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Other segments from the episode on March 25, 2009

Fresh Air with Terry Gross, March 25, 2009: Interview with Frank Partnoy; Review of the new music album “Keep it Hid.”


Fresh Air
12:00-13:00 PM
Frank Partnoy: Derivative Dangers


This is FRESH AIR. I’m Terry Gross. My guest, Frank Partnoy, spent two
years selling derivatives, those complex financial instruments that
helped sink our economy.

He made a lot of money as a broker with Morgan Stanley, but by the time
he left in 1995, he thought he’d become the most cynical person on
Earth. He believed derivatives were a fraud and investment banking was a
fraud. He’s been warning the public ever since.

He’s going to tell us about his experiences selling derivatives, and
he’ll take us through the history of how they got us into so much
trouble and how the swaps and derivatives lobby succeeded in getting
credit default swaps exempted from regulation.

Frank Partnoy’s 1997 Wall Street memoir, “Fiasco,” has just been
published in a new edition, and he has a new book about to come out
called “The Match King: The Financial Genius Behind a Century of Wall
Street Scandals.”

Partnoy is a professor at the University of San Diego Law School,
specializing in financial market regulation. Frank Partnoy, welcome to
FRESH AIR. You were kind of there at the beginning, selling derivatives
at Morgan Stanley. Give us a sense of what derivatives were like when
you started selling them. What were they then?

Professor FRANK PARTNOY (Author, “The Match King: Ivar Kreuger, The
Financial Genius Behind a Century of Wall Street”): They were wild
financial instruments. They were side bets. They were relatively a large
market. They were in the billions and billions of dollars at the time.

I worked with a group of about 70 professionals in New York who
generated $1 billion in fees in two years. That was pretty good money
back then, about $15 million a person. And it was a wild scene.

This was before a lot of the sex discrimination lawsuits changed the
culture on Wall Street, so the trading floor was a bawdy place. There
were lots of - behavior that people there probably aren’t very proud of
now and some of which I probably can’t discuss on your show. But it was
a very energizing, incredibly interesting experience, lots of money
changing hands and lots of money being made.

GROSS: Just give us an example of a derivative that you would sell.

Prof. PARTNOY: For example, we would sell derivatives linked to bonds
issued by foreign countries. So we would go to Argentina, and we would
buy up some bonds there, and we would repackage them and enter into a
swap and sell those bonds to investors in the United States.

And sometimes the investors understood what they were buying, and
sometimes they didn’t. But we would basically try to find assets that we
thought were cheap, and then we would enter into these transactions to
repackage them in ways that would be attractive, we thought, to

GROSS: How do you make Argentina bonds more attractive to investors
through derivatives?

Prof. PARTNOY: A lot of the way you make them attractive is by going to
the credit rating agencies, Standard & Poor’s and Moody’s, and trying to
pitch them and pay them a fee to call these bonds AA or AAA, and we
would often find these assets that were very risky. Sometimes they were
mortgage securities, even back in the ‘90s. Sometimes they were other
risky bonds. And we’d go to the credit rating agencies and we’d say,
would you be willing to rate this AAA? And they often did.

In fact, there was a transaction that we did involving the National
Power Corporation of the Philippines’ bonds, which ended up getting
rated AAA. And I always thought that somebody would call me on that.
They’d say no, there’s no way you were able to get a AAA rating on that
for First Philippines Trust.

And so I named it FP Trust. I suggested that we name it FP Trust after
First Philippines Trust, but I wanted that name there for good. It was a
15 year security, and so those were my initials so that I could always
point back and say no, no, no. This is something we really did.

(Soundbite of laughter)

GROSS: FP for Frank Partnoy. How do you convince the ratings agency to
give you a good rating when you know the bonds that you’re selling
aren’t worthy of it?

Prof. PARTNOY: Sometimes it’s easy, sometimes it’s very hard. The rating
agencies use models, which the investment banks developed. They could
get very complicated, sometimes they involved complicated math. And we
would make an argument to them that this was more like a General
Electric bond than a risky bond.

We would try to demonstrate that the bond would perform well over time,
and it didn’t hurt that we paid them substantial fees. Some people don’t
realize that but S&P and Moody’s, the rating agencies, are paid by
issuers. They’re not paid by investors. They’re paid by the companies
and the trust structures whose bonds they rate. And so they would get a
bigger fee. They’d get a higher fee for a complicated deal.

GROSS: So you know, in your memoir, “Fiasco,” you write about how
aggressive your sales methods were. So give us an example of an
aggressive way of selling derivatives back in the mid ‘90s when you were
selling them.

Prof. PARTNOY: Well, the key parts to the aggression were not telling
clients about the risks associated with the securities, and these are
not individual clients all the time. These are sophisticated clients
like Proctor & Gamble. You might remember Orange County, which went
under because of investments in these risky instruments.

GROSS: Right.

Prof. PARTNOY: And the people who approached these institutions, who
worked at investment banks, would go in with a feral attitude. The
phrase that was used the most often was: I ripped their face off, which
seems so violent and contrary to the idea that you would be looking out
for a client’s best interest, but the idea was that you were going into
the client to try to sell them something that was massively overpriced,
that hid risks that the client wouldn’t understand. And the idea was
always that you’d make as much money as possible. You’d gorge the
client. This is how 15 people could generate $1 billion in mostly
riskless fees in two years. You can’t do that while taking into account
your client’s best interest.

So the people who went into Orange County and Proctor & Gamble, they
were selling them unfathomably complicated instruments that they knew
the buyers couldn’t possibly understand.

GROSS: And most of your customers were big institutions, not individual

Prof. PARTNOY: They were the largest institutions. See, this market,
even back then, was a $50 trillion market. So these are massive
institutions that are making massive bets. But the information gap is
still huge. The institutions are not nearly as sophisticated as the
people who are selling these things on Wall Street.

GROSS: So you eventually left because you grew so disillusioned with the
derivatives and the methods of selling them, but while you were still
doing it, how did you feel good about it?

Prof. PARTNOY: Well, I’m not sure I can say I felt good about it, but it
is fascinating, and it was an incredibly interesting time, developing
all of these new products and new methodologies, and it was energizing
to be at the center of the universe.

I mean, the derivatives trading desk was the engine that drove the
profits at most financial institutions until – really until very
recently. So this is the hotbed. It’s where information is flowing from
all over the world, and we’re creating these new products that have
never been seen before. We’re using math and financial techniques that
have never been used.

So it was incredibly interesting. And I was a lawyer, I was a person
with a law background. I had studied math, but for me to see the
interaction of regulation and finance was absolutely fascinating.

That wasn’t something that I was going to do for my whole life, but I’m
certainly glad that I was able to see it from the inside. Even today, at
financial institutions as they’re crumbling, I think the derivatives
area is a really interesting area.

GROSS: So why did you leave selling derivatives, and when did you leave?

Prof. PARTNOY: Well, unfortunately, I didn’t care enough about the
money. I left in 1995, and I can say some of my best friends are in the
derivatives industry, or were until recently, and I left in part because
I had learned enough.

I didn’t want to do this for the rest of my life, and like a lot of
people who I went to law school with, we had in the back of our minds
becoming an academic and being able to sit back and comment on issues
and talk about policy.

I didn’t want to do that just from the ivory tower. I wanted to get some
experience first, and after two years, I thought that was about enough.

GROSS: If you’re just joining us, my guest is Frank Partnoy. He’s a law
professor at the University of San Diego Law School, and he used to sell
derivatives for Morgan Stanley in the mid ‘90s.

He has a memoir about that called “Fiasco: Blood in the Water on Wall
Street,” that was just rereleased in paperback. And he has a forthcoming
book called “The Match King: Ivar Krueger, the Financial Genius Behind a
Century of Wall Street Scandals.”

So we’re talking about derivatives, which you used to sell at Morgan
Stanley. Now, part of what made them profitable was that they weren’t
regulated like stocks or like bonds. So there was a lot of flexibility,
so to speak…

(Soundbite of laughter)

GROSS: …that you had when you were selling them. Why were they seen as
different from stocks and bonds in terms of them being in a category
that didn’t require regulation where stocks and bonds did? What made
them different?

Prof. PARTNOY: This was no accident. This was a carefully engineered
distinction that was run through regulators in Congress by some of the
most powerful and effective lobbyists ever.

And they began the deregulatory moves in the 1980s, as soon as it became
apparent that the derivatives industry would generate huge profits and
also create these massive risks.

The story really goes back to Bankers Trust, which a lot of people
don’t’ remember. It was this stodgy old bank that a man called Charlie
Sanford transformed into a risky trading operation.

He was quite successful. He hired quants, people who understood physics
and mathematics. And in 1985, when accounting regulators said hey, we
should really start regulating these instruments, in two weeks, Bankers
Trust and nine other banks formed a group called ISDA, I-S-D-A, which
now goes by ISDA as the International Swaps and Derivatives Association.
Then it was called the International Swap Dealers Association.

And they became this incredibly powerful lobby. And they had a number of
friends, and the most powerful of their friends were the Gramm family,
Wendy Gramm and Phil Gramm. And Wendy Gramm and Phil Gramm really
together, from the late 1980s through 2000, orchestrated a massive
deregulation of derivatives, which I think we can really point to as
being one of the major causes for why we’re in so much trouble.

GROSS: When you say deregulation, were they ever regulated?

Prof. PARTNOY: They were. And derivatives have been subject to various
legal claims based on regulation over time, and in fact where Wendy
Gramm came in was to eliminate that uncertainly.

Common law always applies to any kind of instrument. And there were
bucket-shop laws that prohibited gambling in states, and people made
claims that derivatives are really just side bets. And in fact, some
derivatives really were like gambling. There were derivatives based on
how many games the Utah Jazz would win in a year, how many albums David
Bowie would sell.

Derivatives really could be based on just about anything, and people
said, well this is really gambling. And it wasn’t until Wendy Gramm and
the Commodity Futures Trading Commission came along that derivatives
were taken out of the regulatory structure in any clear way. And she was
– people might remember her as Ronald Reagan’s favorite economist. She
was a conservative, very smart woman who came along and headed this
regulatory organization. And when she left in January of 1993, she
signed an order that exempted these derivatives from regulation, and
many people describe that as her farewell gift to the derivatives

And very shortly after that, not coincidentally, she was nominated and
began serving on the board of Enron.

GROSS: So you know, you’re talking about the lack of regulation of
derivatives. When you were selling derivatives, were they easier to sell
and easier to make big profits selling them because they weren’t

Prof. PARTNOY: Absolutely. They were in the dark. They were in the dark
corners of the markets. And you knew that they wouldn’t be disclosed.
You knew that the companies who were buying them wouldn’t make
disclosures about the risks associated with these instruments.

If you sold to a company, for example, you were confident that the
disclosures about what you had just sold wouldn’t make it to the public.
They wouldn’t see that this company had taken on some massive risk, and
no one would know how much you had charged. The commissions wouldn’t
appear anywhere. There wasn’t a competitive market, really.

And so it was a dark, shadowy, but very large, multi-trillion-dollar
part of the market where people could make a lot of money, and this is
where the banks survived.

Much of investment banking became a kind of commodity business where you
couldn’t make a lot of money. You can’t make money in the sunlight in
banking. It’s just not possible. People come in too quickly. So you have
to make money in the dark.

And derivatives were kept in the dark, and that’s why people gravitated
there, and derivatives really kept the banks afloat for many years. That
was the place where they were able to make money, charge large
commissions, take on risks themselves and have their clients take on
these huge risks because nobody would ever know about it.

GROSS: So because derivatives weren’t regulated and aren’t regulated, an
institution that invested in them, they wouldn’t have to put that on
their books.

So that part of their value is completely opaque, and you just - you as
an investor in that company wouldn’t know the real value of the company.

Prof. PARTNOY: You couldn’t possibly figure it out. So even now, today,
when people are going to companies like AIG and trying to figure out
what the risks are associated with these companies, they can’t figure
out what the risks are.

And back then, there were virtually no disclosures about derivatives.
You got something called the notional amount, which would be the size of
the underlying bet, and that was it. And many companies wouldn’t even
tell you the notional amount.

AIG only began disclosing the notional amount of this massive business,
this second pillar of secret credit default swaps in mid 2007, but they
had massive exposures. They had been involved in that business for a
long time.

GROSS: My guest is Frank Partnoy. His 1997 memoir about selling
derivatives on Wall Street, “Fiasco,” has just been published in a new

We’ll talk more about derivatives and how they helped get us into this
economic crisis after a break. This is FRESH AIR.

(Soundbite of music)

GROSS: If you’re just joining us, my guest is Frank Partnoy. He’s a law
professor at the University of San Diego School of Law, where he teaches
financial markets, derivatives and structured finance. And he used to
sell derivatives for Morgan Stanley in the mid ‘90s.

And since leaving, he’s really tried to blow the whistle on the lack of
regulation of derivatives and swaps. His books include “Fiasco,” which
is a memoir about selling derivatives, that’s just out in a new edition,
in paperback. And he has a forthcoming book called “The Match King: Ivar
Krueger, the Financial Genius Behind a Century of Wall Street Scandals.”

We’ve been talking about the deregulation of derivatives. I want to talk
with you about the infamous credit default swaps, but first I want you
to give your best crack at defining what credit default swaps are.

Every guest we have on who talks about the financial meltdown, we ask
them to give it their best shot, and eventually, we will all understand
what credit default swaps are.

Prof. PARTNOY: A credit default swap is a bet on whether someone will
default. It’s that simple. I will enter into a bet with you, and I’ll
bet on whether you will default on your home mortgage or some other debt
that you have.

And the person who’s betting on a default wins, and the person who’s
betting against a default loses. It’s that simple. It’s a side bet based
on whether an individual or a company will default.

Now, credit default swaps can become incredibly complicated in terms of
trying to figure out how to value them, what’s the underlying event of
default, how do you assess them when portfolios of them are combined. If
you have a bunch of subprime mortgages, and you put them together, and
then you bet and enter into this side bet based on default, that can
become very complicated to evaluate. But the basic bet is very simple:
Will you default or not?

GROSS: But they function basically as unregulated insurance, too, don’t

Prof. PARTNOY: That’s right. So credit default swaps are essentially
like insurance, and if you write a credit default swap, you’re basically
writing an insurance policy.

This is why AIG, which was traditionally an insurer of lives and cars
and all kinds of risks - fires, securities litigation - it saw this
business as attractive and fitting in with its normal business line.

That’s what AIG was. It had $1 trillion worth of assets. Its pillar – if
you can think about it as being one pillar of its business - was this
very traditional insurance business. It looked at credit default swaps,
and it said, oh look, here’s another insurance business. I can write
insurance. I can insure against the defaults of different individuals or

And that’s what it did. That business, that pillar, grew to where it was
really almost a second, free-standing pillar - a second business that
was almost as big and maybe even more profitable than its traditional
business. It grew to half a trillion dollars. That was the size of its
credit default swaps.

And credit default swaps overall grew to $55 trillion. And these were
just side bets that were basically like insurance: somebody is betting
on a default, and someone else is insuring against a default. And if
there is a default, then there’s - a payment will exchange hands.

GROSS: Give us an example that relates to subprime, to the famous

Prof. PARTNOY: For example, the reason we ended up in this crisis was
that people entered into these subprime mortgages, and then it was
apparent that they would begin defaulting in much higher numbers than
anyone anticipated.

Now, if there were no derivatives based on those subprime mortgages, the
actual losses would’ve been relatively small. We’re talking about maybe
a couple hundred billion dollars of losses or something like that.

But the problem is that the derivatives market enabled people to bet on
whether an individual would default on a mortgage over and over again.
There’s no limit. You could bet 100 times on whether Frank Partnoy will
default on his mortgages.

And those bets then get bundled up and repackaged in all sorts of very
complicated ways that weren’t disclosed at all. And that’s why we ended
up in this trillion dollar mess because large financial institutions,
many of the banks and AIG, they all wrote insurance against many of
these people defaulting on their subprime mortgages, and when they
defaulted, that was a tail wagging a very big dog.

GROSS: Now, credit default swaps were kept exempt from regulation
through the Commodity Futures Modernization Act of 2000, which has one
or two really interesting stories behind it.

First of all, give us an overview of the bill.

Prof. PARTNOY: Well, it’s quite a mouthful, but basically what the bill
was intended to do was to cement the deregulatory status of derivatives.
So these shadowy instruments had been taken out of the regulatory
structure, but they had only been taken out through letters from
regulators and regulations, not through an actual statute, and there was
still some uncertainty.

And the very powerful derivatives lobby wanted to cement the deregulated
status. And so this was the last thing they needed. This was the nail in
the coffin. And just as Wendy Gramm had started off the deregulation
back in the late 1980s and early 1990s, Phil Gramm finished the job in
2000 with this CFMA legislation.

And it’s important to go back in time and think about what was happening
in December of 2000. This is the aftermath of Bush against Gore, and
people are focused on hanging chads, not on derivatives. Derivatives are
not the focus of the legislative agenda.

And this legislation had been sitting on the back burner. The
derivatives lobbyists had been waiting to pounce. And then on December
14 in the House and December 15 in the Senate, they pounced.

And Phil Gramm added the provision in the evening, just hours before the
Christmas break. It was never debated in the House. It was never debated
in the Senate. It was shoved into an 11,000 page omnibus budget bill. It
was passed by unanimous consent in the Senate. There wasn’t even a vote,
and then President Clinton signed it on December 21.

It was his last major piece of legislation before everyone left for the
holidays, and nobody even knew about it. There was no reporting on it.
The focus was on the conflicts in the presidential election. And the
derivatives industry quietly celebrated at the end of 2000, knowing that
they had cemented the deregulatory status, and then they were off to the
races over the last eight years, doing everything that led to this
current crisis.

GROSS: Frank Partnoy will be back in the second half of the show. His
Wall Street memoir, “Fiasco,” has just been published in a new edition.
His book, “Infectious Greed,” will be republished later this year, and
he has a new book about to come out, “The Match King: The Financial
Genius Behind a Century of Wall Street Scandals.”

I’m Terry Gross, and this is FRESH AIR.

(Soundbite of music)

GROSS: This is FRESH AIR. I’m Terry Gross. We’re talking about how
derivatives helped get us into this financial crisis. My guest, Frank
Partnoy, sold derivatives at Morgan Stanley from 1993 to ‘95. He left
disillusioned and has been warning about their dangers ever since. He is
a professor at the University of San Diego School of Law. His Wall
Street memoir, “Fiasco,” has just been published in a new edition. When
we left off we were talking about the legislation that further
deregulated derivatives and credit default swaps, the Commodity Futures
Modernization Act of 2000.

Now, you write in your book that the person who actually drafted the
part of the bill that cemented in the deregulation of derivatives was a
lobbyist from the financial lobby group, the International Swaps and
Derivatives Association. Tell us about that.

Prof. PARTNOY: He was an extraordinary powerful guy, this guy Mark
Brickell, and he was one of the central characters in this group ISDA,
the International Swaps and Derivatives Association. And he would show
up in the halls of Congress and he would be there drafting legislation.
He was a vehement opponent of Jim Leitch, who was one of the leaders in
favor of regulating derivatives, and he really worked Washington. He
also used the complexity of derivatives against the members of Congress
and their staffs. Whenever the staffers or members of Congress would ask
questions about derivatives, he would be there to almost mock them, to
belittle them.

He also engineered a very interesting lobbying campaign targeting the
media, in particular the Wall Street Journal, and ISDA, this trade
group, insisted that the Wall Street Journal not even use the word
derivatives. And I found this correspondence in which the Wall Street
Journal was praised over a period of time when it gave up on the word
derivatives because it sounds so inflammatory - it sounded inflammatory
at the time – and they started calling them things like securities
instead of derivatives, and - and that won the praise from ISDA and Mark

GROSS: So if Mark Brickell of the finance lobby group basically wrote
the part of the bill that kept swaps deregulated, who invited him in?

Prof. PARTNOY: Oh, he invited himself.

GROSS: Well, somebody from Congress had to allow him to draft part of
the legislation.

Prof. PARTNOY: Well, that’s right, but - but these are not people on the
staffs of Congress at that time who are experts in this market, so they
need advisers to talk to them about how to respond to a crisis. And
let’s also remember that ISDA is a trade group and that these banks are
very large contributors to both parties. Every bank is giving money to
Democrats and Republicans across the board, and so although ISDA invites

itself in, they invite themselves in having bought a bunch of tickets in

And so when they come in, it’s not a surprise that they’re given time
and even allowed to draft legislation.

GROSS: So when the Commodity Futures Modernization Act was passed in the
very final days of the Clinton administration, ensuring that credit
default swaps would remain deregulated, the Treasury secretary at the
time was Lawrence Summers. This was President Clinton’s Treasury
secretary. He is now President Obama’s chief economic adviser. Did
Summers support this bill and support the deregulation of swaps?

Prof. PARTNOY: I don’t know whether he supported the bill. He certainly
supported the deregulation of swaps. He was part of the president’s
working group that supported deregulation. And some of the members of
that group have apologized. I think Arthur Levitt has come forward and
said that this was a mistake. Even Alan Greenspan, when cornered, said
that this was one of the mistakes that he had made. But certainly the
brain trust at that time supporting deregulation of derivatives was lead
by Alan Greenspan, but the other members were certainly Bob Rubin and
Larry Summers and Arthur Levitt.

GROSS: So earlier were we talking about how you think the ratings
agencies like Moody’s and Standard and Poor’s basically enabled the
people selling derivatives to overprice them by giving high, you know,
high ratings to the products when they weren’t worthy of them. Do you
think that the rating agencies need to be more regulated than they are?

Prof. PARTNOY: Well, I think the rating agencies need to be more
accountable than they are. I think they need to be subject to liability.
They’ve been arguing that they have First Amendment rights in their
opinions, just like the opinions expressed on your show, except that
they’re actually being paid many, many millions of dollars for their
opinions, and I think…

GROSS: In my field you call that conflict of interest.

(Soundbite of laughter)

Prof. PARTNOY: Well, there’s a big conflict of interest at rating
agencies, and hopefully Congress is going to do something about that.
People don’t realize, there is something called Section 11 of the 1933

Securities Act, and it applies to create liability for banks and
accounting firms and law firms, lots of participants in the financial
markets. The rating agencies are explicitly exempt from that statute.
They cannot be held liable. And they generally have not been held liable
in the past. They need to be much more responsible when they engage in
reckless conduct.

They’ve had a pretty good run. They have had 50 percent operating
margins, higher than any other company, really any other publicly traded
companies in the U.S. So they need their feet held to the fire little
bit more, not just in terms of people pointing fingers at them but also
in terms of liability.

But I’m not sure what we need is more regulation. Part of the reason we
got into this situation in the first place was because of regulation. It
was because of too much of the wrong kind of regulation. Essentially
what happened - and it goes back to the great crash, actually, of 1929,
when we started deferring regulatory decisions to the credit rating
agencies. We started saying, well, regulators like the Federal Reserve
or the SEC, they can’t figure out which bonds are safe and which one’s
aren’t safe, so they’re going to differ to the credit rating agencies.
And they continue to do that.

In fact, this most recently announced plan by the Obama administration
defers to the credit rating agencies, even after they’ve gotten almost
everything wrong. They rated AIG Triple-A before its collapse. They
rated Lehman Brothers very highly before its collapse. They rated Enron
investment grade before its bankruptcy. They rated Orange County Triple-
A before its collapse.

They’ve gotten almost everything wrong, particularly on these sub-prime
assets, and yet regulators and investors continue to rely on them. And I
think what we need to do is take a step back and ask why do we continue
to rely on these incredibly dysfunctional and inaccurate credit raters,
and please can we try to create a new regulatory structure that will not
only supervise them and hold them accountable but that will also give us
some other metric. And one of the metrics I’ve been suggesting
regulators should use is the market. They should look to market prices
rather than these conflicted rating agencies which are charging for
their ratings.

GROSS: My guest is Frank Partnoy. His 1997 memoir about selling
derivatives on Wall Street, “Fiasco,” has just been published in a new
edition. We’ll talk more about derivatives and how they helped get us
into this economic crisis after a break. This is FRESH AIR.

GROSS: If you’re just joining us my guest is Frank Partnoy. He is a law
professor at the University of San Diego Law School. He used to sell
derivatives for Morgan Stanley in the mid ‘90s. He has a memoir about
that called “Fiasco: Blood in the Water on Wall Street,” that was just
new re-released in paperback. And he has a forthcoming book called “The
Match King: Ivar Kreuger, The Financial Genius Behind a Century of Wall
Street Scandals.” What are you most pleased with what you’ve heard so
far about the Obama administration’s plans to reform the finance system?

Prof. PARTNOY: The thing that I’m most pleased about is that they’re
smart and careful and incremental and they’re proceeding in a flexible
way. So when they’re talking to the markets, the most recent news from
both Geithner and Obama suggests that they’ve had many, many
conversations with sophisticated people in the markets to make sure that
they understand that they need to partner with the private sector. They
understand that they need to harness the value of markets.

Let’s remember, these credit default swaps, which we’re agreeing now,
many people are agreeing should be regulated, these are powerful
indicators of problems. If you looked at the credit default swap market,
these side bets, they would have told you there were problems at AIG, at
Bear Stearns, at Lehman Brothers. They were canaries in the coal mine
early on. And I think the administration understands that they need to
regulate these markets but they also need to harness the power of

GROSS: Paul Krugman, the New York Times columnist – he’s a Nobel Prize
winner and a liberal economist - was very critical of the Obama
administration’s plan to help private investors buy toxic assets by
loaning money and shouldering a lot of the risk. Krugman says that the
plan is based on the idea that the bad assets on banks’ books are really
worth much more than anyone is currently willing to pay for them.

So he is afraid that we’re going to help private investors buy these
toxic assets, that the assets aren’t going to be worth much in a long
run, and that if the investors pay more than they’re really worth, we’re
going to owe a gazillion dollars. It’s going to be the taxpayers who
have to pay the bill. Are you as concerned as he is?

Prof. PARTNOY: I am somewhat concerned about that, because we do need to
put these two parties together to make it work. The banks have to be
willing to sell and the private sector has to be willing to buy. And
right now the gap between the price at which the banks are willing to
sell and the price at which the private sector is willing to buy is very
wide. And basically what the government has done is to come in and say
we’ll subsidize the private sector purchases, we’ll encourage the
private sector by providing these loans on attractive rates. And
hopefully they’ll try to persuade the banks, which now they can exert
some control over, to be willing to sell the assets at lower prices. I
think whether Krugman is right or not will depend on what price the
banks are willing to sell at. If they’re willing to sell at lower prices
and the private sector is willing to move up, then the market will clear
and these transactions actually will take place.

I do think his concern is still there though, which is quite a
legitimate one, which is that much of this, much of what we’re doing
now, is similar to the same sort of gambling the banks were doing
initially when they entered into these credit default swaps and other
derivatives transactions.

If the market continues to tank, then we could lose as taxpayers even
more money. And so really all of us collectively are now going to be
invested in this derivatives market and hoping, and our futures will
depend on, this derivatives market improving.

GROSS: So you know, I got to ask you, we started our conversation by
talking about how you used to sell derivatives in the mid-‘90s and then
you ended up trying to blow the whistle on them, saying that, you know,
this could be trouble. When you left Morgan Stanley after selling
derivatives, did you keep investments in derivatives or did you worry
about them so much that you got rid of whatever you had? Maybe that’s
too personal and I shouldn’t ask, but I’m just kind of curious.

Prof. PARTNOY: Well, I don’t invest in derivatives. Most of the people
who sell derivatives wouldn’t touch them. One of the things I was so
struck by, working at Morgan Stanley, was that when you went to the
traders of the most complicated instruments and asked them what they
invested in, they all invested in just one thing. They bought Treasury
bills. They knew what the markets were like. There was no way they were
going to speculate based on these complicated assets that they were
trading all day. So, now I don’t think I – I haven’t and I don’t think
I’d put very much money into these instruments.

GROSS: Interesting. I guess in some ways I didn’t need to speculate
because you were making a fortune on Wall Street.

(Soundbite of laughter)

Prof. PARTNOY: Well, if you’ve made enough money on Wall Street, the one
thing that you want is to make sure that it’s safe. And I think one of
the most interesting things that’s happened to the Wall Street is that
they threw up this boomerang of risk and it came back and sliced their
heads off and that’s not the way Wall Street used to work. Wall Street
used to be the place where the smartest people were and the people who
traded these complex instruments would never end up taking the risks
associated with them.

But what happened with the subprime crisis was that whereas they used to
toss this risk off their balance sheet, when they – they threw it off,
it came back. And within these institutions they lost the ability to
figure out whether something was risky or not. They ended up taking
these really bad debts and the smart folks had left. They had gone to
these hedge funds and the hedge funds have actually - the smart ones -
have actually made a fair amount of money off of the crisis. The people
who called it correctly, who bet against the subprime markets have made
huge amounts of money because they saw this coming, and I think it’s one
of the ironies of the situation that we’re in, that Wall Street actually
cut it’s own head off. They actually took on the risks that they
previously had understood so well.

GROSS: So, is there anything good you have to say about credit default
swaps? Like why regulate them? Should we get rid of them altogether?
Should we just say that these are poison, let’s just stop making them
and selling them?

Prof. PARTNOY: No, absolutely not. We have to remember that derivatives
are like fire or dynamite - they can be very dangerous, but they can be
very useful as well, and credit default swaps can be an incredibly
useful tool. If we had paid attention to credit default swaps, we
would’ve seen a lot the problems early on because sophisticated people
who are making side bets based on whether people will default are going
to notice when people are more likely to default. And the prices in the
credit default swap market are a very, very nice early warning indicator
that we should take advantage of.

We shouldn’t stamp out that market, we don’t want these instruments to
go away - and derivatives are not going to go away. Credit default swaps
are not going to go away. We shouldn’t want them to go away.

GROSS: What do you think of short selling? Do you think that that should
remain legal? And I’ll ask you to describe what it is before you answer
the question.

Prof. PARTNOY: Short selling is essentially betting against stocks.
There are different ways to do it, but the typical way is that you
borrow a stock and you sell it and you make money when you buy it later
at a lower price. Short sellers are incredibly important, and I think
that they’ve been wrongly vilified in this crisis. I think if anything
we need to subsidize short sellers. They’re the heroes, they’re the
people who spot at many of these problems early on. When bankers
complain about their stock prices going down because of short sellers, I
think we all should raise a suspicious eyebrow. The reason the prices of
these banks went down was because they had bought risky assets that went
down in value.

The short sellers were people who had found out about this early on, who
had dug into the details of their financial statements and had
investigated the banks, almost like forensic accountants or financial
journalists, finding all of these massive, massive risks. And everyone
wants to blame someone and the fingers are pointing in all sorts of
directions. And many people in Congress have said that the short sellers
are some of the perpetrators, but I really think that’s wrong headed. I
think that, let’s again take a step back and think about the role of
short selling. Companies naturally are going to tell us positive
information, right? If they have good news, we’re going to hear about
right away.

What about the bad news? Nobody talks about bad news. And we need
somebody out there in the market who can play the function of trying to
ferret out the bad news of going in and investigating. And people won’t
do that for free. Maybe a journalist will do it for a relatively small
salary, but people in the financial markets aren’t going to go out and
find bad information about companies unless you pay them for it. So, I
actually think that we should take a very light touch to short sellers
and hedge funds. They are the heroes really. If we had paid attention to
them a year or two ago, we would’ve understood that the banks were much
riskier than – than the regulators imagined.

And I think that, as we’re thinking through the regulatory structures,
and I think the Obama administration understands this, that showing
deference to markets and calling in these experts, the short sellers who
really do understand these financial risks would be a wise move.

GROSS: So, are you glad that you left Wall Street when you did in the

Prof. PARTNOY: Well, it was incredibly stupid decision from a financial
perspective because these industries boomed and I would’ve made huge
amounts of money, I mean I did just fine, but from a financial
perspective it was, it was dumb. But I’ve been able to since 1995 look
at the industry from a big picture perspective and write about it
freely. And I wouldn’t have been able to do that - and I do feel for
people who are in the industry, who know all these stories, who could
tell them but they can’t. When you talk to them privately, they’ll tell
you something off the record and they can’t really speak their mind and
the one thing I’ve been able to do over the last decade or so is to
speak my mind.

And to have that freedom and that’s something you really can’t put a
price on. So I am glad from that perspective that I’ve had that

GROSS: And why can’t people still working on Wall Street speak their

Prof. PARTNOY: Well, they would be fired immediately if they spoke their
mind. Even when they leave they need to sign confidentiality agreements
so that their employers know that they won’t speak their mind. You just
don’t, you can’t do it, you don’t shoot the golden goose. And
particularly in a time like this when people are struggling on Wall
Street and they’re nervous about whether they’ll keep their job or be
able to get another job. This is the last time you would want to go out
and out your firm. I think we will see a few people who have already
made their bunch of money, who will come out now, who will talk about
the problems. But most of the people are going to seal their lips.

GROSS: And you didn’t have to sign a confidentiality agreement?

Prof. PARTNOY: Incredibly, no. I had my exit interview with Morgan
Stanley and it was very cordial and I shook hands with the person who
was giving me the exit interview and left and that was the end of it. If
they had made me sign a confidentiality agreement I might not have been
able to write “Fiasco”. I would’ve encountered all kinds of problems
with things that I’ve been saying or writing about. And fortunately I
slipped through the cracks.

GROSS: Well, thank you so much for sharing some of what you know with
us. Thank you.

Prof. PARTNOY: Thank you.

GROSS: Frank Partnoy’s 1997 Wall Street memoir “Fiasco” has just been
published in a new edition. And he has a new book coming out, called the
“The Match King: The Financial Genius Behind A Century Of Wall Street
Scandals”. Partnoy is a professor at the University of San Diego School
of Law. Coming up rock critic, Ken Tucker reviews the new solo album by
Dan Auerbach, the Black Keys singer-guitarist.

This is FRESH AIR.
Fresh Air
12:00-13:00 PM
‘Keep It Hid’: Intimate, Thrilling Heartbreak


Dan Auerbach is the singer-guitarist for the Black Keys, the critically
acclaimed Akron, Ohio duo. The Keys specializes in rootsy blues-rock,
but on his solo debut, Auerbach broadens his style to include folk,
country and even psychedelic elements. Rock critic Ken Tucker has a

(Soundbite of song, “Trouble Weighs a Ton”)

Mr. DAN AUERBACH (Musician): (Singing) What’s wrong, dear brother? Have
you lost your faith? Don’t you remember a better place? Needles and
things, done you in like the setting sun, oh, dear brother, trouble
weighs a ton.

KEN TUCKER: Dan Auerbach commences his solo album by emphasizing the
solo aspect, strumming an acoustic guitar and singing plaintively about
how his troubles weigh a ton. At age 29, Auerbach sounds as though the
troubles he’s seen are considerable and hang heavily upon his slender
shoulders. But then, when you steep yourself in the electric blues, that
posture comes naturally. On this album’s title song Auerbach distorts
his voice and comes up with the sound from, as he describes it here, an
open coffin lid. The voice of death come looking for you on “Keep it

(Soundbite of song, “Keep It Hid”)

Mr. AUERBACH: (Singing) Lock the door and close the blinds. They’re
coming for me girl and I ain’t got time. If they ask you, darlin’. Oh
about what I did. Baby you gotta keep it hid.

TUCKER: The thing about Auerbach is that he doesn’t wallow in either
misery or menace. He doesn’t overdo the drama inherent in the musical
choices he makes. Where other performers might strive for authenticity
in the form of anguished cries and tremulous guitar solos, Auerbach
takes a different tack. He approaches a song such as this one, called
“Heartbroken, in Disrepair,” with a lusty energy, as though the subject
matter of unhappiness exhilarates him. He gets off on the performance of

(Soundbite of song, “Heartbroken, in Disrepair”)

Mr. AUERBACH: (singing) There is no light, there is no charm. All my
belongings, I hold in one arm. Under the bridge, asleep in the shade.
All of the terrible choices that I made. Searching for light, gasping
for air. Heartbroken, in disrepair.

TUCKER: This album also permits Auerbach to dial down the volume that’s
usually cranked up on his Black Keys album. The result is the sound of a
voice with what is perhaps a limited range, but is nonetheless very
expressive. It’s all about creating intimacy, drawing you in with
artfully tentative vocals that sound as though he’s working out the
words as he figures out the guitar chords.

(Soundbite of song, “Goin’ Home”)

Mr. AUERBACH: (Singing) I’ve spent too long away from home. Did all the
things I could have done. Gone are the days of endless thrills. I know
I’m not the only one. So long, I’m goin’, goin’ home.

TUCKER: Of course, you can’t take the blues-rocker out of the music
entirely. The song I just played goes on to build after three and a half
minutes to a guitar and drum rave-up. And on this terrific song called
“My Last Mistake,” Auerbach channels ‘60s bands like Canned Heat and the
Troggs while writing a lyric that shows him to be very much a
contemporary fellow sensitive to the needs of his loved ones, without
being a wimp about it.

(Soundbite of song, “My Last Mistake”)

Mr. AUERBACH: (Singing) Tell me now, tell me true. Of all the things I
did to you was this the one. That made you break. Did I make my last
mistake. Only you can play the game. Rope-a-dope and lay the blame.
Can’t you see, my body shake. ‘cause I made my last mistake. I was out
of line before…

TUCKER: Coming after the thick, meaty, grunginess of the last Black Keys
album, “Attack & Release,” this Auerbach solo album sounds like a
clearing of the throat and mind. You don’t need to know that he’s
usually half of a loud, thrashing, vehement music act to appreciate the
floating, airy atmosphere of “Keep It Hid.” Auerbach has said he wanted
this album to quote “flow like scenes in a movie.” And I think he
succeeded. He’s created not a Black Keys film noir, but his own kind of
film — a melodrama with mellow humor, a mood piece about a hero who
feels most comfortable delivering monologues in the dark, sitting on the
side of a motel bed, looking out at a cold parking lot and a warm, full

GROSS: Ken Tucker is editor-at-large for Entertainment Weekly. He
reviewed Dan Auerbach’s new CD, “Keep It Hid.” You can download podcasts
of our show on our Web site
Transcripts are created on a rush deadline, and accuracy and availability may vary. This text may not be in its final form and may be updated or revised in the future. Please be aware that the authoritative record of Fresh Air interviews and reviews are the audio recordings of each segment.

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