Michael Lewis: Complexity, Fraud and Listening to Contrarians

Michael Lewis isn’t a fraud examiner. But as a journalist and author who has written multiple books about financial shenanigans on Wall Street, he has important insights into the nasty underbelly of markets and how fraudsters can thrive there.

The latest market selloff could be a good case in point as investors look for guidance amid concerns over rising inflation and the potential for a recession.

“When there is this kind of convulsion in the marketplace, it is an excellent opportunity to see who is prone to the con because everybody is looking for somebody to tell them what is going to happen,” said Lewis at the 33rd Annual ACFE Global Fraud Conference in Nashville on Monday.

“The truth is that there is no predicting what is going to happen. So, when you see someone get up with great certainty and say they know what is going to happen, put a little check mark on their file because that is the person you are going to be investigating in three years from now.”      

In a virtual interview on Monday, Lewis spoke to ACFE’s Chief Strategy Office John Warren, J.D., CFE, about why CFEs should pay attention to cryptocurrency, the legacy of the 2008 financial crisis and the increasing complexity of markets.

Lewis best sellers include “Liar’s Poker” about his time as a bond salesman at Salomon Brothers in the 1980s, “The Big Short” about the 2008 financial crisis and “Flash Boys” that recounts how high-frequency traders gamed the market. Lewis says his next book could be on cryptocurrency. That’s not because he thinks bitcoin will replace the U.S. dollar. Rather, his interest lies in the enormous amount of wealth created over a short period of time through the rally in crypto coins and tokens. “I am looking at characters who were previously not that important, but who have become very important because a bet they made a few years ago has paid off,” he said. “I am figuring out how to write a book about it.”

Crypto Lessons

The sudden popularity of all things crypto arguably holds certain lessons for CFEs and could potentially point to dangers ahead.  “Excessive confidence and certainty in things that are inherently uncertain is a red flag. And it is a red flag that doesn’t get pointed out and people get rewarded for it,” he said.

But the other red flag stems from the increasing complexity of crypto and the broader the financial system. That’s a theme that Lewis has tackled in the past whether he was writing about the collateralized debt obligations (CDO) blamed in part for the global financial crisis or the high-frequency trading technology that allowed some players to front run others in the market. “All of a sudden you can’t explain to your mother what you do for a living because it has got so complicated,” he said.

While there has been a push for greater transparency in the financial system, that complexity makes it increasingly difficult to fathom what is truly happening. “In some ways, we can know more about what is going on inside of Goldman Sachs than ever before, but there is new form of opacity,” he said. “Complexity is the new opacity.”

That’s why it’s now more important than ever not to be intimidated by those claiming the subject matter is just too difficult to comprehend. “That is what happened with Bernie Madoff; it’s so complicated you can’t understand it,” he said. “That’s the giant red flag … the complexity masks the behavior.”

Plain English

It falls on journalists like Lewis and CFEs to ensure that they “poke and poke” until their questions are answered in plain English, and it is then they can figure out whether this involves fraud or is simply someone taking advantage of market loopholes.

When you are untangling the financial web, it helps to look for teachers to explain what is happening, says Lewis. This is what he did when writing the “Big Short.” In this case, those teachers were the handful of investors who had gone all in to short the mortgage market in the run-up to the 2008 financial crisis. “What they all had in common was that they didn’t accept what everybody was saying,” he said.

Two of these investors, Charlie Geller and Jamie Shipley, were buying up cheap insurance across different sectors against what many people thought were once-in-a-lifetime tail risks. When it came to the mortgage market, they soon realized that those risks were very real and imminent, and that the CDOs being churned out by Wall Street banks and ratings agencies were highly fraudulent. They took their concerns to the FBI, the Securities and Exchange Commission and the press, but to no avail.

The story holds several lessons, not least the importance of listening, especially to those who might at first appear odd and are going against the grain of conventional thinking. “[For fraud examiners] it takes a lot of nerve to listen to those arguments because it sounds so implausible, but you have to listen to arguments like that because sometimes they are right.”

This applies to whistleblowers who may come across as eccentric at times but could hold the key to a big fraud case. “You have to be able to listen to the argument and evaluate the argument rather than the source of the argument,” he said.