First things first: someone is going to make Octopus into a movie. By this time next year, the books author, fellow Rolling Stone contributor Guy Lawson, will have a fat deal (he may already have one as far as I know) and will be hobnobbing with John Cusack or Ed Norton or whoever else gets to play the incredible role of Sam Israel, the Madoff-esque Ponzi artist who headed the infamous Bayou hedge fund. When I try to get Guy on the phone for whatever reason, I’m going to get fobbed off instead on a personal assistant with a name like Minka or Yue-Yue. That’s just a fact.
The reason for that is that Octopus is an incredible dark comedy with one of the craziest true-life ironic twists you can possibly imagine. But this incredible plot twist is not the reason this is an important book that should be read by everyone who wants to know how Wall Street works.
What I found most compelling about this book was the material in the beginning chapters, in which Israel, through Lawson, describes his early career as a trader on Wall Street. It’s this experience in the deeply corrupt netherworld of endless, relentless insider trading that warped Israel’s mind to the point where he could become perhaps the biggest dupe in the history of con artistry.
If you don’t know the Bayou story, and want to wait to learn the big surprise ending, stop reading here. But if you do know the outlines of the tale, here’s the recap: Sam Israel ran a $400 million hedge fund whose clients, like Madoff’s, were some of the richest people in America. The fund, however, was a fraud that he and (primarily) two other accomplices were perpetuating through a disturbingly simple phony accounting mechanism (readers will be shocked to learn how easy it is for a hedge fund to fake its results). Instead of a booming investment phenomenon that was killing the market through the use of an advanced computer algorithm – this was what Israel was claiming – the fund was actually a gnarled mass of horrific losses and bad gambles that he was covering up with new investment, a classic Ponzi situation.
So Sam Israel was a con artist, one of the best and most accomplished on Wall Street. But as the reality of his crime weighed on him, and he fell into a deep, drug-fueled funk, Israel began to become delusional. And eventually, he himself was conned by a series of Sting-like grifters who convinced him that a secret network of Trilateral Commission/CIA/Bildeburg-style elite insiders were trading in a secret bond market that generated huge guaranteed profits for the small club of financial titans allowed entry into the group.
Israel was led to believe in the existence of this secret bond market after falling hard for an inspired piece of manic conspiracy theory literature called The Last Circle that posited the existence of a massive international financial-political conspiracy called “The Octopus.” Israel believed the Octopus definitely existed, and this belief led him to a series of disastrous trades in which he signed over huge chunks of his fraud-ridden $400 million stake to con artists, who promised to “invest” it for him in the secret bond market.
The story of Israel’s drug-fueled psychological downfall and descent into a nightmare-fantasy existence is definitely the stuff of movies, a high-end cross of Confessions of a Dangerous Mind and Permanent Midnight (the only thing that would have made some parts of this book funnier is if Israel had been seduced into the secret bond market by a briefcase-toting Alf/Mr. Chompers). And that’s great fun, and I’m sure lots of people who have no interest in Wall Street will enjoy that story.
But this is also an important book because the reason Israel fell for this extraordinary con was based entirely upon his real experiences on Wall Street. Israel had grown up among some of the biggest movers and shakers on the street, including his first hedge fund boss in the early eighties, Fred Graber. Israel started essentially as a gopher for Graber, who had built a very successful hedge fund that was based, it turns out, almost entirely on front-running, insider trading, and other easy money schemes.
Hilariously, the Graber model for making money – sitting back and collecting relatively small (read: insufficiently gigantic) sums on a risk-free basis by trading on little bits of inside info here and there – eventually comes to represent, in Israel’s mind, the simple, honest path of a gray-flannel-suit-wearing Wall Street trader with humble ambitions. Israel could have followed the Graber model and lived like an ordinary rich person (by the early nineties, he was mostly there), but he wanted to be a Huge Otherworldly Success, so he abandoned the “honest” grifting of his old boss’s generation to go for something bigger.
But it’s the description of this “honest” period of Israel’s life I find fascinating. Nobody who reads this book will fail to realize how it is that the current lineup of Wall Street nobility, the Goldmans and Chases et al, make money.
As the book reveals, there are so many ways to game the market without risk that it almost inspires laughter. Israel hung out in bars and played Bud Fox, getting tips about acquisitions and other commercial moves that he traded against. At other times, Graber/Israel traded a few seconds ahead of the market, front-running trades that earned them easy money over and over again. Most damningly, they moved markets themselves. This passage, about Graber’s favorite stocks, stuck in my mind:
As a velocity trader, Graber constantly bought and sold the same stocks... He talked about the stock he traded with intense passion, passing around made-up gossip, false speculation, and occasionally real news – anything to stir up action. One of Graber’s abilities was to “paint the tape,” the illegal practice of trading with the sole purpose of moving the price of a stock. The agribusiness giant Archer Daniels Midland was one of the stocks Graber fooled with relentlessly. To paint the tape on ADM, Graber and Israel would call eight different brokers and put in buy orders simultaneously to run up the price – at a time when Graber was holding lots of the stock ready to sell into a rising market. It was a racket the Securities and Exchange Commission was hopelessly ill-equipped to stop.
“The SEC questioned Freddy all the time,” Phil Ratner recalled. “But they couldn’t catch him. He traded so much that it was impossible to say he’d traded on inside information.”
If Fred Graber was able to do this sort of thing with a $100 million stake, how easy do you think it would be for a too-big-to-fail bank with hundreds of billions under management to do the same thing? For a bank that had the power not just to move stock but to move, say, LIBOR?
In the last few years I’ve gotten numerous calls from small hedge fund operators who complain that their investment banks seem to be trading against their positions. I’ve had other calls from brokers who’ve complained that big banks will call them with small orders for things like corn futures just before a giant client order for the same commodity will be dumped on the market.
All of these activities are just larger-scale versions of Israel’s early experiences on Wall Street. For an unscrupulous company, and most of the big ones on Wall Street are the very definition of unscrupulous, it’s impossible to lose when you own the information. Israel’s experience with this was part of what made it possible for him to believe in the existence of a secret market for the extreme rich where no one ever lost.
The other thing that led him to believe in the Octopus? The Fed’s response to, among other things, the 1987 crash. Israel saw that whenever Wall Street screwed up, the Fed jumped in and rescued everyone with cheap cash. His reaction to 1987:
…the Fed had propped up the market. To pay for the massive rescue, the Fed had created money out of thin air. The end of the gold standard had turned the dollar into a fiat currency, effectively giving the Fed the power to print money. It was a kind of Ponzi scheme, Israel thought, but at the highest level of abstraction – and secrecy.
Sam believed he’d discovered the central illusion at the heart of modern capitalism. He had the dizzying sensation that there was nothing underneath the whole edifice of Wall Street, the dollar, the American economy.
Sam Israel saw that Wall Street made its money cheating, and he also saw that the government enabled the cheating. He then drew what seemed to him a logical third conclusion, which was that the two realms were conspiring in secret to make a second shadow market for the elite of the elite, one bursting with fantastic riches. He didn't realize that the real market was the shadow market.
Anyway, all of this is a great read, and not just a painless but a thoroughly enjoyable introduction to how the game works. Sam Israel’s fantasy world is what will get the movie made, but it’s his reality that should have us all freaked out.