The Well-Read Investor

Episode 9: Diana Henriques

Financial Journalist and award-winning author, Diana Henriques and Sr. VP of Research at Fisher Investments, Mike Hanson discuss what caused the crash of 1987.

Today we have Diana Henriques on the program to discuss her book, A First-Class Catastrophe: The Road to Black Monday, the Worst Day in Wall Street History.

Diana is a financial journalist with really too many major awards to mention, spanning a decades long career covering some of the most impactful stories of the era—including Enron and Long-Term Capital Management. She’s the author of several books, but most will recognize her mega bestseller, The Wizard of Lies: Bernie Madoff and the Death of Trust, which eventually went on to become an HBO miniseries starring Robert DeNiro.

We wanted Diana on because there really hasn’t been a good book about what caused the crash of ‘87, but her easy to follow narrative fills the void. Our conversation ended up ranging well beyond all that, though. Diana is delightful and just full of knowledge and experience, there is so much here to learn.

You can find Diana on Twitter @dianabhenriques or her website dianabhenriques.com. Enjoy!

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Michael Hanson (0:07):

Hello and welcome to the latest edition of the Well-Read Investor, the podcast that profits your mind and your money. I’m your host, Mike Hanson.

Today we have Diana Henriques on the program to discuss her book, A First-Class Catastrophe: The Road to Black Monday, the Worst Day in Wall Street History.

Diana is a financial journalist with really too many major awards to mention, spanning a decades long career covering some of the most impactful stories of the era—including Enron and Long-Term Capital Management. She’s the author of several books, but most will recognize her mega bestseller, The Wizard of Lies: Bernie Madoff and the Death of Trust, which eventually went on to become an HBO miniseries starring Robert DeNiro.

We wanted Diana on because there really hasn’t been a good book about what caused the crash of ‘87, but her easy to follow narrative fills the void. Our conversation ended up ranging well beyond all that, though. Diana is delightful and just full of knowledge and experience, there is so much here to learn.

You can find Diana on Twitter @dianabhenriques or her website dianabhenriques.com

Let’s dig in! Enjoy!

Michael Hanson (01:30):

So, Diana, thank you again so much for joining our podcast. I'm very excited to talk to you about your book, A First-Class Catastrophe. One of the reasons I wanted to have you on is because your ability to tell a dramatic narrative and yet give us very broad forces as things are happening, is really very cool because I thought it would be a very difficult thing to do with 1987. We always ask our guests why should a well-read investor read this book?

Diana Henriques (01:56):

It’s important for current investors to understand how dramatically different the market really is from the historical illusions we have about the stock market. Going into the 1980s, lawmakers, Congress, bankers, average investors, all thought they knew how the stock market worked. You know, the stock market's been around since 1792, it's not a new invention. They thought they knew how it worked, but while no one was really watching, no one really paying much attention, tectonic, gigantic shifts were occurring in the world of wall street that would dramatically affect how the market worked, in ways that neither wall street nor Washington were remotely prepared for. And those changes didn't go away.

Diana Henriques (02:53):

But I also think one of the reasons well-read investors should read this book is the world of investing knows this this event. It was the formative event of most of the people at the head of wall street firms right now.  When I talked about the book with younger audiences, I always said, you need to read this book because your boss has lived this book. You're going to need to talk with them about this. And the knowledge that you'll gain from the book help your career. It was a formative event in the life of most of the people running monetary policy in the country right now.  Treasury secretary, Steve Menuhin’s father Bob Menuhin, on the trading desk at Goldman Sachs on black Monday and terrible Tuesday and made one of the most signal contributions to stabilizing the market. So, the world we live in today is largely run and regulated by people for whom this was the formative experience of their early careers. Its personally helpful to a reader to be on the same page with those people.  So, the book helps to introduce readers to the modern-day market. It’s important to understand, not just what we learned that day, but the fact that the market we saw that day, in sudden revelation, is the market we live in today.

Michael Hanson (04:18):

You know, one of the things we talk about a lot is the value of experiential knowledge which I believe should be at a premium and yet it's not very much in our industry, but you start the book far earlier than 1987 and talking about the silver market, which is a fascinating episode in itself. So, tell us a little bit about that.

Diana Henriques (04:35):

I will confess that, this was a long and sometimes contentious conversation with my editor. Where do we start this book? I mean, history doesn't have a curtain that goes up, they don't roll the initial credits. You can step into a historical story at any point, and you have to decide where you do. I chose the silver bubble, the silver crisis of 1980 for a very specific reason. I had gone back and looked all through the seventies. Critical but poorly understood period in wall street history. But when I looked at the various crises of the 1970s, they were like 1929, they were like 1907. They were events in a particular marketplace. They were in their silos.  The silver crisis was different and it was the first one that was really different. It was a crisis that began in an obscure little marketplace for silver futures in Chicago, in New York, a couple of eccentric, Texas billionaires who decide they're going to corner silver.

Diana Henriques (05:42):

So, it crystallized for me this sudden realization and some of these regulators saw it. Paul Volcker instantly understood this was a different creature. This was a crisis where there were no borders. His pure moral force allowed him to pull together all of the effected regulators, get them into the same room at the fed building in Washington DC, and get them on the phone checking to see which banks had exposure to silver loans, which wall street firms had exposure. He had the SEC chief there. He had the CFTC chief there. He had banking examiners controller of the currency, treasury secretary people, all in the same room because they were all trying to put out this fire. So, one of the big, big, big lessons of 1987, one of the lessons, as I say that we're living with today is regulatory fragmentation. The balkanization of the American financial regulatory machinery. We take it for granted for 150 years.

Diana Henriques (06:50):

So, we have long accepted as just, the sky's blue, we've got fragment regulators, what else is new? We've accepted it as a given that each silo in our financial landscape has a different set of regulations, different rules, sometimes even different calendars for their holidays, for heaven's sakes.  And yet we learned in 87 dramatically that no, we're all in the same boat. It's all the same marketplace. Now I have spoken widely and with great passion, as you can tell, about the need for a thorough regulatory overhaul for the United States system. We need unitary financial regulation and we needed it 30 years ago. That revelation was part of what I wanted this book to show. To do that I had to start with where it became apparent that that was changing. And that was the silver bubble.

Michael Hanson (07:52):

Remarkable. If you go back to just 2008, those are such amazing episodes of clear interconnection that people didn't see, that the housing market, mortgage market could infect itself into the equity market and so forth. I think that's really fascinating.  But in your book, A First-Class Catastrophe, there's some really big concepts. And I just want to talk with you about a few of them. One of them is this idea of the rise of Titan investors in the eighties, because you're speaking, I'm saying to myself, well this is just as investing is getting mainstream to the public as well. I would say in a certain sense, it's becoming integrated into everywhere. And you talk about these titan investors. What are those? And what's the effect there?

Diana Henriques (08:28):

Well, that was a big and largely unappreciated change. I mean, as recently as the 1970s institutional investors were the dominant players on the New York stock exchange. And that began to change dramatically. And for some important reasons, the interest rate dislocations of the 1970s had left big pension funds, which had left them underwater. They were largely invested previously, for as long as their big pension funds, they invested in mortgages and bonds, safe, prudent sleep at night investments, right? And then the seventies come along and none of those investments are performing the way they're supposed to. And nobody's sleeping at night and they realize if they're going to have a prayer of meeting their obligations to pensioners, they've got to move into the stock market.

Diana Henriques (09:17):

That's the only place they're going to be able to get the, of returns they need. Well, they start to do that, but you know, they don't hang out a sign. They don't send a letter to the SEC or to the New York stock exchanges say, Hey, we're about to bring $80 billion into your marketplace. They just did it. And some big wall street firms, the Solomon brothers in the lead perhaps, started catering to their needs, big block trades that they would do on their own trading desk, and then break them down to take them to the, for of the stock exchange. You could see if you were paying very close attention that some things were changing as these big groups started to emerge. The mutual fund industry, which had kind of blown up after 1929 started to get its legs in the 1960s and grow even more in the 1970s.

Diana Henriques (10:12):

And those big giant funds needed special care and attention from wall street as well. So, you've got big pension funds, big endowment funds and big mutual funds all moving into a world that, I mean, lawmakers and wall street veterans are still thinking, you know, this is my daddy stock exchange. I mean, this is, this is individual investors owning a piece of America. That was the world they thought they still lived in meanwhile, billions of dollars that had never been there before are moving into the stock market.

Michael Hanson (10:53):

When I speak with an institutional investor today, I see similar things and that there's this amazing reach for yield and bonds and maybe what some would argue is under allocation to certain other asset classes or over, depending on how you think. And yet, here we are again today with certainly the Titan investors, still having a huge place, I've heard you once say that algorithm trading began with portfolio insurance.

Diana Henriques (11:14):

It did. It was the grandfather of algorithm trading. And you know, I will confess. I mean, I love all the characters in my book, but to me, the young professors at the Berkeley school of business in California, who devised portfolio insurance, a novelist would kill for characters like these.  Their story, their personalities, their genius, was one of the uncovered parts of the story of 1987 that I hope this book filled in. I was fortunate to catch them before we lost them. One of them is now passed away. To have been able to grab their story, and I should say they were extremely generous. These young men, they were hitting with the cancel culture in a major way. I mean, we didn't have Twitter back then, but if we had that, they would have been its victims.

Diana Henriques (12:06):

They were excoriated in the media. And I would totally understood if when I reached out to them, they would have said, are you out of your mind? We're not talking to you, but they did talk to me a great, great lengths, so that I could understand what they understood about the way the market had changed, which they saw these big investors coming in and they knew these were risk averse investors. If they could come up with a product that would help these big investors reduce their risk, then they would feel safer in pursuing the returns that the stock market could give them. Their pensioners would be better off, and everybody would be happy. So, I understood what their mission was and that involved their own early perceptions of these big changes in the market.

Diana Henriques (12:55):

It takes off, it gets adopted by more people than they ever dreamed, whatever use it, it gets copied. So, people were using it that they don't even know about because you know, other Viking houses have ripped off their ideas. So, they estimated on the Eve of 1987 on the Eve of black Monday, that there was between 25 and $45 billions of money following the same strategy.  And that scared the bejesus out of them. It was $80 billion and they didn't know it. The rise of automated trading allowed the practitioners of portfolio insurance, as it was called, to automatically deliver the orders into the marketplace that were necessary to maintain the balance between cash and investments that they wanted to maintain. So that was the granddaddy of these automatic algorithm trading positions.

Michael Hanson (13:56):

So, you've won awards and you had a lot of coverage for long term capital management going another 10 or 11 years into the future. Those are some characters in geniuses as well. Do those seem like similar personalities to you? I imagine they would have been canceled as well in 1998 when it happened.

Diana Henriques (14:13):

That's a very interesting question. I haven't had to tackle that before. That's a terrific question. The genius was there. I think the difference was in their openness to new knowledge. The three professors I cite from Berkeley immediately picked up their notebooks and their slide rules and their computers to try to figure out what they got wrong and to inform. And aluminate the rest of financial academia about what happened.  They genuinely engaged with the question of whether they had responsibility for what happened. And if so, how did that come about what had they missed about how the market worked, that allowed a tiny 3% change in orders to snowball into an avalanche of selling on the street?

Diana Henriques (15:10):

So, the long-term capital management team, brilliant, brilliant people, So the it's what happened after the explosion that distinguishes the two stories really, after long-term capital management the protagonist in that tale did very little public reflection, very little public exploration of the factors that brought about that widely underestimated crisis. Whereas the academics who were involved in portfolio insurance after Black Monday undertook one of the most remarkably open-minded efforts to understand what happened. And I'd love to see more of that kind of non-defensive open inquiry in terms of goes wrong today.

Michael Hanson (16:02):

So, coming back to 1987, I think I heard you once in an interview say: Ultimately, it's human behavior that causes these types of things. And of course, it will happen again. And I think we've had instances of that. Talk a little bit about your observations on human behavior with some of these things in the lead up. And then also, I wonder if you have any observations on today in terms of things that just seem like they're repeating themselves. I mean, the strange world we have today.

Diana Henriques (16:23):

Well, it's a strange, strange world. I think with the advent of the computer and all of the analytical tools it put into the hands of financial economists. I think there had been a mythology that arose that markets behave in rational and predictable ways. It became an article of faith that markets are rational. They are the consummate collection of millions of instantaneous decisions and that they can't be wrong because they reflect all of those decisions. But at the heart of that theory is a little rational economist sitting there saying I'm going to maximize my profit. People do not always act to maximize their profit. You know, it's like saying, well, I'm going to go to the flea market and I'm going to compare what I would have to pay for these tchotchkes on this table with attractive tchotchkes at the other table.

Diana Henriques (17:17):

And I'm going to make a very rational decision about it. Oh, and by the way, the tent, the flea market is on fire, but I'm not going to let that affect my choice. I'm still going to stand here and make that decision. And then I'm going to walk over there and make that decision. We don't do that. We say, Oh my God, the tents on fire. I'm out of here. The lesson there is human nature has not been repealed, and we haven't come up with some magical charm that keeps us from getting frightened. And here we are at today's marketplace. We're in a market where people do not realize they are ignoring red flags, that somewhere down the road, or even a few years ago, they would have looked at and said, oh my God, the tents on fire, they don't realize their blind spots. We never see our own blind spots. The reason what's happening, is happening is rooted deeply in the human psyche. It is rooted deeply in our ability to fool ourselves. It’s important, even as we understand that we have these blind spots to maintain humility about them and try to figure out ways to protect ourselves from ourselves. Markets are the manifestation of human emotions.

Michael Hanson (18:43):

To me, bias and blindness are similar things because when everybody's doing the same thing, that's where you get blind and that's where biases are. And then ironically, that's when insurance stops working when everybody's doing the same thing. As many of our listeners will know, you got quite a lot of notoriety for your book. The Wizard of Lies about Bernie Madoff. And then of course, the subsequent HBO series. But I've heard you talk on the issue of trust. And I've heard you say some very interesting things about that, including it's the pillars of the community you should watch out for the most on some level. What does that mean?

Diana Henriques (19:14):

Well, I jokingly say to audiences, you have all of the toolkit, you need to run a Ponzi scheme. All you need to run a toolkit is trust and a bank account, that's all it takes. Look at the number of Ponzi schemes that surface every year, one, every five days on average. So, it's not like they've gone away just because Bernie Madoff went to prison. Ponzi schemes remain a chronic problem for investors and they become a worst problem when safer interests, safer investments are paying such low interest rates, just absolutely a dream for con artists because they can offer you, hey I got this very low risk, very liquid short-term bond fund.

Diana Henriques (19:57):

It's paying two or three quarters percent. Now you you're smart enough to know, Whoa, there's no super safe, highly liquid, low risk, short term bond fund that can pay me two and three quarters percent. 10 year government bonds are not paying that much. It must be a fraud, but for most people, there's nothing about that sales pitch. That's going to sound suspicious, especially if it's coming from a highly respected and admired successful member of the community. So don't be surprised that Ponzi schemes are run by people like that. Those are the only people who can run Ponzi schemes. Only people who inspire trust, who can lie easily and without ever being caught.

Diana Henriques (20:49):

People who seem successful, who seem secure, those are the only people who can run Ponzi schemes. Now, thank God. Most of them don't. It wasn't accidental that Bernie Madoff was a wall street statesman. I knew Bernie two decades before you'd ever heard of Bernie Madoff. He was one of the legitimate fathers of NASDAQ in 1970, 71, 72. He helped write the rule book for NASDAQ. After 1987, his firm won a commendation from the SEC for how well it had performed when the rest of the NASDAQ market was falling apart. So that’s who Bernie Madoff was to the people who entrusted their money to him. And it's important that we remember that, you're not going to see a Ponzi schemer coming.

Michael Hanson (21:38):

I want to finish up with a little bit about your career, your working life. How do you select a topic for your book? And I know that, you're working on a book on the founding of the SEC, which is such an important moment still to this day in this industry. How do you come up with a topic, what's interesting to you and what's some of your method?

Diana Henriques (21:54):

Well, I take a leaf from the wonderful David McCulloch's book and say I look for the book I want to read that isn't there and then I go write it. I'm fascinated by financial history and it is a very neglected field in history. A passion for history has informed all of my reportorial work. My whole career as a journalist has been informed by trying to read about the minutes of the last meeting, trying to understand how we got here to this news story I’m covering today. Trying to try to excavate financial history for the general reader is my passion. So I try to identify moments in financial history that I think it's critical to understand in order to safely live in today's world. And I try to address those. It became clear to me after 2008 especially, that we needed to know what we've learned on 1987 on black Monday.

Diana Henriques (22:57):

We needed to know that because we were still living with the consequences of it. The Blue-Ribbon commission that came out after the 1987 crash, the Brady commission, one of its signal recommendations was we've got to fix our balkanized regulatory system. That was the same recommendation made after the 2008 meltdown. Exactly the same, almost in exactly the same words. So, I saw that we had not learned the lessons of 87. We didn't, we didn't even remember 87. So that, that became to me a moment that needed to be understood.

Diana Henriques (23:34):

And the book I'm working on now, which focuses on what it took to regulate wall street for the first time, the unprecedented step that Franklin Roosevelt took in 1933 and 1934 in regulating the securities trading and creating the SEC. With those two acts, we got the FDIC, we got a 10 K's and proxies and prospectuses. and we got the SEC. We got the mutual fund laws. The investment companies act of 1940, which were the very last gasp of this regulatory reform push, which democratized American investing in a way that we could only dream about before. They're fascinating years because we are still hearing daily about the blessings of deregulation. Well, let me tell you this. Nobody calling for deregulation today has ever lived in an unregulated market. Roosevelt had the men who followed him to Washington had lived in an unregulated market in the 1920s. They knew what it could do. They saw it bring an entire financial system to its knees. So, we don't realize today the blessings of regulation that we've experienced since 1934.

Michael Hanson (24:57):

But one of my recollections of FDR and that time is that the people that he brought on to create things like the SCC, one of his philosophies, was it takes one to know one. And I want to know who can do this stuff…

Diana Henriques (25:08):

Well, one of the most controversial choices he made in setting up the sec was the band. He first put in charge of it, who was Joseph P. Kennedy, the father of president Kennedy, who was a wall street speculator, very sharp elbowed ruthless wall street player. He famously said at the beginning of the 1920s we're going to make a lot of money in this market. Let's get in and do that before they pass a law against it. The idea of putting Joe Kennedy in charge of the SEC outraged Roosevelt's closest followers. I mean, there were people who would work on the various investigative commissions uncovering all of the evils that have been done in the 1920s, who were aghast, and Roosevelt famously said send a thief to catch a thief.

Diana Henriques (25:58):

Kennedy knew where the bodies were buried. He knew what wall street had been up to. And yet wall street in its own perversity trusted him. They knew he understood how not to kill the goose, that's laying these golden eggs. That was the challenge at the heart of this dramatic story. How do we regulate capitalism without killing it? So, Kennedy was a way of Roosevelt saying, he knows your world. He wants to preserve it too. We're going to make sure we don't destroy it, but you're going to be regulated. The fact that wall street came under new deregulation, helped it restore its credibility in the eyes of the American public and helped it become one of the deepest, most liquid best regulated markets in the world. So, the debt that wall street today owes to those people, it hated so much back in the 1930s is incalculable.  

Michael Hanson (27:08):

Wow, well that is that's something to really look forward to. And I'm excited to read about that. We always like to finish though with just kind of a more breezy question and ask you, what do you read for fun? And what's interesting to you?

Diana Henriques (27:17):

Oh man, what do I read for fun? There is no reading for fun. When you're working on a book, I say, there's no guilt free leisure. When you have a book contract, every minute, you're not working on the book and guilty about not working on the book. But I just thoroughly enjoyed The Price of Peace, which is the new biography of John Maynard Keynes. We all talk about Keynesian economics and I'm not sure I thoroughly understood what that meant until I read Zachary Carter's wonderful new book. So I just finished reading that. Now Keynes was an advisor to Roosevelt when he came to Washington with the new deal and so it wasn't completely, you know, for fun reading for me. It was it terrifically entertaining and insightful in terms of how original ideas of John Maynard Keynes have been used, abused, distorted, and misunderstood, rejected, reclaimed right up to today. That's the kind of financial history I love. it takes you back to the roots with all the wonderful characters and all the costumes, all of the cute, funny, old cars. And, but it brings you up to how you can use this knowledge today.

Michael Hanson (28:29):

Yeah. That's, that's very interesting to hear. I will certainly check it out because, you know, my opinion of Keynes is just, as you say you have to read him, you have to read them to know him and just to read something like the economic consequences of the peace is actually an incredible persuasive document and quite a piece of literature, in fact.

Diana Henriques (28:40):

And he wrote it when he was barely out of short pants. I mean he was a brilliant young man, an incredible genius, and his passion for the good life, a life of peace and comfort and education and art and music. He wanted everyone to live that life and stupid people running governments kept getting in the way. So, his economic ideas were an effort to help government create better lives for their citizens. And when you read him through that lens, not through the economic and finance lens only, but through the humanitarian and humane man of letters lens, it really opens up your understanding of what we mean by Keynesian thought and Keynesian theory.

Michael Hanson (29:38)

It's true too, you just always wish we have more of those in the world today. He was a man that lived on aesthetics and in an idea of beauty, I totally agree with that. Well, Diana, thank you so much for being a guest on our podcast. I will recommend A First-Class Catastrophe. It is very much in that grouping of books that needs to be read and needs to be understood by today's set. Thank you so much for being on the program.

Diana Henriques (29:58):

I had ball. Thank you so much.

OUTRO

Michael Hanson (30:10):

That was Diana Henriques. She’s really the epitome of Well Read Investing. Our conversation reminded me of my boss Ken Fisher’s 2009 book, How to Smell a Rat: Five Signs of Financial Fraud, an approach to spotting crooks in the investing advisory business. It’s a topic every well-read investor should be educated on, and if you want to hear more I’d recommend Diana’s TED talk on the nature of trust, which you can find online. Thanks again to Diana, and we’ll be eager to have her back on the podcast for her next book on FDR and the creation of the securities advisory acts, which still today shape the investing industry.

Be on high alert for our next episode October 21st, as we world champion poker player—Annie Duke—on the program to discuss her book: Thinking in Bets: Making Smarter Decisions When You Don’t Have All the Facts, as well as the release of her latest book, How to Decide. Annie has a background in academic psychology which she applied to become a great poker champion. While poker and investing are surely very different things, I think you’ll be fascinated by how much of the right mindset is shared. This one is absolutely cannot miss.

Lastly, you know what to do by now: wherever you may be hearing the Well-Read Investor, please comment, like and subscribe—it really does help us. And join us on twitter @wellreadpod, or Instagram @wellreadinvestorpod.

Until then, here’s hoping all your reading profits your mind and your money. Take care.

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