting division that keeps track of customer holdings and their loans against their holdings), which was completely unrelated to investment banking.

My eagerness to think out of the box about investments was never going to sit well with Linton. What I really needed was a mentor who could help me push through my most fertile ideas and give me the skills to navigate personal relationships in a high-powered business setting.

Linton was no risk-taking giant, but luckily, Dan Cowin was. A Burnham partner who ran his own business as a “lone wolf” broker and investment banker, his own urge to creativity was more than apparent in his custom suits and handmade shoes. Along with his impeccable wardrobe, Dan had a brilliant mind, and his deep-set eyes didn’t miss a thing.

Linton was unimpressed when I invented a convertible mortgage bond for financing a real estate trust, but Dan noticed. When I started an unsolicited takeover of Sinclair Oil, a large refiner and service station company, I met with more resistance from Linton. Apparently, Burnham didn’t yet have the clout to complete these deals, but I was sure they would have been big winners, and I suspected Dan agreed.

My hopes for the future were invested in this job and I was working really hard, pouring everything I had into it, trying to get ahead, but I felt as if I was being held back at every turn. It was frustrating, but I honestly didn’t know what to do.

Daniel on the phones, keeping track of his investments.

Warren Buffett’s Eulogy: “When in my mid-twenties, I worked for two years in New York. One episode from that period dramatizes the sort of friend Dan was. I had a bright idea that required $50,000 for about a week. But I had little net worth and no cash—and the transaction was not bankable since I would not be able to get possession of the purchased security. Dan simply said, “I’ll lend you the money” and then promptly did so without collateral interest or a note. No one else in the world would have done that for me at the time.”

Then, two weeks before Christmas of 1963, Linton fired me.

I was stunned. My wife was six months pregnant with our second child. Two years out of Harvard, I still had those huge student loans hanging over me and a car loan to pay. Now I’d gotten fired from my first job on Wall Street. Whether it was justified or not, who would hire me after this? Word gets around quickly on Wall Street. My promising career could have been over.

That’s when Dan stepped in. He met with Linton and somehow persuaded him to let me work in Dan’s office until I found a new job. His intervention saved my career.

For three months, he had me run his deals. Working closely with Dan gave me the opportunity to learn from a master. Dan Cowin was one of the best deep-value investors I ever saw. I was deeply affected by his business skills and still apply them to this day.

It was only at Dan’s funeral in May 1992 that I learned he had been Warren Buffett’s close adviser.

In the early days, when Buffett was at Graham-Newman, Cowin had lent him $50,000 for a week on a handshake. Buffett used it to save $1,000 in taxes on mutual-fund shares.11 They became close friends over the years. As a senior partner, Dan had far more experience and resources, but he shared information and ideas with Buffett as he did with me.

In 1962, just as Dan was starting to notice me at Burnham & Co., he also noticed something interesting about Berkshire Hathaway stock. Selling at a major discount from its book value, the stock seemed like a bargain to Dan. He told Buffett about the stock, and the two of them started buying it with Tweedy, Browne as their proxy. Had anyone realized they were snapping it up, it could’ve significantly raised the price.

In 1992, Dan Cowin died of cancer. The funeral was deeply sad. I savored the heartfelt eulogies given by Larry Tisch, who was the CEO of CBS at the time, and Ace Greenberg, who would become the CEO of Bear Stearns the following year, just as Dan had predicted.

Warren Buffett had written a touching eulogy, but he was too upset to read it himself. His then-wife, Susie, delivered it for him instead.12

This is the kind of friendship and admiration Dan evoked in those of us who knew him well. Not much publicity ever was generated about Dan, but he was the epitome of the great men of Old Wall Street: quiet, connected, and very smart, with total integrity. I’ve met a lot of lousy people in the investment business who were callous, arrogant, crude, and greedy beyond all measure. I’ve also met some of the best people in the world: the hardest-working, most honest, charitable, considerate, and loyal friends and colleagues you could ever hope to know.

Dan Cowin was one of the best, and I miss him.

BEAR STEARNS

Small unstructured organizations facilitate rapid, big scores.

A memo from Alan Greenberg in 1985.
When I left Bear Stearns, I took my saved paper clips with me. Guilt stricken, I later returned them.

My first interview with Bear Stearns was a real gamble. In July 1964, Bear was backed by impressive capital of about $15 million and about 500 employees, whereas I was a green kid who had just been unceremoniously fired from his first job on Wall Street.

Although I had youth, confidence, and vigor on my side, stalling out right away like that had me worried. What if the kings of Wall Street decided I didn’t have what it took? At Burnham, I’d gotten an early taste of the kind of passion I could tap into for this work and I wanted more, but what if I wasn’t as good as I thought? Or worse, what if no one on Wall Street would give me a chance to prove myself?

The first investment firm I approached wouldn’t even hire me as an investment banker. At the interview, John Loeb, Jr., clearly had been unimpressed. Without hiding his disdain, he offered me a lowly job in research as if it were a gift.

“If I developed a deal on my own, would you be interested in hearing about it?” I asked the pinstriped suits.

Without missing a beat, they shook their heads emphatically. “We wouldn’t care at all.” Not an auspicious start. I was wondering what to do next when Dan Cowin got me the interview at Bear Stearns.

Four young hotshots came to the interview: Ace Greenberg, E. John Rosenwald, Jr., Jerome Kohlberg, and Sigmund “Sig” Wahrsager. Little did I know that I was meeting them just after they’d given an ultimatum to the Bear senior partners: “Either you put us in charge or we’re gone.” Once they took the reins, these four dynamos would open the doors to a whole new culture, introducing innovative ways to make deals that would change the way business was done on Wall Street. I had arrived at the start of the wave.

Curiously enough, the men themselves couldn’t have been more different.

Ace Greenberg was the epitome of the rough-and-tumble world of Wall Street. Puffing a cigar like a chimney stack, he was such a genius on the trading floor that few others could keep up. When he came to Bear Stearns fresh out of college in 1949, they paid him $32.50 a week and put him to work as a clerk. In 1958 he was a partner; in 1978, the CEO. By the time he died in 2014—all too young—Ace had become a Wall Street legend.13

Bear Stearns was John Rosenwald’s first job out of college too. He rapidly made his way up the ladder to become co-president, then vice chairman of the board. As soon as he amassed a fortune, he started giving it away so avidly he gave the impression that that had been his goal all along. He would be renowned as one of New York City’s premier philanthropists.14

Jerry Kohlberg and Sig Wahrsager were a study in contrasts. Where Jerry was reserved, Sig was boisterous. Sig accomplished things with social finesse that Jerry could never have hoped to achieve. With a law degree and an MBA, Jerry had a style that was polished, but cerebral and aloof. Although he moved in prominent business and social circles, he could never understand why so many people avoided him. Personally, I found his imperial demeanor intimidating. Somehow he always made me feel inferior when I dealt with him.

Both men were brilliant. Both would become pioneers. But they could never get along. A few years after I met them, they would barely be speaking to each other.

When I sat across from them in that interview in 1964, none of us knew that these four men were about to revolutionize the industry. Their offices at One Wall Street were dark, antiquated, and unimpressive. In the thirty-five years since they’d been built, no money had been wasted updating them.

As the receptionist led me down the hall to the conference room, I was appalled to see the old black telephones with thick, stiff wires on clunky wooden desks that reminded me of the furniture in grammar school. My heart sank. It was not at all how I had been picturing the Big Time. Was this really the pinnacle of Wall Street?

Because I was a friend of Dan Cowin’s, Ace stepped forward to welcome me warmly and shake my hand. He introduced me to the others, then spent a few minutes listening and answering questions, as he looked over my credentials. I couldn’t escape the impression that Dan had already had a few words with him about me. “Why did you leave Burnham?” he asked.

I was ready for this, but it wasn’t a moment I savored. “I was fired,” I told him. “Probably because I had no respect for my boss, Robert Linton.”

“I don’t either,” Ace shrugged. I liked him immediately.

He went on to say that Bear was growing and needed fresh blood. His plan was to build a team with “street smarts and sharp elbows.” It would be years before he would start calling them people who had “PSD degrees” (poor and smart with a deep desire to become rich). By that time, he’d have built a firm that was second to none.15

Bear was a tough, rewarding place to pursue a career, he told me, but he would always be available when I needed him. Everyone who worked for him had his phone number. “If I can help you, I want to. I’m someone who’s known for getting things done around here. When my phone rings I answer it myself.”16

To my great relief and delight, he said he wanted to hire me on the spot. And then I heard the offer: retail stockbroker with a 12-month guarantee of $10,000.

The good news was they approved my request to assist on any investment banking deals that I originated. The bad news was that it meant I’d be starting out with no clients and no income when I had family of three and $15,000 of debt. A part of me wondered whether the responsible choice would be to take a dead-end salaried job, as so many other sensible people in my position would’ve done. But it wasn’t in my nature to make the safe choice out of uncertainty or fear.

It was a scary prospect. At a 40 percent commission rate, I needed to generate $25,000 in gross commissions in order to actually earn the guarantee they were offering. In today’s dollars, that’s more than $195,000.17 The pressure was immense. But something told me I could rise to the challenge, even if there was little evidence of that yet. It was just going to take more time than I’d expected.

Once more my dream of being a swashbuckling investment banker uncovering golden treasures was eluding me, drifting away to the horizon out of reach. For now those glory days were going to have to wait. I swallowed my pride and took the job. Little did I know it then, but by taking that risk, I’d opened the door to adventure.

Even while I was working at Burnham, I was always looking for ways to up my game, even if it meant taking risks that made some of my colleagues uncomfortable. No one was expecting me to seek out deals like this, but I knew that I’d never make my mark if I only did what was expected.

So, I began to avidly research companies. Nothing would be gained by acting on hunches. Whatever deals I made had to be based on solid information. It was sometimes hard work to get that information, but I was convinced that once I had all the data in front of me, I would be able to find innovative ways to connect the dots.

When I came across Kinney & Co., a small company in Indiana producing a popular inverted sugar solution to treat nausea, I found the opportunity I was looking for. It was a concoction like Coca-Cola without the flavor. They’d been making nice profits selling it over the counter, but I’d heard a rumor that the company was for sale. Wouldn’t that be a nice fit for the company that sells Maalox? I thought.

In the early 1950s, William H. Rorer, Inc., had been a single-product company, selling nothing but Maalox. Once the founder’s son, Gerald, took the helm, he decided against that strategy and initiated the aggressive acquisition of a wide range of products. Rorer soon became very attractive to investors as a relatively small company with an impressively broad product line.18 A market-tested sugar solution already growing in popularity might be exactly the kind of purchase that would appeal to Rorer. William H. Rorer made the famous antacid, Maalox, and Kinney made a cure for nausea. It seemed like a match to me!

When I pitched John Eckman, Executive Vice President of William H. Rorer, the idea of a merger with Kinney & Co., he was interested immediately. He agreed that it was obviously a good fit with the pharmaceuticals he was acquiring to build on the success of Maalox. Harry Kinney liked the idea too. The rumors were right. He had been hoping to sell his company and was eager to make a deal.

John was a member of the prestigious Union League of Philadelphia, the top-ranked city club in the country, and he recommended we all meet there.

The Union League House is a regal example of French Renaissance architecture, with twin circular staircases rising to the doors beside a brick-and-brownstone façade. The union was founded as a show of support for Abraham Lincoln in 1862, the year he issued the Emancipation Proclamation.

As you might expect, the interior of the house harkened back to more refined days, with walls of patinaed wood, soft leather chairs, and gleaming marble floors. Its three dining rooms were rich with moldings, tapestries, and crisp white tablecloths. At every place setting, there were enough silver forks for a family of five.

I’ve met at elegant places like this countless times since, but this was a first for me. It was also the first independent Wall Street deal of my life. I felt a rush of elation as I inhaled that rarefied air.

The three of us ordered martinis, the establishment drink at the time, and started talking avidly about the merger. When it came time to hammer out the details, John said, “Well, since Michael represents you—”

“Represents me?” Harry exclaimed. “I thought he represented you!”

Suddenly, it dawned on them that I’d just put the deal together on my own. They looked at me and laughed.

I smiled sheepishly, then made matters worse when I gestured with my hand and inadvertently knocked over the small glass of clear liquid near my plate. I hadn’t noticed when the waiter left it there. “What’s that?” I asked.

“Why, that’s the ‘dividend’ for your martini,” John explained, smiling.

I had never felt more out of place in my entire life.

My fee on that first deal was $10,000 (almost $80,000 today). I’d just doubled my salary. It felt good. I’d had a discouraging start at Burnham, but this was more like it!

I did something then that I’d never do now. Before I even had the money in hand, I went out and bought a house that cost $22,000—more than my annual income.

It may have seemed reckless, but the house was a good investment. When I took the job at Burnham, Ed Midgely, one of my former classmates at Harvard, asked me where I was planning to live. “I don’t know yet,” I told him. “My choices are fairly limited. We don’t get paid a lot at Burnham.”

“Why don’t you take a look at the apartments where we’re renting?” Ed explained that the apartment buildings on Staten Island had been overbuilt because the Verrazano-Narrows Bridge between Brooklyn and Staten Island had taken too long to complete, so many of the apartments were available for low rates.

“Our building even has tennis courts.” He smiled. “I just park my car near the ferry and take a five-cent ride to Manhattan every day.”

Soon I was doing the same thing. My neighbors were pleasant, and the commute was easy. It was a good decision at the time.

Now that I was ready to buy my own house and starting to come into my own as a savvy dealmaker, I wanted to make a smart choice. If I could find a house in New Jersey, I would pay lower income taxes.

Also, I was having to send my older son to private school on Staten Island, whereas the public schools in New Jersey would be a good substitute. In those days, mortgage interest and property taxes were tax deductible, but school tuition wasn’t. If I could buy a house in an area with a good public school for the kids, it would be a much better deal.

Just before the school year started, we found a great house near the train station in Glen Rock, New Jersey. We needed to sign the purchase contract in order to register Mark for school, but I didn’t have the $10,000 from the Rorer deal yet and the clock was ticking.

“I’ll get this deal done,” I told the loan officer at Manufacturers Hanover Trust. “No question about that. But I’ll need to borrow the house down payment from you, in the meantime, so my son can start school.” I thought I might have to make this pitch to several banks, but that officer gave me the loan.

I didn’t need it for long. The check was on the way. Since I’d started the Rorer deal under the auspices of Burnham, my fee went to their offices. They had every right to deduct a percentage for themselves, but somebody there decided to forward the full amount to Bear Stearns instead. When he saw it, Ace didn’t want a piece of it either. “You didn’t cost us anything doing this deal,” he said, and he signed over the whole $10,000 to me! I’d stacked up risk upon risk to make this deal and pulled it through in the nick of time. Making an extra $10,000 because of Ace’s generosity was an unexpected cherry on top.

A short time later, my luck got even better when a friend introduced me to a Los Angeles lawyer named Seymour Lazar. Seymour was visiting New York and asked me to meet for a drink at his hotel, the Algonquin.

For more than a decade in the early 1900s, the hotel was the site of daily meetings of the Algonquin Round Table, a notoriously outspoken, hard-drinking group of literary writers, journalists, editors, actors, and critics who called themselves the “Vicious Circle.” By day, it was the favorite haunt of people like Harold Ross, Dorothy Parker, Harpo Marx, and the founders of New Yorker magazine. By night, it morphed into one of New York City’s finest cabarets.

It was a theatrical setting, ideal for artists and show business legends—not many financiers. But then there weren’t many people in finance like Seymour Lazar.

Seymour Lazar was always an iconoclast. He made and lost millions of dollars as a securities trader and in a series of legal disputes. He was a hard man to keep down.19

Before he got bored with being an attorney, he worked on cases with famous lawyers like Melvin Belli and Marvin Mitchelson. In the counterculture of the 1960s, he hung out with Beat poet Allen Ginsberg and psychiatrist/psychedelic-drug activist Timothy Leary. 20

Corporate raider and financier Meshulam Riklis said of Seymour: “He was a smiling kind of a character and a very social guy, but he was no fool.”21 Riklis would later recall Seymour’s observation that attorneys who earned their living by suing big corporations were making money “the easy way.”22

In 2006, Seymour faced criminal charges for posing as a class-action plaintiff for twenty-five years in more than seventy lawsuits filed by the notorious law firm of Milberg Weiss against corporations such as Lockheed, Pacific Gas & Electric, United Airlines, Standard Oil, and even Bear Stearns. The cases had purportedly made $44 million for the law firm.23 But that was long after I had stopped acting as a broker for Seymour or for anyone else.

The former partners of Milberg Weiss pleaded guilty to paying clients kickbacks in connection with dozens of securities-fraud lawsuits against public companies. In its part of the case, the firm paid $75 million to settle the allegation that it maintained a collection of professional plaintiffs who kept small holdings in numerous public corporations in order to file for damages whenever share prices dropped.24

At the time of the indictments, Seymour hadn’t practiced law for years. “When they arrested me, they threw me in irons,” he complained. “The government wanted to keep me in jail forever. They didn’t want me to have any bail because they thought I was going to flee. I have all my money here, my art here. I have $11 million in Bank of America here… Where do they come up with these things?”25

Seymour did not contest the facts of the case, but he denied that his actions were illegal. He argued that he was a pawn, caught between powerful corporate attorneys and the Bush administration. Nonetheless, he pleaded guilty the following year to federal charges of filing a false tax return, making a false declaration, and obstruction of justice. He paid a fine of $2 million and spent six months in home detention with two years’ probation. 26

It was “a terrible part of his life,” Seymour’s daughter, Tara, said, especially for a man who was known to be so generous with money and advice. In better times, she said he had always been a larger-than-life personality who loved to laugh and tell jokes.27

Seymour did not take well to his confinement. “I swear, they treat me like an absolute thug,” he said at the time. “I’m not supposed to leave the house. Did I hurt anybody? Who did I cheat? Did anybody get screwed?”28

For all his eccentricities, Seymour proved to be remarkably reliable. He was creative, persistent, and well informed. He liked to move fast. He always said he was “an in-and-out trader. If I bought a stock in the morning, and still owned it at noon, that was a long-term investment.” If he lost, he didn’t let it break his pace, but quickly moved on to something else.29

At the time when Seymour was one of the largest independent traders in the country, I was one of the largest retail stockbrokers in Wall Street. By 1967, he had bought and sold hundreds of millions of dollars in stocks. Most of it was related to mergers and acquisitions.30

Years later, the New York Times would call Seymour “a flamboyant renegade,”31 but that phrase doesn’t begin to do him justice. Everything about him overflowed. While most people constrain themselves, Seymour gave his ideas, his enthusiasms, his generosity, and his personal style free rein. With so much going on inside his head, he talked rapidly, jumping from one idea to another, sometimes speaking in non sequiturs. Few anywhere could ever follow what he was saying.

When I met him at the bar of the Algonquin, he was sporting a long ponytail and outrageous sideburns, even for the ’60s. He wore his patent-leather Pierre Cardin jacket and slip-on shoes with no shirt or socks underneath.

Seymour was with a drop-dead gorgeous woman named Olga James, whom he introduced as the wife of the jazz great Cannonball Adderley. Ten years earlier, she’d starred in the award-winning Otto Preminger film Carmen Jones, which had broken the conventions of its day with an all–African American cast.

When I joined them, Seymour explained that, as an attorney, he represented several protest groups, rock bands, and up-and-coming artists like Lenny Bruce, Miles Davis, and Cannonball Adderley. I would later hear rumors that he had also taken LSD with Timothy Leary and dated Maya Angelou, who had been struggling to make a career as a cabaret singer at the time.32

As much as he loved the company he kept, he confessed that he was getting bored with the practice of law. In entertainment law, he had been doing deals before anybody else because he could see they were there for the taking.33 Now he wanted to do the same thing with risk arbitrage. He asked if I knew anything about it.

I told him that our firm leader, Ace Greenberg, was one of the best and largest risk arbitrageurs in the world. “I will be your broker,” I told him. “But Ace will help me service your account.” He seemed happy about this, and he asked if I could stay for dinner that night and then join him in a box at the Metropolitan Opera. Dazzled, I accepted!

Soon I learned to be a very good risk arbitrageur myself. The work made good use of my investment banking training, and the commissions were great. The average holding period was only about two months, so the accounts turned over six times a year!

The price I paid was high. Risk arbitrage is 24/7. There was no downtime. I couldn’t afford to miss a single call.

As many of us still recall, in those days the only phone service came through landlines. If you wanted to be able to pick up the phone in different rooms, you added an extension, an extra phone from which you could use the main line. Naturally, I put extensions throughout the house—even in the bathroom, where I had also installed a steam unit.

One day I realized that I couldn’t hear the phone ring when I was in the shower. So I added a red light to the phone. Whenever a call came in, the blink of that red light penetrated the steam like the warning lights of a fire engine flashing through the smoke.

In 1968, when the Bear had earned a reputation for having the most successful stockbrokers in the industry, I got a call from Sam Clapp, one of the colorful friends Seymour had collected.

Back in the day, when Sam was an international tax attorney with a prominent Boston law firm, he’d had an English tailor and a Boston family. Now he was a resident of Nassau in the Bahamas and owner of a small brokerage firm/trust company. He still had the English tailor, but not the Boston family.

“Michael, it’s Sam Clapp,” he said briskly. “What’s the highest commission rate that Bear Stearns pays its stockbrokers?”

“Forty percent,” I replied.

“What about a really big broker?” he countered. That’s when I knew he was thinking of his new wife, Martica, who was the highest-earning stockbroker in the world.

Martica Clapp did not have an MBA. Maybe not even a BA. When she met Sam, she was making her living underwater by kissing a trained grouper while tourists snapped photos. The groupers had prospered because people were kissing them, not catching them. Martica had prospered even more.

Since Martica had become probably the biggest retail-commissioned broker in the US without any prior relevant experience, many of us wondered if she really kept all her commissions.

I introduced Sam to the senior partners of Bear Stearns for further discussions. Martica never joined the Bear. I guessed it was because we all believed that her only client was Investor Overseas Services, and Bear Stearns already did a lot of brokerage business with them. Also, we suspected that some of her big commissions somehow didn’t remain with her.

My willingness to deal with risky clients like Clapp and Lazar earned me big money but required extraordinary vigilance on my part to scrupulously comply with regulations and laws myself. And the gamble paid off. My gross commissions in my first year at Bear Stearns turned out to be $25,000; my second year, $100,000; my third, $500,000. By 1967, four years after I took the job, I had made my first million dollars.

Bernie Cornfeld, a friend of Seymour’s, had started Investor Overseas Services (IOS) from scratch in Geneva in 1955. Known as the enfant terrible of the financial world, Bernie had been born in Istanbul in 1927, the son of a Romanian actor who soon moved the family to the Bronx.

Within five years, IOS employed twenty-five thousand people to sell more than a dozen mutual funds across Europe, door to door. The funds were especially appealing to American servicemen and expatriates. Mutual funds had emerged as a good way for small investors to accumulate capital. Bernie liked to call the funds “the people’s capitalism.”

The mutual funds showed their appreciation by directing brokerage trades to any brokers Bernie selected. Apparently, Bernie had selected Sam Clapp’s wife, Martica, as his lead broker. Since Martica was a Bahamian citizen, she didn’t have to suffer such onerous annoyances as income tax filings. Maybe he thought he’d get kickback money.

Soon, Sam and Martica had their own castle—the grandest estate in the Bahamas. In the center of Paradise Island, it stretched from a beach pavilion on the Atlantic Ocean to a Nassau harbor boat house and dock. It was a social hub in the soaring ’60s. Alas, it was not to continue.

For fifteen years, Bernie ranged the world in the company of celebrity jet-setters from his home in an ancient French castle while building IOS into a $2.5 billion empire. It ended when IOS began to falter in the 1970s. IOS was then taken over by Robert L. Vesco, who siphoned more than $220 million from the company, was charged with securities fraud, and became a fugitive.

During the investigations, Bernie was the target of a variety of government agencies. Ironically, he was only found guilty of cheating the phone company of long-distance charges with a little blue box that tricked AT&T into thinking that he was only making local calls. For that, he served time in prison in Lompoc, California. Some people, including Seymour and I, looked into the possibility of taking over IOS. We thought we might be able to borrow money from the banks and, because we were giving them healthy commissions, they would give us favorable loans.

Although he was later acquitted of all charges, Bernie also spent eleven months in a Swiss jail for defrauding IOS employees by selling them stock in the company while it was failing. Afterward, he spent years trying to restore his empire. There was no question in his mind who was responsible for its collapse: Robert Vesco.

When Forbes listed the fugitive financier Robert Vesco among the four hundred richest Americans, it identified his occupation as “thief.” According to Larry Richardson, Vesco “could talk you right out of your socks, or blast you out of them, or you would find somebody else owned your socks.”

IOS could not have slipped into worse hands. Vesco was a small-time takeover artist from New Jersey when I met him. He was managing a tender offer in which I was participating. He reneged on his oral agreement with me to accept stock that I had delivered. I immediately threatened him with litigation. He relented and paid for the stock, but I knew then that he was no good and I stayed away from him thereafter.

Vesco’s particular genius was that he didn’t bother with skimming the brokerage fees from the IOS stock trades. He took the whole thing. Under his control, IOS began buying strange new securities issues that quickly became worthless. Where the cash from the new issues went, no one saw. Soon he was on the lam.

When Vesco fled, IOS was liquidated. Some American and European banks were ruined in the process. At the time, it was one of the biggest frauds in history—equivalent to more than $1 billion today.

For thirty-five years, Vesco lived as a fugitive on his massive yacht and on his private Boeing 707 big enough to house a disco. Payoffs kept him out of harm’s way for years, but his attempt to buy amnesty from President Nixon by donating $200,000 to the Committee to Re-Elect the President was a failure.

At Bernie’s death in 1995, the remarks of those who knew him were as profoundly conflicted as they had been in life. Money manager Fred Alger remembered him as “a brilliant, absolutely brilliant, innovator in the field,” while Richard M. Meyer, a New York lawyer specializing in mutual fund litigation, cited the millions lost by investors: “He only looks good when you compare him to his successor, Robert Vesco. He championed taking a buck from anybody, without scruples.”

Making partner at Bear Stearns in 1969.

I was on the fast track until 1977, when I decided to go through a lifestyle change and moved from a suite overlooking the Metropolitan Museum of Art to a shack in Malibu Colony.

In 1996 Vesco was arrested in Cuba, of all places, for peddling a phony cancer cure. He died, unmourned, in 2007.

PARTNER AT BEAR STEARNS

Moving from producer to manager costs income potential short-term, but increases your upside.

In 1969, just five years after my first interview at Bear Stearns, the firm invited me to become a general partner. My proclivity for taking well-informed risks that paid off handsomely had already made me one of the highest-earning brokers on Wall Street. Now my future was secure.

In some ways, it was exactly what I’d been planning. I would finish my degree, take a job on Wall Street, make my fortune, and become a partner at a major firm. When my dreams came true, I assumed that this was how America worked. But it really was lucky timing. We had been in an extraordinary boom. Along with all the best brokers in the late 1960s, I made a lot of money. In 1970, we gave all that money back.

So many of the risks I took in those days were based on absolute confidence in my abilities and the unwittingly false assumption that things would always work like this. Looking back on it now, I’m amazed at my naïveté. I lacked experience. As is usually the case, experience is what you get right after you needed it.

In mid-1969, when I became a general partner in Bear Stearns, their profits for the prior year had been $30 million. They made me a 2 percent owner. I was entering a new chapter in my career.

When he heard I’d been made partner, L. Jay Tenenbaum, a partner at Goldman Sachs who managed their risk arbitrage department, sent me a letter. We’d never met, but for years L. Jay and I had been getting each other’s mail off and on because of the similarity of our names and the small world of high-end finance. L. Jay was a widely admired trader known for being cool under fire at Goldman Sachs, a premiere firm that made Bear Stearns look like a scruffy little up-and-comer. In a few years, when he retired, he would become a pillar of San Francisco society.

“Congratulations,” L. Jay wrote. “When are you going to change your name and get rid of the extra ‘N’?”

I emailed Ace while he was working on his book asking if he would do me the honor of writing an inscription. Something nice and long, since I paid retail.

His response:

To my pal Michael: You were there. You saw it all, and you were smart enough to leave. My wish is that our paths continue to cross for fifty more years. –Ace

“Thank you for your note,” I replied. “For a long time, I’ve considered changing ‘Michael’ to ‘L. Jay’ but recently, it became unnecessary.” It was the beginning of a warm, mutual friendship.

The risk-taking environment at Bear Stearns was pervasive. Everyone was looking for a smart angle to make big profits. It fit me like a glove.

Bear Stearns’s senior partner, Salim L. “Cy” Lewis, was a powerful personality and a tough trader. At six-foot-four and nearly 300 pounds, he was a giant of a man with an imposing presence. When he dropped out of Boston University after three semesters because he couldn’t afford tuition, he even took up professional football for a while. Always critical of others, Cy led the firm with intimidation and a volatile temper. Most of his colleagues tried to avoid his frequent furies.

Adept at finding opportunities during the 1930s, Cy had acquired sizable holdings in utility companies that were being dismantled and in railroads that were being reorganized. He also invented the “block trade,” in which institutional investors could sell a block of shares of stock or bonds in one trade at a small discount from the market price.

During the 1950s and 1960s, mutual funds were new and growing rapidly. As they expanded, they bought ever larger holdings of common stocks. Very quickly a problem developed. Whenever the “expert investors” wanted to sell some of these stocks in a hurry, everyone saw what they were doing and assumed it was the wrong time to buy.

They started to use spot offerings, wherein the fund would make a deal with a large retail brokerage firm to sell the unwanted stocks for a fat commission. Cy figured out that funds would rather sell them all at a firm price, even if it were at a larger discount. It was a brilliant but high-risk maneuver. Cy would buy blocks of shares at a negotiated discount, then quickly sell them. To facilitate rapid sales of these blocks of stock, the firms maintained data on the major holders of all stocks. The equity sales team was led by E. J. “Johnny” Rosenwald, who was (and is) one of the greatest salesmen anywhere. He turned Bear Stearns into a leading force in stock trading.

In The Rise and Fall of Bear Stearns, Ace wrote, “There is no question that Cy transformed Bear Stearns from a small commission house to a risk-taking machine. He did it by himself, against the wishes of some of his superiors. For that, he deserves all the credit in the world.”34 Years later, firms like Solomon Brothers and Goldman Sachs would dominate the block trading business, but the Bear started it.

Although the contrast between them was great, Jerry Kohlberg and Sig Wahrsager were both invaluable players in those days. On the investment banking side, Jerry helped pioneer the leveraged buyout, in which the assets of a company are used as collateral for a loan that covers most of the cost of the acquisition. Along with his two brilliant associates, Henry Kravis and George Roberts, he generated big fees and profits for the firm by using this tactic.35 Jerry also saw the great potential of “bootstrap” deals. (Bootstrap is another name for LBOs. It’s now called by the more venerated name private equity.) Years later these transactions would vault him to the apex of a major new business, Kohlberg, Kravis & Roberts (KKR).

A short, stocky powerhouse of a man, Sig was a tough, highly imaginative investment banker who built important client relationships with institutions that prized his creativity and brilliance. Never one to suffer fools gladly, Sig’s skeptical gaze put you on notice from the start that you had better be right when presenting him with the facts. He once burst out laughing after seeing the business plan of a well-regarded company. They had come to Bear Stearns for financing, but, after Sig’s gleeful insult, they haughtily took their business elsewhere. Bear Stearns was embarrassed—until they found out that the company’s purported business was a massive fraud!

Sig surrounded himself with very bright, driven—if somewhat scruffy—staff. I’ll always be grateful that Sig took a liking to me back when I was starting out as a stockbroker and let me work on deals that I had originated.

It was an exciting group of people to work with and to learn from. The culture among Ace’s team of those who were “poor, smart, with a deep desire to get rich” may have been rough and tumble at times, but we took pride in knowing we were making Bear Stearns one of the shrewdest, most innovative and consistently successful firms in the business.

On the other hand, the administrative processes at Bear Stearns were so antiquated and counterproductive it sometimes felt as if we were living in the 1940s.

When I was offered the partnership, I asked to see Bear Stearns’s financial records. The chief administrative partner, Alvin Einbender, had the files delivered to my office. When I read them, I was stunned. I’d expected data that was relevant to the management of the business. I thought there must have been some mistake when I got only income tax returns and standardized forms for the calculation of regulatory capital. But that was all they had!

In disbelief, I went straight to Alvin’s office. “You don’t know where you make your profits!” I told him.

“You’re right,” he said. “What are you going to do about that?”

By fall, I’d organized a working group, hired Arthur Young & Co., and started the design of Bear’s first real management reporting system.

This should have been done by Managing Partner Teddy Lowe. Born Victor Theodore Lowenstein, Teddy tried to create the impression of excellence with his arrogance and immaculately tailored suits. Otherwise, he ran the firm at low-level inefficiency.

Networking was his forte, yet his approach was purely old Wall Street. His business card said only “V. Theodore Lowe.” One day I brought it up. “Teddy, don’t you think it would be helpful to at least have your phone number on your business card?”

“People who are important enough know how to find me,” Teddy sniffed. “The others, I don’t care about.”

John Slade, another important senior partner, took a similarly backward, unbusinesslike approach when he ran the international department. In the major financial centers of London, Zurich, and Frankfurt, international finance was extremely dynamic, but John preferred to spend time in Paris, Amsterdam, and Geneva, so he located our offices in those cities!

Even worse, the research department of the firm was dismal. Cy Lewis had nothing but scorn for research. “In an up market, you don’t need it. In a down market, you don’t want it,” he always said. He preferred an old-school approach, relying on sources and hunches.

With this state of affairs, I soon transitioned into management activities. I sensed big career opportunities at this undermanaged firm. In a couple years, I’d reorganized the research department and updated the firm image and logo.

When I ran the research department as codirector from 1971 to 1973, I quickly eliminated a bad practice that has since become illegal. Whenever an investment banker financed a company going public, the company would insist that the banker continue to write favorable research reports about the company, so the stock would go up. When I ran the research department, I said, “People won’t have confidence in us if we go around pimping for our client companies!”

When a client’s stock went up, that was exactly the time when we’d want to recommend a sale, but we couldn’t do that if it would subvert an attempt by the client to raise more capital. It was a clear-cut conflict.

To alleviate the problem, I introduced investment banking research, which covered investment banking client companies but did not recommend either sales or purchases. It should’ve been like that throughout the industry, but it wasn’t. The common practice of shilling with favorable research reports was so popular that I suspect it never really ended, even after the practice was finally made illegal. My guess is, nothing’s changed. It’s just less overt now.

After a false start trying to build an investment management department at a firm not known for this skill (a strategic error on my part), I took over the risk arbitrage department in 1973.

It was a huge career opportunity for me. Cy Lewis, Ace Greenberg, and Marvin Davidson had all been risk arbitrage managers and subsequently went on to run the firm. I saw a chance to eventually be the managing partner!

I ran the department until 1977, introducing the innovation of providing written research on arbitrage opportunities to our brokerage clients, breaking the traditional “wall of secrecy.” I also significantly increased the size of each of our investments, which made our profits grow.

Basically, risk arbitrage relies on making a series of educated bets, buying and/or short-selling securities of companies that are engaged in corporate transactions.36 For example, if a stock were trading at fourteen dollars a share, but a proposed transaction was valued at sixteen dollars a share, we would buy it at fourteen, as long as our assessments showed that the transaction was likely to close in a reasonable amount of time. If the closing took place in three months, we would then make a two-dollar-per-share profit, which would be a very high annualized return.

The risk lies in the possibility that the deal will fall apart.37 But a sophisticated player sees the nuances others don’t see. We would handicap a formal tender offer very differently, depending on whether it came from an agreed friendly merger or from a threatened hostile takeover. Research may show that, although the offer is attractive, there is significant shareholder resistance. Antitrust issues can cause government investigators to challenge an agreement. An arbitrageur assesses the likelihood of whether the management will capitulate or the government will lose and places his bets.38

The pressure was omnipresent. You might get a call on Sunday night letting you know that a famous merger lawyer was seen leaving a client’s office and he was frowning! You needed to prepare for the bad news on Monday.

In the 1960s, International Telephone & Telegraph (ITT) bought more than three hundred major companies, such as Avis Rent-a-Car, the Sheraton hotel chain, and Continental Baking, the makers of Wonder Bread.

When ITT attempted to buy the ABC television network for $700 million, it generated a lot of buzz, and all the smart investors bought a lot of ABC stock. Seymour had a huge position. The Sunday night rumor was that President Lyndon Johnson had been paid to approve the sale. We all knew that KTBC-TV, the Austin, Texas, TV station owned by Lady Bird Johnson, had been favored with big national advertising dollars, so the rumor was credible.

Then a stunning series of setbacks hit in 1968, when the US Justice Department swooped in and halted the takeover of ABC because of potential antitrust violations. Seymour had already bought three bottles of fine champagne to celebrate the sale, but when it was stopped, the stock collapsed. It cost a lot of people money.

It was a jungle. On any given day you could make an enormous amount of money or lose it all. Some people were attracted to that danger like a moth to the flame.

In those days, it was one of the highest-pressure jobs in the world, and it still is today. Not everybody can stand the tension. You’ve got to have the nerve for high risk on a daily basis. If you don’t—if you try to proceed with caution—you’re in the wrong job.

Ace liked to say that, no matter what, you had to risk getting involved in a lot of deals. Back when he was working his way up, very few Wall Street firms were engaged in such complex dealing, but he helped the Bear make money almost every month.

When the market was going our way, the risk arbitrage department made 50 percent of Bear Stearns’s profits. In a slow year, it accounted for 100 percent.39

OPTIONS TRADING

Starting new ventures in an established firm has big upside.

In 1973, the same year I took over the risk arbitrage department, the leading commodities exchange in the world introduced a brand-new way of trading options. It was time for me to up the ante and tackle options, the riskiest trades of all.

Partitioning off part of their massive trading floor, the Chicago Board of Trade created the first exchange listing standardized stock options. Christened the Chicago Board Options Exchange (CBOE), it opened its first day of trading on April 26, 1973.

Options are contracts giving the holder the right, but not the obligation, to either buy or sell a particular asset (usually a stock) at a set price on or before a specific date. The right to sell is called a put option, while the right to buy is a call option.40

A few years after options trading began, I was asked by Bear Stearns to investigate this intriguing new market created to standardize options and trade them in an organized way. It was obvious to me that options trading was a way for savvy investors to engage in a variety of investment and trading strategies. Options offered new ways to minimize losses and to hedge gains on investments with a small outlay. Since the cost of the options was a low percentage of the value of the shares, investors would leverage their assets far more freely, making it possible to secure gains that were magnitudes greater than before.

Their versatility was also appealing. With a unique risk/reward structure, options could be combined with other financial instruments. The margin of loss could be fixed.41

Options could be a higher-risk strategy than stocks. When a stock option expired, it became worthless—it was a 100 percent loss. Since the price of most options would be only a small fraction of the price of the related stock, the amount of money at risk was much less, which I thought created interesting opportunities.

When I returned from the CBOE, after analyzing its potential, I said, “This is a great new business. It could be huge. We need to do it in a big way!”

“You’re doing fine with risk arbitrage,” they told me. “Would you be willing to create and run an options department, too?”

“Absolutely.” I was nothing if not ambitious.

Today options are regarded as one of the most successful financial products in modern times, offering unequaled versatility and leverage.42

The combination of a pioneering approach and compliance innovations made it a big success for Bear Stearns very quickly. I hired good people so that the other departments in the firm wanted to do business with us. If they had to worry that my team might embarrass them, it would never have worked. Because the investment turned over quickly, the commissions were very attractive. That made the firm very happy.

It was not long after I set up our operations in Chicago that we started having a lot of expensive “misunderstandings.”

Option prices are very, very volatile. Thus, mistakenly buying instead of selling could cause big losses to us. These “trade errors” were never in our favor. Usually they weren’t even errors.

Quickly, I said, “All right, we can eliminate this problem if we simply record all the calls.”

It was an innovation in the industry. Recording technology was a lot more cumbersome than it is today. In 1975, audio cassette tapes weren’t very commercial, but we made it work. The “errors” dropped to almost zero!

Computer technology was just starting to emerge in those days. It would be another year before the first Apple computer, hand-built by Steve Wozniak, went on sale, and when it did, only 175 of them would be sold.43 The first IBM PC—a $1,500, twenty-one-pound computer with 16K of memory—wouldn’t be released until 1981.44 It would be another decade before personal computers really took off.

Long before then, computers looked promising to me. I wanted to use them to analyze option values. With a soaring number of options listed, we were looking for overpriced options to sell and underpriced options to buy. As I saw it, a computer should be a lot better at sifting through that vast amount of data than human beings.

As a fundamental value investor, I usually thought that the price-earnings ratio of a stock was the best single indicator of a stock’s investment value. It measures the current share price against the current earnings per share. If this ratio were low, the stock was usually a bargain; if the ratio were high, the stock often was not a bargain. When I compared those price-earnings ratios to the prices of options, I could find what might be good buys and what might be good sells. If, for example, a stock were trading at ten dollars a share and options to buy it at ten dollars a share were trading at two dollars, the stock would have to increase by 20 percent for the option holder to break even [($10 + $2) ÷ $10 = 120 percent].

My computer would show which stocks required the lowest price change for the option buyer to break even. When such options were available for stocks that also had low price-earnings ratios, then they were candidates for purchase. This was the very first application of computers for research in options. It worked so well that word got around. It generated so much buzz on Wall Street that we started to do a lot more business.

Soon I was also using computers to automate our options compliance. We could quickly spot inappropriate options trades by our brokers. As a result, we had the lowest customer complaint ratio in the whole industry.

It was gratifying to see the options department thrive. As it grew, I became better known in the industry, including advising the Pacific Stock Exchange to enter the options business. I also made a point of publicly debunking the options valuation theories that were a load of horseshit. I knew that they simply didn’t work.

The industry was relying on the revered but useless Black-Scholes formula developed by Fischer Black, Myron Scholes, and Robert Merton. It was the best-known options pricing model in the world. In 1997, two of its inventors won the Nobel Prize in Economics for it. (The formula’s third inventor, Fischer Black, died before the nomination, and the prize is never given posthumously.) The Black-Scholes model measured four factors:

• time left to option expiration

• ratio of the option price to the price of the related stock

• market price volatility of the related stock

• risk-free interest rate

However, the options market is made up of three very different segments. Near-the-money options are used to leverage investment portfolios because their premiums are reasonable. In-the-money options are a chance to buy stock with no premium, and out-of-the-money options are very speculative. It’s impossible to conceive of a single formula that could apply to each segment, since the basic economics of each one are so different.

During this time, a Stanford business school professor invited me to speak to his class about options. William Sharpe, who had just come to teach at Stanford in 1970, sat in on the class. Sharpe was one of the pioneers of mathematical investment formulas, helping create the capital asset pricing model and the Sharpe ratio for risk-adjusted investment performance analysis. He had built his career on the value of mathematical formulas for investing.

My argument, then as now, was that a stock that had soared in price would rank as very volatile, which would then indicate that its call options should sell at high prices—in other words, the model would have you pay even more for a call option on a stock that had risen rapidly. And, conversely, you would pay a very small premium for a call on a stock that had not risen rapidly—just the reverse of what a value investor should do!

By the end of the lesson, I’d made my case and the class was with me. I doubt that William Sharpe was; he didn’t stick around. But twenty years later he would win the Nobel Prize in Economics for pioneering work in developing a general theory for the pricing of financial assets.45 Go figure!

When I repeated the challenge to the Black-Scholes formula in an article in the May 23, 1977, Barron’s Financial Investment News, I got only fan mail.
Next, I joined distinguished Harvard Business School professor of investment banking Samuel L. Hayes III in writing an article entitled “The Impact of Listed Options on the Underlying Shares” for Financial Management, the official journal of the Financial Management Association. We disproved the political criticism that options increased stock market volatility. We showed that the large volume and variety of option trading actually dampened the volatility of the related stocks because it increased the supply.

Despite the irrefutable evidence against them, option pricing models live on. Even the brilliant Warren Buffett has endorsed them.

PSYCHIC OPTIONS

Listen to the conventional wisdom, then give precedence to your own intelligence.

Despite my adherence to mathematical principles, I didn’t close my mind to other investment approaches. The rigorous innovations I’d introduced to options trading had worked well. I began to wonder if more speculative innovations might pay off as well. I was certainly willing to take some risk in exploring them.

In the fall of 1974, paranormal phenomena were all the rage. Practitioners on national TV appeared to bend spoons with the power of their minds. Psychics attempted to channel spirits or speak to the dead. A few years earlier, Lynn Schroeder and Sheila Ostrander had written the popular book Psychic Discoveries Behind the Iron Curtain, revealing research into Kirlian photography of a corona around all living things. The book claimed that Russian scientists had been advising the Pentagon on ways to harness psychic energy.46

In 1973, the director of the Defense Advanced Research Projects Agency (DARPA) at the Department of Defense requested that the RAND Corporation evaluate the American and Soviet scientific literature on the matter.

RAND found that both nations were actively involved in research, but “if paranormal phenomena exist, the thrust of the Soviet research appears more likely to lead to explanation, control and application than is US research.”47 This response turned up the heat on paranormal research in America.

At the same time, Jeane Dixon, a California psychic who had reportedly predicted the assassination of President John F. Kennedy, was selling books by the millions. When she predicted terrorist attacks in the United States after the assault on the 1972 Summer Olympics in Munich, Richard Nixon took her “psychic intelligence” seriously enough to set up a cabinet committee on counterterrorism.48

It occurred to me that, in options trading, even a small prediction advantage could have a great leveraged payoff.

A close friend of mine who worked in the New York City government was intrigued by psychic phenomena, too. She was acquainted with three paranormal practitioners who were so famous that you could just turn on the TV to see them.

Debunking options myths that survive to this day.

I suggested an experiment. We would select thirty-two stocks with options traded. Each of the practitioners would predict the future price trend of those stocks for the week: generally up; generally down; steady; up, then down; down, then up; or narrow fluctuations. If they were successful, the predictions could give us a unique advantage in options trading.

Each of the psychics agreed to participate, but only anonymously—in case they failed. My friend assigned them code names and collected their recommendations without disclosing their names to me.

They started on October 29, 1974. In the first few weeks, the three practitioners only agreed on seven of thirty-two stocks. It wasn’t too promising, but I thought, Well, maybe not all three are good at this. I’ll stay with it.

By February 27, 1975, the results of the experiment were so awful, I disbanded it.

All three practitioners had predicted the movement of thirty-two stocks every week. That amounted to ninety-six votes a week for seventeen weeks. Only eleven predictions were correct after four months. I would have done great betting against this group!

Needless to say, I stuck with a rigorous approach.

But apparently the US government was harder to dissuade. In January 2017, when the CIA made twelve million previously classified documents available online, one of the most striking revelations was that Congress spent $20 million on paranormal research over a period of twenty years between 1975 and 1995. All but $750,000 of the funds came from the Defense Department.49

“Given the things we don’t know about how the brain generates electricity, we’d be crazy not to devote a small amount of money to this,” one congressional aide told the Washington Post.50

Alarmed by the Soviet Union’s apparent progress in the field in the 1970s, the CIA briefly sponsored the research. The 2009 farce with George Clooney, The Men Who Stare at Goats, was based on Jon Ronson’s nonfiction book about this era, when the government hoped to create a military unit with the ability to do remote viewing, walk through walls, become invisible, and even kill a goat by staring at it.51 Although one goat dropped dead after being stared at for days, it seems to have died from either sheer exhaustion or despair. Anyway, I never viewed goats as a threat. In fact, I rather prefer goat cheese.

The CIA initially believed that Israeli psychic Uri Geller was capable of bending spoons with his mind. Then Johnny Carson debunked his powers once and for all by simply challenging him to bend a spoon on TV.52

Eventually, the CIA realized, as I had, that the experiment was not paying off. So Congress funded the research from then on. Our tax dollars at work!

JEFFREY EPSTEIN

In 1976, Ace Greenberg called me. “There’s a smart guy named Jeffrey Epstein who teaches math and physics at the Dalton School. He had one of the Dalton trustees call me because he wants to come to Wall Street. Will you see him?”

The answer for any of Ace’s requests was always “Sure.”

Soon thereafter, a clearly bright, ambitious young man showed up in my office. It turned out that my son Andrew, who was then a student at Dalton, knew Epstein’s work well. Andrew confirmed that he was an outstanding teacher, as well as being very popular, especially with the female teachers.

After grilling Jeffrey a few times, I hired him to develop and market our quantitative analyses for options. And he was terrific at it. Then, a few months later, came the fateful phone call from the head of personnel. They had just completed due diligence on his job application to the firm.

“Are you sitting down?” Not a good beginning for a call from our head of personnel. “We checked out Jeffrey Epstein’s academic record. It’s all lies.”

“That can’t be true,” I countered. “He comes to us from one of the top prep schools in the country.”

“I know, so I double-checked. None of his colleges have ever heard of him.”

Wonderful news. I had hired a liar. Even worse, he was dating Ace’s daughter.

I went to see Ace and told him about the findings of our personnel department. Between Jeffrey’s prominent presence at Dalton and the now delicate nature of his involvement with Ace’s daughter, I wasn’t sure how he would want me to proceed.

“Treat him like anyone else,” Ace said.

I confronted Jeffrey, expecting the usual excuses and denials, but he confessed immediately.

“I always knew I’d be a great teacher,” Jeffrey explained. “And I am!” The trouble was that no school would hire him without appropriate academic credentials. So he made them up. “I wanted to tell you the truth, but I was afraid the Dalton School would hear about it…”

Whatever the lies, the facts spoke for themselves: Jeffrey was a great options marketer. He had learned quickly and excelled within weeks. No one’s perfect, I reasoned, and I usually give people a second chance. So I let him stay. This was one time I shouldn’t have.

By 1980, Jeffrey was made a limited partner in the firm. His career was soaring. His name was appearing on Page Six as one of the hottest bachelors in Manhattan. Then suddenly in 1981, he was pushed out of Bear Stearns for violating firm rules in regard to a woman. Since I was no longer working in New York, he dropped from my radar until I saw a 2003 article in Vanity Fair entitled “The Talented Mr. Epstein.”

It ran with this lead:

Lately, Jeffrey Epstein’s high-flying style has been drawing oohs and aahs: the bachelor financier lives in New York’s largest private residence, claims to take only billionaires as clients, and flies celebrities including Bill Clinton and Kevin Spacey on his Boeing 727. But pierce his air of mystery and the picture changes.53

In 2006, Jeffrey was accused by the Palm Beach Police Department of running an underage prostitution ring. When he made a plea deal in 2008, he was sentenced to eighteen months in jail.

One of the young hookers swore that she had had sex with both Prince Andrew and an internationally famous lawyer. Epstein reportedly had twenty-one private email addresses for Bill Clinton, who had flown on Epstein’s plane at least eleven times. Sometimes I wonder where Jeffrey would be today if I had had the wisdom to fire him.

WHAT REALLY HAPPENED AT BEAR STEARNS

Bear Stearns grew to be one of the top five United States investment firms, but today it no longer exists.

Only twelve years after I left Bear Stearns, they were broke. It was an epic tragedy stemming from a Faustian bargain.

In May 1923, three wealthy brokers founded Bear, Stearns & Co. with $500,000 of their own money. Cautious businessmen, the company didn’t put much of their own capital at risk. As a result, they remained profitable throughout the crash of 1929 and the Great Depression that followed. By 1933, they had seventy-five employees and almost a million dollars in capital.

They then hired an aggressive bond trader, Salim L. “Cy” Lewis, who began using the firm’s capital to deal in bonds. Cy pointed out that this strategy would allow them to not only earn a commission for executing customer orders, but also profit by reselling the bonds for a higher price than they had bought them at. The deals were very profitable. Cy was made a partner in 1938, when he was only thirty years old.

Four years later, World War II began. When the government commandeered the railroads, the price of railroad bonds plummeted by 90 percent. Cy bought them. He assumed that America would win the war, the railroads would reorganize, and the bonds’ prices would soar. That they did, and so did Cy’s power in the firm.

Soon thereafter Cy wielded his new power to push aside the partner who had hired him. Thus began a pattern of brute-force succession at the top of Bear Stearns.

After graduating college, Alan C. “Ace” Greenberg was hired as a clerk. By then, the firm had 125 employees and about $17 million in capital.

Ace excelled at handicapping events, and soon he was demonstrating that skill on the firm’s trading desk. After he developed a specialty in risk arbitrage, he ran that department. Because it became the most profitable activity in the firm, he acquired power.

Employing the aggressive model initiated by Cy himself, Ace used his new power to force Cy to share control of overall trading decisions. By 1964, Ace and three other young partners had taken total control of Bear Stearns. It was the second brute-force succession at the top. Once again it occurred because of the profit-making skills of the new leader, together with the unwillingness of the incumbent leader to see the major younger talent leave the firm. Although crude, it was an effective succession process. Alas, it was the last time this crucial change worked this way.

In 1969, Ace interviewed James E. “Jimmy” Cayne. Jimmy had a background in sales that included scrap metal, office products, and municipal bonds—none of which were relevant to Bear Stearns. Ace hired Jimmy because he was a champion bridge player and Ace wanted to be one, too. Considering what Jimmy was paid, this was surely the most expensive bridge lesson in the history of the world.

At this time, I was one of the top two commissioned salesmen at the firm. I had built my business by finding high-return investment ideas. Ace asked me to advise Jimmy how to build a successful stockbrokerage business. This was my first meeting with Jimmy and the only one for the next five years. To call him unappreciative of my efforts would be generous. He was arrogant, impatient, coarse, and, by all appearances, not particularly intelligent. I figured he’d be gone in a few months. Boy, was I wrong.

Several weeks later, Ace announced that Jimmy had been appointed liaison between the stockbrokers and the municipal bond department—a made-up job to assure Jimmy of an income. He became a toll bridge. I was startled by this feat of political prowess. I should have been more startled.

While I had earned my way up in the firm, Jimmy had schemed his way up. The New York retail sales department was the largest retail stockbroker office in the country. It had been built up over a ten-year period under Ace’s patronage, but the day-to-day work had been done by Lewis Rabinowitz and Ed Levy. For reasons that were unclear to us, Jimmy was made co-head of the department. Ed and Lew capitulated and left.

One day when I was discussing option compliance issues with some new stockbrokers hired by Jimmy, they volunteered their commission arrangement with the firm. I was appalled. It seemed that Jimmy’s department kept showing big accounting profits because a lot of its indirect costs weren’t charged to it.

With these kinds of machinations, I didn’t see how the firm could make a fair profit, and I told my partners about it. Nothing changed.

It was clear to me then that Jimmy was a calculating schemer, but I still wondered how intelligent he was. Then one day, around 1976, after a partners’ meeting, I asked Jimmy if he’d like to play backgammon. I was a so-so player, but my math skills were very strong. We played two games in my office. I lost them both. Even more appalling, in the second game, I didn’t even realize I was losing until the end! That’s how good he was. It was chilling to realize how dangerous a wily man like that could be to the firm.

When I moved to Los Angeles in 1977 to build an investment banking business, my move took me out of the running for managing partner. I had had enough of administration and politics. I just wanted to do deals. It was a relief to be off Jimmy’s hit list, since he had been methodically eliminating every partner close to Ace.

The very next year, Cy Lewis retired at age sixty-nine, after forty-five years at the firm. His high-pressure life, personal excesses, and continuous political pressure had worn him out. At the partners’ annual dinner at the Harmonie Club, he was presented with a gift. When he attempted to untie the big ribbon bow, his hand wouldn’t work. It oscillated up and down. An alarmed hush fell over the room.

Sitting next to him, I reached over and said, “Can I give you a hand?” At that moment, he suffered a fatal stroke and fell over backward.

Ace moved into an even more powerful position after that. Over the next ten years, I built the top regional investment banking franchise in the firm, making increasing amounts of money but never attempting to amass any real power. Periodically, I warned Ace and the senior partners that Jimmy was a danger to the firm and should be controlled. I never could mask my strong feelings.

On October 19, 1987, the Dow Jones Industrial Average dropped in price by 22.6 percent, the highest daily decline in history. Bear Stearns stock dropped by a third to eight dollars per share. It was all the more dramatic considering that a tender for 20 percent of the shares at twenty-three dollars each was to close only four days later!

I called Ace and predicted that the buyer, Jardine Matheson, would want to reduce the price of the tender. I said that I would vote to do so because of the materially adverse change in the securities market.

When Ace told Jimmy, he immediately called me. “You’re just wrong,” Jimmy said. “You don’t understand the British. Jardine is on the way here now to assure me that they are going to proceed with the tender offer.”

“Let me ask you, Jimmy,” I said disdainfully. “When you have a tooth extracted, do you put it under your pillow?”

If Jimmy thought he hated me in that moment, it must’ve been even worse when he found out that I was right: Jardine canceled the tender offer.

In the years that followed, I watched Jimmy methodically push out Ace, to whom he owed his entire career. I loved Ace, so I hated Jimmy. Most partners had focused on building up the firm franchise. By contrast, Jimmy spent most of his time in Machiavellian schemes.

Once he had reorganized the operating heads of the major business lines, he controlled the compensation process. Then he pushed out executive committee members in favor of the operating executives, who, of course, were beholden to him, and thereby gained control of the executive functions of the firm.

One day in 1993, an emergency board meeting of Bear Stearns was called with only one agenda item, the transfer of the CEO position from Ace to Jimmy Cayne. The purported reason for the change was an upcoming meeting between Cayne and an Asian company CEO. Cayne averred that Asian custom required that meetings only be between persons of “equal rank.” Through this tacky ruse, he formalized his seizure of power at the firm.

In 2001, Cayne became chairman of the Bear Stearns board of directors, allowing him to stack the board even more in his favor. Ace remained chairman of the executive committee, but he was regularly outvoted by Jimmy’s bloc.

That is how the third brute-force power struggle at Bear Stearns ended: a salesman with few financial skills was in almost total charge. It was the beginning of the end.

At the old Bear Stearns, talent had been more prized than loyalty. In the end, neither talent nor loyalty could compete with a quenchless thirst for wealth and power.

When Jimmy took over as chairman of the board, he focused relentlessly on acquiring total power and endless personal wealth. With his crude, autocratic style and lack of either leadership or administrative skills, he proved to be disastrous for the firm.

Beginning in the 1990s, the large American financial institutions had become increasingly complex. Instead of simply making loans and taking deposits, they invested in a wide range of assets, many of which could not be sold readily. To make matters worse, the banks’ auditing firms were too willing to accommodate maneuvers that skirted the capital adequacy rules. The auditing firms looked the other way when extremely leveraged affiliates failed to show up in the banks’ financial statements. That allowed the banks to employ far greater leverage than the regulators would ever have permitted.

When the Glass-Steagall Act was rescinded in 1999, commercial banks and investment banks plunged into each other’s businesses after sixty-six years of separation. The result was that large financial institutions became so complex, it was impossible for outsiders to analyze them. By then, the largest firms had gone public, so it was the outsiders whose money was mostly at risk, while the insiders focused on increasing their own compensation.

During this period, Jimmy’s Bear Stearns stock holdings rose from very little to 6.4 million shares, despite his periodic sales. At the peak price, his shares had a market value of over $1 billion. The engine behind this dramatic increase in his wealth was the great growth of the firm, together with its enormous increase in the illiquid investments financed by short-term capital.

That these strategies were shortsighted must have been obvious to the most experienced officers of the firm, but most of them were political captives by then. Few remained who were willing to risk their jobs by challenging Jimmy’s scorched-earth strategies for short-term gains, even if it meant he was setting Bear Stearns on a course for disaster. The exceptions, Ace and Johnny Rosenwald, quietly sold off their Bear Stearns shares while they did damage control.

In the modest times of 1983, Bear Stearns had under $10 billion in assets, all of which—except $800 million—were US government bonds. The firm had $235 million in equity and only $71 million in long-term debt. Despite this conservative business strategy, the firm earned $187 million after partners’ compensation. Of course, we partners weren’t paid high salaries before the firm went public in 1985, so these earnings are a bit overstated. Nonetheless, the riskiness of managing this balance sheet was much less than managing the 2007 balance sheet of:

Total Assets $385 billion (36 x equity)

Risk Investments $105 billion (9.5 x equity)

Equity $11 billion

Long-Term Debt $99 billion

The firm reported earnings of $3.3 billion pre-tax (before $3.1 billion in special charges). Even the $3.3 billion in earnings before special charges was small compared to the $105 billion of risk investments. (Corporate securities were $61 billion; mortgages and asset-backed securities were $40 billion.) So, in 2007, earnings were about 3 percent of risk investments, and in 1983 they were about 22 percent.

Thus, earnings growth was increasingly dependent on large, high-risk investments with modest returns, which were bought using enormous amounts of short-term financing. Even after 2007, when management reduced short-term financing and increased cash holdings, they still relied on $163 billion in such financing. In other words, the firm’s liquidity relied heavily on the short-term lenders’ confidence in the management at Bear Stearns.

When Bear Stearns went public in 1985, I was on a small committee charged with changing the compensation process. For about sixty-two years, the Bear Stearns partners had taken only low salaries, in order to keep the earnings in the firm. Every two years, the proportionate ownership of the firm was changed to reflect any perceived shifts in the relative importance of each partner. These changes were usually gradual, but an individual partner’s ownership might vary across a wide range from 0.1 percent to 6 percent. The objective of our committee was to find ways to maintain this long-term financial incentive for the partners, since their ownership percentage was no longer at stake every two years. We decided upon a bonus pool that would be redivided in the same fashion every two years. I called it a “synthetic partnership.” Synthetic or not, it provoked similar political struggles and abuses, only this time it wasn’t the partners’ capital at risk.

Jimmy quickly solidified his control over the bonus pool. His vast expansion of the scale and riskiness of Bear Stearns’s business resulted in the bonus pool’s soaring to $140 million in 2006. By that time, the analysis and control of Bear Stearns had become too daunting for mere mortals.

Since the invention of the computer, investors have sought to design programs that would assist them in investing. During the 1980s, mathematical geniuses were recruited to invent models that would harness the many permutations of investment strategies with options, derivatives, swaps, and credit-default contracts.

It was a good idea, in principle, as long as the decision makers remembered that the mathematical geniuses were not investment experts and that the investment experts needed to understand the prediction error rates of the mathematical models. But, alas, they did not. Instead, when the computers churned out financial data based on the negligible investment savvy of brilliant mathematicians, the decision makers worshipped it like holy text.

Ironically, it was the lawyers who were the most objective. They had to write public documents explaining what was really going on in the risk-control area. Apparently, they were scared enough to make sure that they understood the process enough to write documents that they could defend if sued.

Take, for example, these prophetic descriptions from Bear Stearns’s last annual report, published after their last fiscal year, ending November 30, 2007, a few months before they went broke:

An estimation of potential losses that could arise from changes in market conditions is typically accomplished through the use of statistical models known as value-at-risk (“VaR”) that seek to predict risk of loss based on historical and/or market-implied price and volatility patterns. VaR estimates the probability of the value of a financial instrument rising above or falling below a specified amount. The calculation uses the simulated changes in value of the market risk-sensitive financial instruments to estimate the amount of change in the current value that could occur at a specified probability level.

The calculation is based on a methodology that uses a one-day interval and a 95 percent confidence level. VaR is not likely to accurately predict exposures in markets that exhibit sudden fundamental changes or shifts in market conditions or established trading relationships.

The aggregate VaR presented here is less than the sum of the individual components (i.e., interest rate risk, foreign exchange rate risk, equity risk and commodity price risk), due to the benefit of diversification among the risks.

In other words, the value-at-risk was an estimate of future relative price changes based on one-day time intervals, excluding sudden changes. And this VaR was reduced by Bear’s management because they perceived that they were so diversified that some of the risks offset each other!

So the actual price changes from more than one-day periods and sudden price correlations changes were not considered. In fact, Bear’s management assumed that most categories of investments would not drop in price at the same time—although that is exactly what has happened in every market crash!

Since 2001, Average Daily VaR Has Increased By Roughly 71% to $25.7 Million.

Average Daily VaR

But even this optimistic VaR number was soaring by 2005.

This unfortunate use of VaR would not have destroyed Bear Stearns had it not used too much short-term debt. The firm’s value would have dropped a lot, but if they had then held on to the assets, the firm’s value would have recovered in a few years.

Despite the obvious uselessness of the VaR calculations in a market crash, Bear Stearns relied on those calculations and borrowed a lot of money, most of it on a short-term basis. This meant that the liquidity risk of the firm was great. Now, consider this passage from their last annual report:

The company maintains a rigorous framework and commits substantial time and effort to the management of liquidity risk. The Global Finance Committee, in consultation with the Chief Financial Officer, has established a funding framework for the Company. This framework ensures flexibility to address liquidity events, maintains stability and continuity of funding in all market environments, and includes targets and guidelines around key liquidity measures. A fundamental premise of the liquidity risk management framework is that the firm is not reliant upon nor does it contemplate forced balance sheet reduction to endure a period of constrained funding availability.

In other words, the types of assets that they owned wouldn’t have to be very salable in a market crash caused by “a period” of illiquidity. Pretty courageous strategy for a firm relying on $28 billion in short-term borrowings that became due each day!

The tragic loss of Bear Stearns could have been avoided. Had Bear Stearns not been so reliant on short-term loans, or so heavily invested in illiquid mortgages, it would have survived the financial crisis.

Some senior partners advocated diversifying by buying the successful investment management firm Newberger, Berman when it became available at an attractive price. A similar proposal was made to acquire the successful clearing firm Pershing & Co. All such efforts were thwarted—apparently by Jimmy. He was well aware that the bonus pool was maximized by high returns on capital. Buying successful firms at merger prices would have reduced this metric. With little regard for the longevity or well-being of Bear Stearns, he exerted relentless pressure to maximize the bonus pool instead.

By 2005, the profits from the firm’s debt business amounted to $3.2 billion, double the profits of five years earlier. But the firm was vulnerable to financial shock because of the large number of such investments in concentrated asset types together with the overnight borrowings that financed them.

As the mortgage market itself became riskier in the run-up to 2008, the firm did reduce its exposure to that market. By the fall of 2007, the firm had rapidly increased its cash holdings by $15 billion in just twelve months. Its mortgage and leveraged finance holdings had dropped by billions of dollars. However, its short-term borrowings had surged by $30 billion, raising its total debt to over $300 billion.

Repurchase financing normally is so safe that it can be used during periods of great financial stress. Even in the midst of the infamous stock market crash of October 1987, repurchase financing was widely available. Twenty years later, many of the banks who were so supportive of Bear Stearns in 1987 had become competitors. Exactly when the firm most needed very large repurchase lenders, most of the lenders saw no need to help. Bear Stearns’s circumstances grew more dire. Ironically, the lender that did finance Bear Stearns in March 2008 made a very nice profit.

JP Morgan (JPM) lent Bear Stearns $30 billion, secured by mortgage-related securities. After studying these securities, JPM refused to make the loan unless the Federal Reserve Bank agreed to shoulder most of the risk, with JPM accepting only the first loss risk of $1.15 billion. Four years later, all these loans had been repaid with interest! The Fed made almost a billion dollars. Thus, it was liquidity risk much more than credit risk that brought down the Bear. In other words, the loss on these investments would have been almost zero had they been able to hold on to them.

What was needed was someone to manage properly the Bear Stearns mortgage assets. But the main architect of these investments was long gone. Publicly, it was reported that Warren Spector had resigned from the firm in August 2007. In fact, he was pushed out by Jimmy.

Warren had made Bear Stearns a world leader in the mortgage business. When Jimmy began to consolidate power, Warren recognized what he was doing and quickly aligned with him, which freed Jimmy to push out Warren’s boss, John Sites. Whenever Jimmy recruited an operating head, that person’s boss on the executive committee became less powerful and therefore easier to push out. The executive committee’s power was usurped by the operating committee, and thus by Jimmy. Pure Machiavelli.

A brilliant strategist, Warren gamed the complicated executive compensation system at the firm and soon was making more money from it than anyone else. He also started demonstrating his independence by making public statements about national politics. Both of these transgressions annoyed Jimmy.

In addition, when Warren threw in his support for Bear Stearns to accept large strategic investments from institutions, including a Dutch bank in 2004 and a Japanese bank in December 2007, he further clashed with Jimmy. Warren may even have been partial to selling the firm to Banc One, since Jamie Dimon was running it and had made a takeover proposal. Any one of these transactions could have saved Bear Stearns. All of them would have diluted Jimmy’s power. Inevitably, Jimmy came to see Warren as political threat, and he kicked him out like all the others.

Maybe Warren preferred to be fired, so that his Bear Stearns stock was freed up for immediate sale at high prices. He isn’t saying. Anyway, he sold.

Alan Schwartz, Warren’s copresident, fared much worse. Because he was less of a threat to Jimmy, Alan never got pushed out. In the end, he was the last leader to leave, losing much of his fortune. Alan was a great salesman and a very successful investment banker, but he was no expert in managing the risky balance sheet that he inherited just as the firm’s flexibility was disappearing. On December 2, 2014, at a Boy Scouts dinner, he admitted:

As I have had occasion to reflect back, I have to admit that if some of us, including myself, had stuck more closely to the wisdom that Ace had imparted to us, we might have had an outcome that he would have been proud of instead of the one in which he was so disappointed.

After the dust had settled, I found it beyond coincidental that the government permitted Bear Stearns and Lehman Brothers to fail while AIG (and, therefore, Goldman Sachs), Bank of America, and Citibank were bailed out.

During the infamous scare in 1998, when Long-Term Capital Management was rescued by “voluntary” private capital injections that had been coerced by the Fed, only Bear Stearns and Lehman Brothers refused to fully participate in the $250 million advances that each of the other major financial institutions reluctantly put up. I couldn’t help but wonder if the Fed refused to bail them out as payback for 1998.

When I began to look into the possibility that Bear and Lehman were being punished for their actions ten years earlier, no one confirmed the theory. I was told that the environment at the Fed that year was frantic. Their single-minded focus had been to stave off Armageddon. The explanation I heard most often was that Bear Stearns wasn’t considered to be “too big to fail,” and that Lehman was “too big to save.” In fact, the Lehman failure was so scary that enormous government funds were appropriated to save the rest of the financial industry.

Decisions like these are easy to criticize years later, of course. In retrospect, they might have gone either way. My own belief is that negative subconscious attitudes can tip the balance in close calls. It’s a safer bet not to make powerful enemies in such a small community.

At the time, Bear and Lehman were the two smallest of the major investment banks, and they shared other characteristics as well. Both had:

Autocratic leaders. Both Jimmy and Richard Fuld maintained power through loyal executives with an accepting board of directors. Dissenting views were not welcome. In the continuous quest for ever higher profits, the liquidity of their balance sheets plummeted.

Suboptimal size. Both were too big to be bailed out on short notice by a small group of saviors. Both were too small to pose a clear and present danger to the world financial system.

No logical buyer. At the end, the businesses that appealed to potential buyers were not the capital-intensive ones. JP Morgan wanted the broker-clearing business and the headquarters building of Bear Stearns. It also got three hundred stockbrokers and some investment bankers in the bargain. Barclays got Lehman’s sales force and investment banking businesses. The big money (and the big risks) was in the trading and investment business, but these were mostly liquidated in the harsh economic environment—an object lesson in valuations for lenders and for investors.

Theoretical risk controls. Both Bear and Lehman contacted the great distressed investor Wilbur Ross for financial aid in the midst of the crisis. Ross hadn’t gotten rich by investing with mathematical formulae. He demanded that Lehman give him the details on their huge real estate holdings. Fuld refused; Ross passed. When Ross demanded that the Bear justify their mortgage valuations, no fundamental research was offered.

Large insider ownership. Bear insiders owned over 30 percent of the firm, but it was not a protection! Lehman’s appeared to be comparable. The firm’s vulnerabilities seemed to be a combination of compensation systems that did not account for risk and illiquidity and a failure in governance that empowered disparate views.

From my point of view, the greater tragedy was that the leader who had built Bear Stearns, Ace Greenberg, was forced to witness its demise as a powerless participant. He remained chairman of the executive committee and one of the directors to the end, but he was regularly outvoted on risk decisions. He wasn’t even allowed to resign! When he tried, Jimmy dissuaded him on the grounds that it would impair the image of the firm, an image that Jimmy himself was so actively destroying.

In addition to his disastrous leadership of the firm, Jimmy Cayne conducted himself in ways that would have enraged shareholders had all of the facts ever been publicly reported.

In 1996 Alan released Memos From the Chairman chronicling the history of Bear Stearns though his famous memos.

He inscribed my copy: Dear Michael, We have had 31 great years together—let’s have 31 more. You were here at the birth of these memos. Hope the book brings back many great memories. Your Pal, Ace.

The only consolation was that Jamie Dimon at JP Morgan knew exactly who Ace was. After the JPM takeover, only Ace and E. J. Rosenwald were invited to high positions at the firm. Showing the same talent and strength of character that had always been his hallmark, Ace worked diligently for JP Morgan until the very last week he was alive, before pancreatic cancer killed him in July 2014.

Before he died, this great leader suffered the betrayal of a man he’d mentored and had given every advantage. It must have been particularly unbearable for him to watch as the firm he had built was destroyed by imprudent borrowing—when he had such a personal aversion to debt that he had never had a margin account or even a home mortgage.

What an ignominious end for the great American success story of Bear Stearns. It had generated growth from $30 million in pre-tax profits and five hundred employees when I became a partner in 1969 to $3.3 billion in pre-tax profits and fourteen thousand employees when the end came in 2008.

Its downfall was one of the most dramatic failures in financial history: on March 13, 2008, Bear Stearns had $18 billion in unencumbered cash; on March 14, it was broke.

SEC COMPLIANCE IMBROGLIO

Never underestimate political and regulatory caprices.

Although I was running the options department from New York, I was responsible for SEC options compliance at every branch of Bear Stearns around the world, and I relied on David Hyman, the firm’s chief compliance officer, to supervise the compliance of the office managers at each location.

For a few months during this period, the San Francisco office operated without a manager. We discussed the importance of assigning someone to options compliance in that office until a new manager was hired. I was assured that it would be taken care of, but it wasn’t.

That left me in the line of fire when a stockbroker in that office was accused by the SEC of “defrauding his clients.” I was named for “failing to supervise” him—from my New York City location!

Immediately I contacted the SEC prosecutor, who eventually admitted to me that he had “made a mistake” in naming me.

“Great,” I said, relieved to have that clarified. “We all make mistakes. I’m glad to forget about it. Just let your bosses know.”

“Oh, I couldn’t do that!” he said.

Considering that in 1981 the SEC had an $81-million-a-year mandate to protect the integrity of industry practices, it was ironic that they were so willing to abandon integrity themselves by knowingly naming someone who was not involved.

It seemed to me that the commission responsible for enforcing important regulations throughout the entire financial industry should exhibit a far more astute capacity to assess the facts in light of other relevant information. For example, in every court where the so-called defrauded clients tried their lawsuits, they lost. Furthermore, according to the compliance data of the New York Stock Exchange, Bear Stearns had the lowest rate, by far, of customer complaints regarding options. And the SEC’s own prosecutor had privately admitted that naming me in the case was a mistake.

All that mattered was that I had been named. Once the great wheels of the enforcement machinery within the SEC had begun to turn, they could not be easily stopped.

If I had hoped that the Bear Stearns lawyer representing the firm might intervene on my behalf, I was quickly disabused of that notion. When I realized he wasn’t putting a priority on defending me, I hired separate counsel, who had been previously the head of the SEC’s enforcement litigation group—the very people who were attacking me. With all of his years of experience as an insider at the SEC, even he agreed that the SEC had no case against me. But as it turned out, that didn’t matter, either.

The SEC, like all the other US government administrative agencies, enjoys an exemption from the due-process laws that apply to court trials in our country. They are prosecutor, jury, and judge all at once! The usual rules for discovery aren’t applicable. No one can file a regular lawsuit until all administrative proceedings are completed—which takes years. To make matters worse, the SEC played dirty by announcing their decisions on Friday afternoons. In those days, that meant it was too late for the media to track down the accused party and get their side of the story before they went to press.

Despite the futility, I kept fighting, fueled by a sense of injustice. The SEC prosecutor offered to let me off by placing a sanction in my record. It was basically a slap on the wrist. But I was offended by the idea of having my perfect regulatory record blemished by a sanction for something I hadn’t done. So I foolishly refused, insisting that we take it to trial, where, to my great embarrassment, I lost.

In the Wild West, they would have called the judge at the SEC a hanging judge. He had a 90 percent conviction rate. The idea that I could lose when they named me by mistake and had no case was unbelievable. When the judge handed down the penalty—a thirty-day suspension—I was livid.

Paul Warnke of Clifford & Warnke was one of the most famous civil rights lawyers in the country and one of the most respected counselors in the world. Paul and his partner, Clark Clifford, had been advisers to presidents. When I hired him to represent me in my appeal to the commission, the SEC staff filled the hearing room just to watch Paul in action.

The questions of the commissioners made it clear to both of us that they had failed to understand the issues and didn’t consider my plight to be worthy of their time. Thanks no doubt to their annoyance, I lost again.

Not only was this process outrageous, it was unconstitutional! Filled with righteous indignation, I was ready to make a stand on principle and take it to the US Court of Appeals for the District of Columbia. That’s when I realized I was standing alone.

Bear Stearns pulled the plug. They weren’t willing to pay for any more defense costs in the matter. A thirty-day suspension wasn’t so bad, they argued. And besides, they didn’t want any more bad publicity.

Warnke spelled it out for me. “You’ve been fucked by the system. We’re not going to charge you for our work. I suggest that you take a thirty-day vacation and then get on with your life. The Court of Appeals is going to be even less amenable to this case. They’ve got bigger issues to consider.”

So much for principle—not to mention my perfect record. That thirty-day vacation passed quickly enough, but I was forced to explain this unjust SEC infraction more times than I can count over the rest of my long career in the securities industry. I wonder how many careers have been destroyed by administrative agencies running amok. This terrible process is now under review. Hopefully, administrative law judges will no longer be employees of the agency prosecuting someone!

STARTING OVER

Striking out on your own is the highest risk of all.

The time came when I no longer wanted to work as an intermediary.

Looking back over the years, I saw how much value I had created for my clients and realized it was time to create that same value for myself!

I was sixty years old, financially independent, and ready for a new challenge. So I resigned from Bear Stearns to begin a career as private investor. I will always be grateful to Bear Stearns for entrusting me with such a variety of opportunities. I did my best for them each time.

When I left the firm in July 1996, I asked Bear Stearns’s chairman and CEO, Ace Greenberg, for a quote for my press release.

When Michael was a broker, he was one of the best. When he was an arbitrageur, he was one of the best. When he was an investment banker, he was one of the best. I will bet he will be a very successful private investor.

I persuaded Michael to join Bear Stearns 34 years ago. He did a lot for us and for me. I will miss his participation at Bear Stearns, but our personal relationships will continue unchanged.

—Ace Greenberg

My Wall Street career was much more colorful (and risky) than that of most financiers. I was trying new ideas on high-profile transactions. I wasn’t raising capital for major utilities, banks, automobile companies, etc., like many others. I also risked millions of my own dollars on the deals.

Creating new processes and products that became the industry standard was something I loved. By the time I was running the risk arbitrage department at Bear Stearns, my confidence in changing the old ways of doing business had grown. It allowed me to boldly break the “wall of secrecy,” giving brokerage clients access to written research on pending deals so they could undertake risk arbitrage investments on their own.

Also, I initiated the use of tape recordings to eliminate so-called error disputes in the options department. It was yet another way of solving a long-standing problem by thinking out of the box. It stopped other firms from disputing the nature of the oral agreements that they had made with us when they found themselves in a losing trade. Not every innovation improved things as much as I had hoped, but over the years, my natural urge to look for original solutions had proven to be remarkably successful. The more I cultivated that trait, the more I yearned to employ it in my personal life as well.

My absolute commitment to success had left me little time for introspection. If I wasn’t working late on Wall Street, I was rushing off to California, Illinois, Texas, Paris, London, Amsterdam, or the Bahamas for business. If I ever did stop to reflect, I quickly realized that I had succeeded in getting rich but I wasn’t having enough fun.

Because I lived in New York, the natural reaction was to undertake a little Freudian analysis. For months, I paid $100 an hour to a mostly silent, overeducated man in a finely made suit on the Upper East Side, who occasionally asked, “What did you think of that?” It didn’t make me any happier.

One night, as I listened on the phone to my parents quarreling, I realized that they had stayed married all of their adult lives without ever being happy together. Whatever their reasons, the choice had made both of them miserable. That was no life for me!

I started divorce proceedings in 1971. Making the decision to free myself from an unhappy marriage had a surprisingly invigorating effect. I was coming into my own on many levels. My promotions at work were teaching me to take the lead and, as a result of my success, I was coming to trust my decisions more and more. It felt like time to move up to the next level.

Although I’d enjoyed risk arbitrage and made a lot of money with it, investment banking was my first love. It was how I started on Wall Street. Not only did I find it more appealing, but it was less relentless. I wasn’t constantly on the phone. I could work around the clock, then take a few days off to go on vacation. It was higher risk but more intellectually satisfying and, when a deal came through, the payoff was bigger.

The only downside was that I was always doing it for someone else. My clients made a fortune with my advice. Only when I invested along with them did I make big money as well. I was doing well, but I sensed I could do better. In the back of my mind, I started to envision a life in which I was making a lot of money but doing it for myself in a satisfying, intellectually challenging career in a place with ocean breezes and perpetual sunshine.

Three times a week, I played tennis in New York on an outside court between high-rises. On a regular basis, random pages from newspapers would drift out the windows and land on the court, interrupting our game. When we stopped to hydrate between sets, the water would have ice on it. I’d always taken it in stride, but I couldn’t help but make unfavorable comparisons. And as much as I hated to admit it, skiing, too, would even be better if I lived on the West Coast.

“There are plenty of places to ski in the East,” one of the senior partners told me when I was making comparisons over lunch. “Lake Placid, Sugarloaf, Stowe…”

“They say Utah has the best powder,” I answered. “Light, fluffy. They call it ‘the greatest snow on earth.’ The flight’s just over an hour if you live in San Francisco.”

“But why would anyone ever leave New York?” he asked with the stunned disbelief of a native New Yorker. “If a Fortune 500 company wants to raise $100 million, they don’t dream of using a firm in California. There are no big firms out there, no major deals.”

“I’ll bet I could put some deals together if I lined up the right people,” I told him.

“Even if you did, they’d send people to New York to finalize the deals.” He shook his head. “California’s Outer Siberia. It’s where Lehman Brothers sends people to banish them. California is code for ‘You’re going nowhere.’”

I knew he was right. No financial giants were emerging in California in the late 1970s. My half-formed fantasy of living on the West Coast was starting to look like a mistake. The skiing and tennis might be great, and I could almost certainly find plenty of suntan oil and health-food stores, but I’d be leaving behind one the greatest business and cultural centers in the world. At the time, Los Angeles had a decent symphony orchestra, but no ballet or opera, no big-league art galleries or museums, few top-quality restaurants, and little fashion sensibility. Now that I’d carefully cultivated these things and appreciated how much value they added to my life, I was reluctant to give them up.

And yet, despite my arguments against it, I found myself looking for a place to live every time I went to California on business.

Many of the high-rise apartments in the Beverly Hills area had spectacular views of the Hollywood Hills that made them hard to resist. Quite often the amenities were nearly up to par with my residence in Manhattan. The location was not only prestigious, but practical as well. Los Angelenos notoriously spent many stressful hours in traffic on their daily commute. Even if I were able to spend that time at work in the back of my limo, I saw it as a bad investment. But with an apartment near my office in Beverly Hills, I could start every morning with a brisk walk to work in the unflinching good cheer of the California sun. It was certainly appealing.

Ultimately, it was population density that changed my mind. The elegant building entries of the houses I looked at invariably led to a lobby with an elevator, then to a hallway with a series of anonymous doors. However high the ceilings and spacious the rooms, it was hard to forget that the people whose chattering you faintly heard through the walls and ceilings and floors were crammed into rooms all around you. My sensibility was affronted by it.

More than anything else, I needed breathing room.

Why move to California if not to enjoy the sensation of wide-open spaces and natural beauty spreading out as far as you could see on every side? Add the lapping of the waves and the fresh salt air at the beaches, and you could find nirvana!

It struck me one day in the middle of a lunch at Alice’s Restaurant on Malibu Pier. Out on the deck we were literally suspended over the rhythmic ebb and flow of the waves. The sunshine gleamed so brightly on the silver ocean that we had to shield our eyes.

In that moment I had an epiphany: “This is where I want to live!”

I’ve always felt a deep affinity for the ocean. I don’t know why. Growing up in St. Petersburg, Florida, I used to play with my family on the beach. In southern Georgia we lived so near the beach, I worked as a lifeguard one summer.

New York had offered me big-league opportunities. It had been an ideal place for my formative years in finance, but after making certain strides in my career, it was time to shift my priorities toward my lifestyle.

And when it comes to quality of life, California is hard to beat. There are beaches in Maine, but they can’t match California’s warm climate and easygoing ambience.

Malibu was magic. As soon as I confirmed that it was only a thirty-minute drive from my proposed office, that was it. Three weeks later I was finalizing my move.

When I described how I proposed to phase out of New York and move to California, Bear Stearns approved my change. I transferred the management of the risk arbitrage department to very skilled colleagues already working in that department. The options department had grown so large and diverse that I broke it into three divisions: retail marketing, institutional marketing, and trading.

The firm asked me to take over the office in San Francisco. In the late 1970s, Los Angeles excelled in big business, but there was no high-level investment banking there. San Francisco was considered to be the finance capital of the West.

When I looked at the federal reserve data, it was clear to me that Los Angeles had a much bigger economy than San Francisco. I thought it offered a terrific business opportunity and argued this at Bear Stearns. As it turned out, I underestimated how vast the opportunities would be in LA. It was far more profitable than any of us could have dreamed.

In the coming years, Los Angeles grew into a world-class city in every way. Business enterprises soared. Money came to town. Successful people who could live anywhere in the world chose LA because of the lifestyle, just like I did. It proved to be a great place to live.

As it turned out, I also underestimated the future of Silicon Valley, which later became the biggest route to riches the world had seen in modern times. It’s conceivable that business would’ve launched into a different stratosphere had I chosen San Francisco instead, but hey, no one’s perfect. Besides, I wanted to give my romance a chance. Something told me it would be worth it.

Leaving behind my magnificent hotel suite on Fifth Avenue and Eighty-First Street and my club memberships, I flew out west. I bought a Hobie Cat sailboat and threw out my umbrellas. The focus of my career changed from arbitrage and options trading to investment banking, and I started going to health spas.

In those early days, Malibu was still rustic. Shopping was minimal. There were two decent restaurants and few tourists. Most people who passed through the area and lingered were surfers, who banded together in tribes out on the waves, and Hollywood people, who preferred to keep to themselves.

Toward one end of the famous private gated community known as the Malibu Colony, I found the ideal spot. The house was nothing to speak of, a run-down wooden shack on a sixty-foot-wide lot, but the location was sublime. About a hundred yards out in the Pacific Ocean, a rocky reef protrudes. The waves crash against it and all kinds of wildlife hangs out on it. The reef also protects my house from the big storms that attack now and then. But most of all, I fell in love with the exceptional view.

When I talked to the Realtor who had the rental listing on the property, she was in dismay. The family who owned the house was desperate to rent it, but they were having trouble evicting their tenant, Alana Hamilton, a former model who hadn’t paid the rent in months.

Between marriages she apparently had fallen on hard times. A year earlier, with a one-year-old infant in tow, she’d divorced George Hamilton. Maybe the $2,000-per-month rent on the Malibu house was a burden for her. Otherwise, why would she have persuaded the maid to let her in, then changed the locks so the owners were shut out?

“Well, I want to rent it,” I told the real estate agent. “The day you get rid of her, I’ll move in.”

About a year after I moved in, the owners were ready to sell the place and asked $900,000 for it. I thought that it was worth $250,000. The Realtor said, “You don’t get it.” I sure didn’t!

Valerie Harper, who was a huge TV star at the time, bought the house instead. But she never persuaded me to give up my lease. Two years later, she sold it to me because she had fallen in love with her New York City trainer. How poetic! I nervously paid $1,250,000 for the house. I assumed I had just lost $500,000. It’s lucky that I loved it enough to buy it anyway, because I was hugely wrong about its future value.

Soon, my deals in Los Angeles were booming, spurred by Mike Milken’s surge. And homes in the Colony began to soar in price, making it the highest-priced land in all of Southern California. Nothing beats luck!

Over the next two years, I replaced the wooden shack with a dramatic new home that I’ve lived in happily for almost forty years. Though we’ve moved to Puerto Rico now, we still stay in Malibu during the hurricane season. I wish I could say I’d planned it all, but the truth is, it was a lucky byproduct of my taking the big risk to move out west, then pay millions for a wooden shack on the beach in Malibu.

THE MALIBU COLONY

Before the land was developed, the twenty-five-mile strip of coast we now call Malibu was nearly inaccessible, sealed against the sea by the Santa Monica Mountains. Bears, bandits, and mountain lions made it hazardous to cross its seventeen canyons. Sheer cliffs dropped down to beaches that could only be reached at low tide. Without a horse and a tide chart, it was easy to find yourself marooned without a way back.54

“That this unwelcoming place would in time become known as a paradise filled with movie stars and billionaires was the result of one of the longest and most bitter battles over land in American history,” according to David K. Randall in The King and Queen of Malibu: The True Story of the Battle for Paradise. Malibu’s regents were Frederick and May Rindge, who arrived as newlyweds in 1887:

It was a marriage of opposites: he was a Harvard-trained confidant of presidents and senators, the rare dreamer who knew what he was doing; she was a Midwestern farmer’s daughter, raised to be suspicious of the seasons. Resolute where he was romantic, May seemed molded from a different clay than her husband. Yet the bond between them would prove to shape history in ways that no one would have expected.55

An unrivaled businessman in California, Frederick was an oil and electric company magnate who owned more businesses than anyone else in the state. His success allowed him to buy the thirteen thousand acres of coastline that became Malibu.56

When Frederick died suddenly in 1905, his widow, May, swore to keep the land untouched in memory of the happy years she had spent there with Frederick, but she met with considerable opposition from the Southern Pacific Railroad, which sought to extend its line all the way down the coast of California. Decades of costly legal battles had begun to drain her fortune when real estate developer Harold G. Ferguson offered a suggestion.57

Why not set aside a mile of the beachfront property, divide it into thirty-foot lots, and lease each one for thirty dollars a month with a ten-year cap?58

May liked the idea. It meant she could retain ownership of the land and, once her financial situation improved, she could shut down the leases and turn the land back into the family ranch again, as if the lots had never existed.59

To attract people quickly, she focused on bringing celebrities to this nearly inaccessible mile of shoreline, which had the further advantage of facing south, so stars could lie on the beach all day without ever squinting directly into the sun.60 Almost immediately, the place became known as the Malibu Movie Colony.61

Across California billboards showed beautiful families laughing and playing at the water’s edge with no one else around. Ferguson let the images speak for themselves. The only text he included was the name of the colony and a single word: “Privacy.”62

Some of the biggest stars in Hollywood signed up. Bing Crosby, Clara Bow, Harold Lloyd, Gary Cooper, Gloria Swanson, Barbara Stanwyck, and Merle Oberon were among the first.

Since the houses would have to be destroyed in ten years, the Hollywood crowd didn’t invest a lot of money in building homes in the colony. Summer shacks were constructed on the beach by set designers from the movie studios for an average price of $2,600.63 Some were little more than shells with colorful papier-mâché interiors that looked like they’d been lifted from a Hollywood backlot.64

It wasn’t until the mid-1930s, when May Rindge relented and allowed stars to buy the land, that more serious houses were designed. By 1938, in the middle of the Great Depression, 140 homes had been built. They were being sold for $1,000 apiece.65 (I knew I had missed out on the real bargains!)

When I started looking in the mid-1970s, each lot was still less than one-tenth of an acre (about thirty feet wide and 125 feet deep), as May Rindge had originally planned, but the prices had gone up significantly.66

On the low end, a fixer-upper in what was now called simply the Malibu Colony could be sold for $260,000. Nicer houses might be priced from $350,000 to $750,000, even though the state of the plumbing was such that all of them required septic tanks.67

The Colony was still populated by movie stars and billionaires, but the musical crowd had started moving in. Bob Dylan, Kris Kristofferson, Neil Diamond, and Tupac Shakur all had houses there. The combination naturally created conflicts, since the movie stars wanted privacy and quiet while the musicians preferred to be surrounded by friends and lots of noise.68 As it turned out, many Colony inhabitants found common ground in their creativity and their love of wild parties.

It was at Malibu Colony that Philip Kaufman wrote the screenplay for The Right Stuff. It was there that Cat Stevens took a swim in the ocean, realized he was drowning, and pledged that if he survived, he would devote the rest of his life to Islam. Linda Ronstadt could be seen regularly jogging on the Colony’s beach with her boyfriend, Governor Jerry Brown. Larry Hagman, annoyed that the teenagers in the Colony were sneaking in at night to steal the pot he was growing in his yard, finally sold his adobe-style home to Sting.69 While Larry lived there, he hoisted a large American flag and led a Fourth of July parade down the beach to my house, trailed by a cloud of sweet-smelling smoke!

It was yet another gamble that paid off. Today the properties built on the lots that May Rindge leased for thirty dollars a month are selling for $11 million to $40 million. The Colony now features some of the highest-priced sales in the country. As of 2018, the market shows no signs of slowing. The limited supply and the spectacular location keep the homes of Malibu Colony in high demand.70