Introduction

Patrick: [00:01:22] Many of the most fun investing conversations are with traders and portfolio managers, because they live and breathe risk, day in and day out. Of course, they are often risking other people's money, but controlling real money in markets is hard to match. Theories and ideals can fade quickly, well laid plans often don't last. This week's guest is someone who has lived through his fair share of market highs and lows and I think you'll be able to tell quickly why I so enjoy conversations like this one. My guest is Danny Moses who is directly in the middle of one of the biggest trades in market history, chronicled by Michael Lewis in his book, The Big Short. Danny was the head trader on the FrontPoint Team, led by Steve Eisman, who along with a small handful of others, like Michael Burry and John Paulson, made enormous profits during the financial crisis, as they figured out, in real time, the disaster that was brewing in mortgage-backed securities and figured out how to position their portfolios in a way that would benefit from their insight. No easy feat. My conversation with Danny is multi-faceted, we talk about Danny's role in The Big Short, both the trade itself and the making of Michael Lewis's book. We cover the history and current state of sell-side research and how ETFs and other trends have made it difficult for traditional bottom-up fundamental managers. We even talk about Dominique Strauss-Kahn. To start this episode, I've pulled a piece from the middle of the interview, because I want to make sure that all aspiring asset managers out there hear Danny's answer about what he looked for when hiring an analyst. You can find show notes at investorfieldguide.com/Danny, and now, please enjoy this colorful conversation with Danny Moses.

Traits of a Successful Analyst

Patrick: [00:02:57] If you were designing a new analyst or you could somehow bestow upon a person three or four traits, that you think would make them successful, and this question's really aimed at younger people that're interested in asset management. What things, or if people know a certain strength about themselves, do you think, make for the best odds of someone succeeding, given all these challenges? Given the fact that the fundamentals don't matter right now, they will, at some point, so, obviously, I think a love for it is maybe one of them because you're not going to last if you're in it just to make money. But are the most common traits that you think ... You seem to have this arbitrage mind, a numbers mind, what would you name as the most important things if you were hiring a 23 year old?

Danny: [00:03:37] Sure, you got to be an out of the box thinker. You have to question everything that you see. It's not so much being cynical, as it is being skeptical. Don't take anything at face value that a CEO's telling you. He may be telling the truth, and most of them do, but don't take anything, don't just rely upon that or other people, in the investment world, to tell you that you're right. You want people that are going to tell you that you're wrong.

So the first thing I do is, when I meet somebody, is how they approach things, in life, in general. Do you just accept everything at face value? Question it. Second is that, and this goes back to when I hired a trader at FrontPoint, when we were really growing. I get all these resumes would come in and I'm not going to single out any university, but let's just take some of the Ivy Leagues. They come in and I see the resume and I meet with them, brilliant people, very smart. But when I said, "So where do you see yourself in two years?" "Well, I'll be the portfolio manager." And I said, "Okay, so what exactly ... how are you going to get to that level?" "Well, I'm a very good stock picker, I'm a very good ..." I go, "What's your track record?" So people that have a false sense of smart, because they did business cases correctly and got an A on it, versus the kid I ended up hiring, that was from Boulder. And I said, "What are you going to do?" He goes, "I'll do anything. I will trade Asia for you, I will trade Europe for you. I will go to any meeting that you want." So it's the hungry person, that's a sponge, that just wants to break into the industry, that you may want to come in, in equities, and then there's an opening in fixed income. Just take it. It doesn't matter where you are, within the spectrum, because you're going to learn, and it doesn't matter where you're learning balance sheet of a company, or what their stock is worth, it's all the same, right? It all goes back to the same math. How do you get to these earnings numbers and how do you get to these interest payments and how do you get to those things? So the first thing is out of the box.

The second is, obviously, integrity, which you can't judge from meeting someone for the first time, but given certain situations, you can see this happen a lot, "How did you handle those situation?" It's a people business, lastly. Doesn't matter if you're dealing with coworker, a buy-side, sell-side analyst, a CEO of a company, and so forth. So understanding people, and reading them, and what drives them, is another key. And that, again, I don't know if you can teach that to someone that doesn't have it already. So willing to put in the hard work, willing to ask tough questions, and understanding that you don't know everything, and really being a sponge and challenging. The best candidates, to me, are the ones that challenge, that ask more questions in the interview than you do. They want to really understand what it takes, and so if you can tell, I think, right away, if the candidate's cut out for investment banking, if he's cut out to be a sell-side analyst, a buy-side analyst. And some are content with being grunt analysts, at least and that's great, just get into the business. So, it's an attitude and expectations.

And what's happening right now, is, obviously, the pay scale's coming down across the board, buy-side and sell-side. So a lot of people are turned off. That, I would never hire the person that's now turned off by it, because things are cyclical. There are some structural changes going on in the business for sure, but again, at the end of the day, it's not going away and it'll come back. So, I would almost want the person that said, "I don't care that the pay grade's coming down right now. I know if I get in, I'm going to be a star, and I want it." So I also think it's the attitude, of level of commitment, you can tell, by people that still want to pursue it. And I know some of these kids out there looking right now, that I'm trying to help, at various places. They don't care what they make. They just want to get in and learn, because they have a passion for the business. You truly need it.

My passion started when I was seven or eight years old, my dad promised my sister and I that we could get a dog if a certain stock, at the time, Oxford Industries, hit $10, okay? So and then back in the day, you had to get the newspaper every day, so I started reading the business section, just finding O, and it was OXM, and I just scanned down, scanned down, scanned down, and you couldn't even ... Right? You had to wait for the paper the next day and I'm like, "Seven and a quarter." A week later, "Seven and three quarters, eight and a quarter." That's actually how I got my interest in the stock market. I'm sure I would've had it anyway, but I'm like, "Wow, what is this? I'm following a company." It hits ten, did we get a dog? No. You know, move the goal post on me, so anyway, I had it at a young age.

The Big Short

Patrick: [00:07:41] Your role in the financial crisis, playing a role on a team that, now, everyone knows about, because it's been in a major book, and a major movie, The Big Short, we can start there and instead of talking about the overall idea, everyone knows the broad story. I think it'd be fun to hear your smaller, particular story, with how you ended up on Eisman's team and what your background was, leading into that time.

Danny: [00:08:03] So I would probably go back to, I worked with Steve Eisman starting in, I want to say, 1996, at Oppenheimer. I was an institutional equities broker, he was our research analyst. His associate was Vincent Daniel, who was also in The Big Short, and so they were a research team and I was a sales guy, at the time. So I would take them around to meetings, fun stories, like taking Steve to Alabama at the Embassy Suites hotel, to see the retirement system of Alabama. Where there's no hot water and he comes downstairs. Great stories like that. But the first go around with these guys was the first subprime crisis, which actually was around auto, subprime auto, Ugly Duckling and those names back then. And that was in the late '90s. And so Steve literally got up to the podium, on the research platform, and said, "The following five stocks are going to 0" and he walks off. It's like Ames, Ugly Duckling, it was a list of them. And I pulled Vinny aside, I go, "Vinny, what is this? What is he talking about?" And he goes, "It's easy, it's the data. Go into the securitization database and you look at the Moody's and S&P flows that're coming in and you can tell. X amount of delinquencies, there's only so much capital that these firms have, they're going out of business. There's nothing they can do about it." I go, "Okay, well that seems pretty easy." So it went into home equity loans from there and so forth, so in the late '90s. So fast forward, Steve leaves and goes to Chilton, then he leaves and goes to an independent research firm that was basically dealing in Fannie and Freddie at the time. Josh Rosner was his partner, who's now all over DC, you see him a lot. And in the midst of that, 9-11 happens and Vincent goes to KBW, to be an analyst there, to fill many roles. Steve stays at Chilton and hires Porter Collins, who was the fourth person that was mentioned in The Big Short, as his associate.

So I leave Oppenheimer from the sell-side and go to a place called Friedman, Billings, and Ramsey. Well, Friedman, Billings, and Ramsey was at the center of the subprime business. They were the ones that brought Saxon public, they brought Credit Home Lenders public, they brought New Century public. So, as a salesman at the time, I was able to see these companies being built from the ground up. About that same time, 2003, 2004, Steve takes Porter and goes to FrontPoint to be one of the first teams on the platform. I am a sales person at FBR covering these guys. Vincent joins from KBW, joins Steve and Porter as well. So fast forward a little bit, the subprime business is growing, I'm a sales person at FBR, I'm the senior sales person, and I refuse to sell any of these deals. And instead, what I do is I go to these roadshows, I take friends with me, that're in fixed income. And I said, "What's wrong with this? There's something wrong here." And so while I wouldn't sell the deals, which hurt me, in terms of my own pocket, and in my stature at the firm, I just didn't believe in these companies. At the same time, Vincent, Porter, and Steve lost their trader, at the time, and they knew these companies well. They lost their trader and they said, "Hey, do you know anyone that can trade for us?" So I said, "I'll do it. I know your portfolio, I know how you think." This was late 2005, early 2006, "Just get me a seat at the table and I'll figure it out." So I jumped over there in 2006 and this was right when things were starting to unravel in housing. So we were tracking housing data, we were tracking delinquent loans and mortgages and so forth, but more importantly, we all understood how these companies were financed, the bonds that they were issuing, the ABX was being created, and just the leverage that was entering the system.

So, if you combine our four brains at the time, it really came down to we could no longer short stocks like New Century or Credit Home Lenders. One, there was not much stock that you could short. And if you found it, you were paying 40% to 50% interest on it. Secondly, they were paying these large dividends, quarterly, even though we knew that they would run out eventually, so it really became the cost to short the securities was more than trying to figure out some other way to do it, which was buying credit default swaps, on the bonds that are being issued themselves, which have been put together in various mortgage backed portfolios. So coming full circle on that, and as the movie portrayed, Michael Burry, who was played by Christian Bale, was very early to this trade and actually was the pioneer in terms of creating the ability to buy, what in effect, is a put option on the mortgage business. We did our first trade in August, 2006, and from the very first statement that we received, we were making money. I can tell you that if we had been in the same position as Michael Burry, I don't think we would've made it through the trade. We were an equity fund that decided to go into the fixed income market. So your investors are going to have a very short leash.

Patrick: [00:12:33] "What the hell are you guys doing?"

Danny: [00:12:34] Exactly. So it worked right out of the gate, and I would say, at the time, roughly, a third of the portfolio was long, a third of the portfolio was short, and a third of the portfolio was in these mortgage backed securities. So it wasn't our entire portfolio, it wasn't really levered up very much. I think, at the peak, we probably had $500 or $600 million worth of combination of CDOs and ABX and single name CDS. And so we probably could have made more at the time, but it was really going along with our strategy.

And so we were able to look at our equities from a credit standpoint, which we had still done, at my next firm, Seawolf, which we can talk about, but it was always a bottom-up approach, because you cannot commoditize lending. It's one thing that you can't do. You can leverage it but at the end of the day, if you underwrite poorly, it'll catch up with you. And Steve was a great teacher for all of that. And so having the balance, Steve is the brains, and really understanding, great instincts. Vinny is the best research analyst of all time. Porter, who understood the banks better than anyone. And me, who was dealing with the street, trading, trying to understand the nuances at the time, really, on the fly, it was great. So I would say that from the book to the movie, the only thing that wasn't portrayed correctly was I was the guy that said, "How are you going to fuck me?" Excuse my French, but can I say this on a podcast..

Patrick: [00:13:48] It's fine, yeah.

Danny: [00:13:48] Okay, and so forth, because I was in the trenches and Vinny and I did travel together, at various times. Porter, Vinny, and I traveled together. Steve, Vinny, and I traveled together. The Las Vegas scene. So some of it was accurate. There was no alligator chasing us out of a pool, but we did go to neighborhoods and knock on doors and so forth. So it was just a surreal period of time and none of us really took it for granted. It was lucky in the sense of timing, like I said, we made money the day we put the trade on, and our counterparts, as you know from the story, were Deutsche Bank and Goldman Sachs. And so it was just really a continuous discovery process, of where the bodies were buried and it was easy to see that people were making money too easily for a long period of time, on Wall Street, in the fixed income business, and it was too easy. And we can go into any of those stories in particular, but a lot of it was behavioral finance 101 and really understanding, recognizing that, and trying to trade away from everybody, versus with everybody. So that was basically it.

Patrick: [00:14:47] You mentioned that you're making money right away. What was the moment, maybe not the first trade, but what was the moment that you first realized something was, that an opportunity was there? That something was seriously wrong. Not only that something was seriously wrong, but that there was a way to trade against it?

Danny: [00:15:03] You saying pre time we put the trade on or during the trade?

Patrick: [00:15:07] Yeah, well, both, yeah.

Danny: [00:15:08] Well, I think that the stocks started to work, at the same time that the CDS was working, so we got confirmation on one side that the other was going to happen. There was a period of time, though, where spreads were widening in the fixed income market and the equities were still holding in, and there was a massive dislocation. So I would be talking to the head fixed income trader at Deutsche Bank and head financial equity trader at the same time and the head financial trader had no idea what was happening on the fixed income desk. So here he is, bidding for stocks in New Century or Creditor Home Lenders, Countrywide, and I said, "Dude, you got to be very careful, because your other side of your desk right now is out trying to short all this paper that these companies are out there creating. So there's a disconnect, so either walk across and find out what's going on." So it was a period of time where there was misinformation in the market and I would say that when the stocks started to drop, it gave us a little bit more confidence in what we were seeing. And then there were some failed deals on the equity side, companies' inability to go out and raise capital any longer. And New Century in particular comes to mind, that they had really a highly levered balance sheet and they would go produce loans into the marketplace and they would sell the loans into the marketplace. So they would get funding from the Wall Street banks, produce the loans, keep some on their balance sheet, and then sell the rest, right? And there was a retention rule that they had to keep a certain amount of bonds.

Well, what was happening was they were selling the best bonds, say if par is a 100, at 103, 104, and keeping the worst. But they were assuming, everyone was assuming that 103 or 104 should be the price for their entire portfolio. So we realized there was a mismatch and that was in the public domain, that you could see that they couldn't sell a certain amount. And so as the performance on those mortgages deteriorated, the bonds deteriorated, obviously. And so the stocks were reflecting the balance sheet valuation of these companies at the time and we knew, once that happened, that the other side was going to follow suit. So it was a combination of having an antenna up. I mean the movie portrays stuff on the news and seeing things that were out there. But I would say failed capital raises, companies going to trust preferred to raise capital instead of traditional secondary equity offerings, and so forth. There was a lot of signals that were out there.

Patrick: [00:17:12] What was the first point that there was, in the movie, there's a bit of a struggle between a great investing opportunity and the understanding that this is a disaster for the country and for a ton of people. What was that feeling like, or that dichotomy like, through the process?

Danny: [00:17:27] That was probably the strangest, craziest thing, the irony that we were at a Morgan Stanley hedge fund. So Morgan Stanley had acquired FrontPoint Partners in the midst of all of this and paid a nice chunk for it. I can't remember the exact amount, but, I'd say, $400 or $500 million, something in that range. And so while we found ourself on a more stable platform, if you wanted to say, we realized, as this was all ongoing, and it was in the book and it was in the movie, that, hold on, we work for the firm that may be at the center of all of this. What do we do about it?

And so that was the first of all, the second part of that, to your point, was what's happening to humanity here? What's going to happen here? And there's this scene in the book, which is very accurate, and I actually have a panic attack on the trading desk because it was the day where the markets, where all the bank stocks were coming undone. We could've been long them, we could've been short them, but everything was just dropping. So it wasn't a performance issue for us that day, it was more like, "Hold on a second, people are really flying out of these names there's a real crisis going on." This is post Fannie and Freddie, this is pre Lehman, right around that time period.

And so Vinny and Porter picked me up and took me to the steps of St. Patrick's Cathedral. So, of course, as a good Jew, I go in and sit on the steps and pray. But sitting out there and Steve had been at a Goldman Sachs conference and he walked down Fifth Avenue, came down, and I remember him coming up on the steps and we were all just standing there. And so the scene in the book, versus scene in the movie, is when Vinny's on the phone with Steve somewhere and he closes out the trade. But the real scene is that in the book, we're on St. Patrick's steps, watching people go by, and it's so surreal, because we're thinking to ourselves, "95% of these people have no idea what's happening right now and their job and their livelihood's going to be affected." They might not even be invested in the stock market, but they may work for companies that have some association and so forth. So we were scared, at that point. So it became not about the money, and it really was never about the money, for us. Of course, you make money for your clients and make money, it was about uncovering something, trading it, and I think the movie did a great job, in terms of us being detectives. And in a fixed income world, equity guys in a fixed income world is really what it was. And so it was unnerving. We were able to deal with it, obviously, but it was scary. And I'll tell you, just to take that one step further, the bailout stuff that happened, the TARP, the TALF, the PPIP, and all the things that were occurring, we got very lucky I think, in the sense that the trade that we were in, while it was legal and there was documents associated with it, at any point in time, the government could've come in and said, "No this is-"

Patrick: [00:19:53] Cancel it all.

Danny: [00:19:53] Cancel it all or whatever. That's why Vinny and I were so emphatic about closing out the trade at 10 cents on the dollar. Let the lawyers deal and let the brokers have the last 10 cents. We're not going to hang on here. I didn't even know, really, what we were dealing with, in terms of documentation. So the timing getting in was lucky, and our timing getting out was timely, lucky. Like hanging on for that last piece, really, for us, it wasn't about that. It was more about that we were right.

Patrick: [00:20:16] How much relationship was there with other people, that were also the detectives in this story? So Burry, Paulson, Kyle Bass, other really prominent names, in hindsight, that also seemed to discover some part of this. How much did you ... were you even aware of what they were doing?

Danny: [00:20:33] We were aware of some of them, because we'd be at dinners or conferences and we would see other equity guys, like, "Hey, equity guy, what's up? You're obviously on the same hunt that we are." And there were firms like Cedar Hill, that they did exceptionally well on the trade. Paulson, obviously, did very well on the trade. But when Michael Lewis came around, he called Meredith Whitney, because he had a relationship with her and we all worked with Meredith at Oppenheimer, just to backtrack for a second. And he asked Meredith, "Who do you know out there, that was involved in this subprime trade?" And she knew Steve well, she worked with him, she was the other associate, with Vinny, for Steve. And so he called us first. He called all these players, I believe, but he picked a select group of three or four that he thought were the most interesting. The way they approached it, like the Michael Burry personality, that he was a surgeon, a doctor, that became this hedge fund guy, and so forth. So it was more of, I think, there were a lot of players out there. Some exploited the ABX, general, just broad sense of how to play the market. Some did single name, bottom-up stuff like us. And I think we were very unique in the sense of we used this information in the bond market to help us with our stock portfolio and everything with us was bottom-up. And we were picking mortgage-backed securities in various jurisdictions in California, by various issuers, that we felt had bad or shoddy underwriting standards. So for us, I think we were the ideal candidate for this trade and for Michael Lewis to portray us because of the uniqueness of how we approached it. It wasn't a blanket shorting call at all, but we were aware of the other people, but really, it was maybe seven or eight firms that we were aware of, that were even involved in this trade, to the degree. Again, a lot of firms were involved in the ABX, but they were doing it against some other commercial mortgage-backed portfolio or something. It wasn't a general, "The world's going to end," it was like, "This is an attractive trade."

Patrick: [00:22:18] What was it like working with Michael Lewis?

Danny: [00:22:20] It was great. So he first came in to interview us for an article, that's how it started. It was going to be a 10,000-word article. Got to know him, I really helped him a lot, in terms of introducing him to various people. Marc Rosenthal, who is mentioned in the book, is his shepherd, I think he says was my contact within fixed income, who worked at C-BASS at the time, to really understand the markets and what was going on. But taking him to those meetings and then Michael asks the most incredible questions because he's a character guy. He likes to delve into what drives a particular person, not about the trade itself, or what the subject matter is, it's he likes to see the introspective nature of a person and how they approach it.

So working with him was great. And then he called up, a couple months after the article came out and said, "Hey, this is going to be a book. I'm going to need you guys even more." So it was an ongoing process. He would send words or paragraphs, like, "Is this accurate?" We would say, "Yes," but he was amazing. He had gotten so much information, and I learned more from reading his stuff than I knew what was going on in the marketplace. And then after the book came out, in March 2010, we did some events together, and so all of us did, and then it was done. And then May 6th, 2010 rolls around and the flash crash occurs. And the first thing I did, other than not breathe for 90 seconds, while it was happening, because were still trading. But now we were onto the next trade, right, was call Michael Lewis and say, "You have to write something." And he'll tell you this. "You have to write something about this because the markets are not sound." There's too many technologies being implemented in trading, it's just the safeguards aren't there, so forth.

So one thing led to another there, and I introduced him to Brad Katsuyama, who, now with Ronan Ryan, they run IEX, and they were at RBC at the time, and I had just met Brad, maybe six or seven months before that. And Brad was explaining to me why the market structure is in peril and what needs to happen and what he's seeing that's going out there. So, long story short, Flash Boys came out of that conversation, and so from that point, I dealt with Michael again, and, really, that was more me than anyone else on the team at that point, because I was trading and so that relationship. So then Flash Boys came out a couple years later. I'm still talking to Michael a lot. So I had nothing to do with his latest book, but we're friends and we talk. He's always looking for the next great story, so we talk from time to time.

Auto Lending Crisis

Patrick: [00:24:38] Let's go all the way back to, because I don't know this story and I'd love to hear it, the auto lending, in the late 1990s. What the backdrop was there? What was the initial thread that Eisman found, that was pulled on, and how did that ultimately unfold? And then I want to ask, your role back then, as a salesperson. Get into some of the nitty-gritty of Wall Street, on the sell-side, and analysts, and maybe tell a few stories there.

Danny: [00:25:02] So I would say that when you get hung up on, whenever you make a short call, pretty much on the street to anybody. But I would say, like I had mentioned, in the auto land, data's the data, so it's produced monthly and you get to see the monthly rolls from Moody's and S&P. Because if you have outstanding debt in the marketplace, in the form of a securitization, then you have to put this data out. And the data shows you what are your loss rates, what are your delinquency rates, and how much cash do you have to back up these pools? And so it was pretty obvious that the underwriting that had been going on, in the mid-'90s, '96, '97, was starting to catch up, because auto loans, as you know, are two to three to four years. And what you normally see, within auto loans, is the first stage of deterioration is you extend loan maturities, the loan to values go up, and all that was occurring. So all that data was available. So what Steve and Vinny saw at the time, was it was inevitable that the companies would either have to raise capital or go bankrupt. Well, they were ignoring the raising capital thing, and they were still producing these loans at a very high clip, so that was just math.

And so the beauty of that is, as a salesperson, when someone gives you that information, you make that phone call. And I used to get hung up on, or you can't get the portfolio manager on the phone. And I may find an owner, so I would search out to see who owned these stocks, right? And I may cover that hedge fund or mutual fund or not, and so I would call up, "Hey Patrick, listen, I see that you guys own 450,000 shares of Ames Financial. I really think you need to get Steve and Vinny in your office and let me just pitch this to you for 30 seconds, why I think you should sell it. Not even short it, you need to sell the position." You may ignore me, you may what, but whenever I got Steve and Vinny in a room with that person, inevitably, that person would sell it. And if they did not own it, and they were a hedge fund, they would short it. It was so compelling. It's just numbers. Really, then you apply that to what happened later on in the mortgage, it doesn't matter what it is. Specialty finance is the most interesting area of all, I think, in the entire stock market, and that's not just because we have focused on financials for so long. Non-deposit funded institutions have the ability to do great things and if they get greedy, they're going out of business. So it doesn't matter if it's auto, doesn't matter if it's mortgage, right? It doesn't matter what area you're in and what you're lending in, if you don't underwrite correctly, then it's over.

So going through with that type of call, was great, because it was a great learning experience, and being on the sell-side, I loved it. Because you felt that you were an extension of all the portfolio managers that were paying you, as a broker, to find them ideas and to search for it. So calls like Steve's, and at the time, there was a handful of those on the street. No one makes those calls, "The following six stocks are going to 0." I really think that's exactly what he said, so imagine as a salesperson, "Okay, well, I guess I'll just go with that then." We had Henry Blodget at the time, so here's all this going on, right? And Henry Blodget's out with a $1000 target on Amazon. By the way, he would've been right, eventually, right? But here I'm making one call in tech land that things have never been rosier, Oppenheimer had a big tech platform in banking. And then here's Steve on the other side, ruining the investment banking business with the financial banker upstairs, right? So you have this ongoing, I may call, "Amazon's going to $1000." This is our morning call, "Amazon's going to $1000 and the following six stocks are going to 0. Hey, it's Danny, call me if you have any questions, I'll be at my desk." So it was ongoing, but having that variety, so having other sectors to cover was great because you needed other stuff to talk about, but I actually loved the whole sell-side experience.

Evolution of the Sell-side

Patrick: [00:28:20] What, from your perspective, having been a part of it and then just in the asset management business ever since, how has the sell-side evolved, if you had to summarize it? What's still good about it, maybe today, what was bad about it, in maybe the late 2000s, what's changed?

Danny: [00:28:35] Great question. So when I got into it, this was the DLJ was the premier platform, right? It was entrepreneurs, you were paid on commission, it wasn't banking first, it was research-driven first. And so when I got in, Oppenheimer was a little, miniature DLJ. It wasn't small, but it was run that way, right? Entrepreneur, great sales traders, great traders, great analysts, and so forth. So it was set up well. And then, obviously, fast forward a few years we had the technology issue with Quattrone and so forth. All over the street, where it was, all right, my research is based upon how many banking fees can I garner, and we went through that whole process and so forth.

So we reemerged later, with, "Okay, street's always going to pay ..." When I say the street, portfolio managers are always going to pay for very good research and so forth, but it became more about access to management. We'll pay you for access to management. And so we moved from buy ratings on stocks that generate investment banking revenues, to buy ratings on stocks, so that I can have the CEOs of those stocks that I'm covering, to visit portfolio managers so that I can get paid. So pick your poison, on either one, okay? So I just skipped eight years, but that's really where we had gone. And in the same time, when Dodd-Frank comes in and the large banks are unable to really prop trade any longer and make money in various other ways, the capital starts shrinking at these firms. So from a trading perspective, the trading desks weren't committing as much capital as they had been in the past. They were all going to more electronic trading, dark pools, their own dark pools and so forth. So all this is going on at the same time, where research, which is still research analysts trying to do very good work, are compromised, so to speak, by many angles. One, to get access to management, two, there's still the investment banking overhang. There always is, whether it's implied or not, it's always a part of it, and then the trading was changing, at the same time. So now you have an algorithmic trading universe, with not a lot of high touch trading, that's choppier, that's harder, with the commission rates dropping, from what was an eighth to six cents, to four cents, to two cents.

At the same time, that the only reason many of these analysts are covering stocks is to get access to the management. You also had a lot of these small boutiquey brokerages pop up, that were trying to be independent analysts, that did not have investment banking at the time. And they realized how hard it was to survive when you're independent because inevitably, you're going to have sell ratings, if you're doing real bottom up work. And you're not going to access to management and you're not getting any banking fees. So great on paper, but not strong on execution. And we like the independent. I love some of these independent firms which have emerged today and some are going to make it, some will be bought by the larger firms, probably. So I've seen a really disturbing transition of analysts that are turning a blind eye, I believe, to fundamentals in companies, and listening to what the CEO tells you, as opposed to doing their own work, knowing that they're getting compensated. It's all how you get paid in this business. If you get paid because you have access to management and the big Boston funds say, "Hey, you're in our top quartile now, because you got us 12 CEOs that are only willing to travel with you if you have a buy rating." I always try to get that list, because I would short a lot of them, because if I was a CEO of a company, I'd want to travel with a guy that has a sell rating on me. Right? "Why do you have a sell rating? I want to ..."

So, there's a lot of gamesmanship that goes on, but I would say this is the worst, in aggregate, that Wall Street research, right now, has ever been, because I believe it is compromised. Listen, there's great analysts out there, there's great firms out there, there's people that really do good work. But it's hard to get a lot of momentum and stability at a firm that is completely bottom-up and objective. Now, there are a couple, like Autonomous, which is a great firm, that follows our sector financials, that is doing a great job and they are completely agnostic. They get no investment banking fees, if they can get a company to come around, they do it, if not... But they're just putting out data. And they're starting to build a larger following and I think that, just to take it one step further, just in the market ... and you're obviously in the business, so you understand this. With more and more computers taking over the landscape, in terms of what's driving, if you look at some of these companies, just pick a company, random company in the S&P, there is a chance, and probably more in the mid-cap, small-cap, there's a chance that seven of the largest ten shareholders of that company are ETFs. And so you're better off knowing what ETF owns your stock than what this company even does. And that's scary to me. And that's when fundamental investing goes by the wayside.

And so you haven't asked this question, but I'm going to take this to the next step, from an earnings quality perspective, that's in the marketplace if you move to a non-GAAP, which I'm taking us completely off subject, but GAAP earnings versus non-GAAP earnings. And once you get on the non-GAAP train, obviously, 99% of the time your non-GAAP earnings are higher than your GAAP. You're excluding stock comp and all these things, which you need to live and breathe. So these ETFs are driven ... there's momentum ETFs, there's earnings quality ETFs, there's dividend ETFs, there's all kinds. So as a CEO of a company, I no longer care about meeting with Fidelity, I care about meeting the criteria of what these ETFs have in them.

So, if my biggest ETF is based upon earnings momentum and I'm reporting non-GAAP, and I know that the ETF is following my non-GAAP earnings, I can make up whatever number I want and that's going to make my stock price go up. So, in what universe does fundamental investing matter, in that? Now, it'll all come out in the wash eventually, right? But fast-forwarding into that, and bringing that all the way back to research. Research, right now, fundamentally at this moment, has never been less important. It will be important again, there's no doubt that we will transition and circle back to bottom-up investing, at some point. The irony in that is I feel that in order for that to happen, the market needs to have a major correction and an unwind. Except for O’Shaughnessy, which completely understands the entire quant model and gets it and will be there to protect everyone. What I'm saying is that there is something that really needs to happen here, and so I think we're going to come full circle, back to the research question. But unfortunately, the only way you're going to get back full circle is if people figure out how broken the markets are.

Patrick: [00:34:51] You bring up what I think is, for me, the most interesting market dynamic story happening right now. I'll give you a couple examples. So one would be, there's a guy who screens for over or under-representation of each individual stock in ETFs in aggregate. So they compare the company's market value, just based on the simple weight in the market, versus its average weight in ETFs. And one of the interesting ones is REITs. So REITs are way over-represented in ETFs, relative to their just weight in the overall market. The reason, as you point out, is dividends. So people are buying dividend ETFs like crazy, REITs have high dividends. But, when you go, and we've done this, look at the quant data behind REITs, the last thing you want to look at, when buying a REIT, is its dividend yield. In fact, the highest yield REITs tend to go on to underperform.

Danny: [00:35:40] Look at the subprime mortgage REITs. Had those have been in existence, they were 40% dividend yields at the time, before they went out of business. Correct.

Patrick: [00:35:47] The other one is a Dorsey Wright, which is a momentum model that trades in other ETFs, that then creates the momentum on which the model then trades. So you've got these crazy cascades, that, frankly, it's very hard to ... the timing of it. So this is one of those occasions when you could be early and it'll be indistinguishable from being wrong. And when we talked on the phone, you mentioned that looking at the market, it's a very non-fundamental tape. And I think that that's a really interesting way of thinking about this market, is just the complete dominance of ETFs, of passive, relative to old school, bottom-up, fundamental work.

Danny: [00:36:24] And I'll add one thing to that, which you've touched on briefly, with the REITs, is that a lot of these equity ETFs are fixed-income ETFs. And that's a big problem. And the SEC ... well, now I don't know if there is an SEC any longer, I think they were just taken out, but they were looking into the mismatch between the duration of the assets in the ETF versus the ability to redeem in four seconds. And there's a massive mismatch. And so you've seen a couple times, where in the various bank loan ETFs I would even say, there's been times where people have panicked. And there hasn't been the time yet where mom and pop have opened up their portfolio and seen a real change in understanding what's going on. What just happened to my bank loan ETF? But you have an equity security that's trading at fixed income. To me, that can't end well. So again, I don't think people understand. To your point, they see yield, like, "Oh, great, 7% a year. I'll just buy this ETF. That's great," without any understanding of what they truly own.

Patrick: [00:37:18] Let's go back to the late 1990's. You mentioned Blodget and someone that's just able to move markets. We don't need to talk about him specifically, but a much different environment, where the sell-side was ascendant. So maybe a couple stories from back then, that you found interesting or compelling, in hindsight, thinking back to that time.

Danny: [00:37:35] Well, they moved markets because there was as much information, and couldn't access as much information as quickly on Twitter and so forth. Now, it comes and goes in four seconds. Somebody's already traded it before the news comes out. I'm trying to think of times where, back to Steve's example in the auto, the stocks were probably down 25% that day and people are calling in and saying, "What's going on? Are you guys saying something?" and so forth. There was time periods, during the crisis, where Fannie and Freddie were trading down a lot, because people couldn't figure out what was happening and we would understand what was happening exactly that the losses were mounting and we were looking at monthly data. Again, equity guys, at that time, weren't looking at any credit data, they were just looking at earnings per share. So were back before information became as easy to access as it is now, to your point, you were able to have market-moving events, in various names. 'm trying to think of all the analysts that we had, back in the day. A lot in telecom, a lot in media, there was one guy that actually, now that I just remembered, Jung Jehan, Jim Jung Jehan. One of the greatest guys and one of the greatest analysts at the time. He covered SDL, JDS Uniphase, and all these companies that were building telecom fiber.

So you'd have level three, who was renting it out, you'd have all these companies, and at the time telecom fiber was the greatest thing of all time. And so arnings were growing exponentially on these companies. Or I should say, revenues were growing exponentially on these companies because telecom companies were coming to the fiber companies to lease the fiber so they could use it in their networks. Well, you could actually do the math, that as much fiber as people had been talking about that was possible, would wrap around the earth a million times. There was just too much of it out there. So these stocks would go up, literally, 20% a day, 32% a day. On an analyst, like Jim, doing a revenue update, saying, "I'm going to take my revenues up 12% for the quarter, it's too low." And then people would immediately extrapolate the 12% to mean, "Oh, 12% every quarter, this is going to compound at 60%, this is going to ..." And so there was time periods, I would say, really, during the tech bubble. So, I got to live through the tech bubble and the subprime crisis bubble. I got to see a lot of iterations. You know what? It doesn't matter what the product is. Doesn't matter if it's tulips in the Netherlands in the 1800s, doesn't matter if it's cotton in the '20s, Jesse Livermore style.

It doesn't matter what it is, people behave the same, regardless. They want to believe what they want to believe. They'll chase when they feel like they're missing something, so forth. So there was a lot of those, I'd have to think back, but again, I'd go back to your point, it was more about access to information at the time, it wasn't as prevalent. It took a lot more detective work to find out what was actually moving markets.

Patrick: [00:40:13] So coming now, post-financial crisis, into Seawolf Capital, where you spent a number of years, continuing to trade and facing this non-fundamental tape. And thinking about the sell-side as providers of ideas to the buy-side, do you think that that has gone down considerably? Meaning, are the best hedge funds, the best buy-side portfolio managers, a lot less reliant on sell-side ideas today, because of this problem? Because the quality of research is lower, with all these other, we'll call them perversions, or externalities?

Danny: [00:40:45] 100% yes. For the most part, I think the great analysts that're on the buy-side use every resource they have to them. Many don't want to be confused or swayed a certain way. Like I said before, being on the buy-side and whether if I love a name, I would search out the person that had a sell rating on it. If I hated a name, I would seek out the person that had a buy rating, right? That's what you're supposed to do, in terms of finding the other side of your trade. As I mentioned before, the access to management. So, if the portfolio manager or the analyst knows he has to pay a certain firm, because he does want to see this company, and he does want access to them, it's a quid pro quo. You have to act like you like the analyst, but they may indeed use it. So I think it's a tool, now, more than a necessity, these sell-side analysts, because they are compromised. And again, not all of them, but many of them are. And so I think, as an analyst, on the buy side, you're doing yourself a disservice if you don't do your own work first, and then go, I think, to the street to see.

So there are still some great ideas generated out of the sell-side, there's some great analysts that're out there, and I can really only speak for our sector, financial services, that will throw you good ideas. Now, people, though, need immediate gratification. If the idea doesn't work, within an hour, a day, or so forth, that's where we've gone. It's about immediate returns and they'll say, "Oh, you were wrong." No, the thesis may be playing out over a period of three to four quarters and you're judging that call over a period. So you can actually weed out the good buy-side analysts and the good sell-side analysts, at the same time, through the same process. The ones that are willing, the ones that understand the dynamics. So the ones that don't, on either side, won't be around forever. The ones that I like to call the athletes, will always survive the roaches of this business. So when we do have washout on the market at some point, whether we do or not, I don't know, but when we do the survivors will be those people. The people that truly understand fundamentals. So I think the value is really hit or miss, at various firms.

What's also happened, I just want to add this, this is certainly in the hedge fund land, is hedge funds have become much more dependent on their brokers to raise them capital, to lend them money for shorts. And that whole business, prime brokerage business, has been now consolidated to two or three firms. So you got Morgan Stanley, Goldman Sachs, JP Morgan, but Deutsche Bank's been slowing down and backing out, Credit Suisse and so on. So you're a prisoner to those firms, also, so if you need to pay those firms X amount, you're going to use their resources more. So things are pyramiding a little bit towards the top, as far as buy-side accessing sell-side at the same time. That being said, you always have these spin-outs and these smaller, unique broker-dealers that can provide in various sectors.

Sector Selection

Patrick: [00:43:19] I'm always fascinated by which parts of the market, hedge funds, or long-short managers in general, tend to traffic in, you mentioned financial services, so I want to dive in there, but why there are certain spots that might be more conducive to finding alpha or gaining an edge? So what was it about financial services that you found attractive, interesting? Why was it fertile soil for an active strategy?

Danny: [00:43:42] Very good question. Like I mentioned before, the specialty finance group, so the non-deposit funded banks, so to speak, that don't have access to our deposits to go. And as we saw with the whale trade that got in trouble, JP Morgan, right? You're using customer deposits to go, you're not allowed to do that. So companies that have a unique strategy, within a certain sector, again, whether it's going to be auto or mortgage or mortgage insurance, or whatever, someone that doesn't have access to an endless amount of capital is dependent on the securitization markets to get funding. So for us, it becomes what is the rate you're willing to accept in that securitization market? That's your cost of funds basically, and then how are you running your business? How are you underwriting your business? So, in the most time, we're talking about it, it's something in the lending space, where you and I are talking about. And if you can find out the trends, or the way that they're running their business, you can easily see what's going to happen down the road. If they're growing too quickly, they're going to be in trouble. If they don't have enough in reserves, on their balance sheet and we still see this all the time, of course, the stocks don't go down, but we see stuff coming, down the pipe. It's just a question of timing. The big banks, for the most part, it's a rate trade. They're all grouped together. There's not a lot of differentiation between the companies, the drivers for the companies, right? It's the fed funds rate, it's the rate, it's the loan growth, for the most part. There's nothing unique, per se. Now, you can operate the best in credit card if you're JP Morgan, you can operate the best in your C&I book, if you're JP Morgan. You can be the best at what you do, but your alpha may be ... it's very small, in our opinion.

And our whole idea at Seawolf, was don't raise too much money, so cap yourself at $500 million in assets so that you can go play in small and mid-cap names and really, no need to trade the Bank of Americas and the JP Morgans, except at the inflection points, oversold, overbought, and so forth. And really find the best management that we think runs a particular company, the best industry, with the best growth. It could be in student loans. We could have a long and a short in the student loan group. You could have a long and a short in mortgage insurance. You could have two longs, two shorts, we never looked at it that way. We didn't need a long to have a short, we were just looking at it on an absolute basis and it just kind of works out. And Porter Collins, my former partner, always had the best example. He goes, "Why would I trade a JP Morgan, when I can create six companies, three longs, three shorts, that do exactly what these guys do?" So find the best and the worst in each of the six sectors that JP Morgan plays in, and go after those six companies. And to us, that was our strategy and unfortunately, our returns have been fine, nothing spectacular, is that fundamentals, again, haven't mattered. Or it's just taking longer than you would've thought. And our investors' timeline may be different than ours, so I think what you're seeing now, and the hedge funds that are staying around are going to survive, have to accept lower fees, but what they should do is get longer duration capital.

So if you go from 2 and 20 to 1.5 and 15 to 1 and 10, as that's coming down, I think the only logical thing is to ask for a larger lockup, so that you have much longer time frame for these things to play out and that's what's also been going on in the market. As these baskets evolve, which we didn't talk about, which are the same as ETFs, but Goldman Sachs has all these baskets. "What basket is your stock in?" Not what the earnings were, what basket is it in? So, long-winded answer to your question, but at the same time, we want to find companies that, if they succeed, the stocks can triple, and if they don't, they're out of business. It's zero-sum in that world.

Patrick: [00:47:10] We've talked about, obviously, the autos and subprime. Thinking back, though, on your out of the box, don't take anything for granted, don't trust anything, do your own work. What was the first for you personally, whether it's a stock or trade or an idea, that pops to memory as something where you were applying that filter, or that way of looking at the world, where you found something and thought, "Wow, the market's got it wrong".

Danny: [00:47:33] I would say it was the JDS Uniphase, that I mentioned before, SDLI merger. It was the merger back, I don't even remember the year it was, I'm going to say it was 1999, maybe 2000, somewhere in there. And I remember that having done the bottom-up work on both companies, that both things had started to turn down and both companies had started to turn down. And they merged with each other and the stocks both went up at the time and I remember thinking, "This isn't right. This math can't work." There aren't enough cost cuts, so to speak, at the time, so that was one of them. But what really changed the way I looked at investments was a book, The Rise and Fall of Long-Term Capital, When Genius Failed, Roger Lowenstein, which is the best book. It doesn't matter that it was about rubles and currency crisis, it mattered that it was the egos of the people, the willingness of the sell-side to trade for free because it was an honor to cover these guys. I was in Long Term Capital's office, my uncle got me an interview in there, in 1996, I want to say, and it was over in Greenwich. And there was a room, they go, "Danny, do you know delta?" I go, "Sure, I know delta." "Do you know gamma?" And I go, "Yeah." He goes, "Do you know theta?" And I go, "Sure, decay." He goes, "How about vega?" It was something like that. I go, "What do you mean vega?" Then they take me in this room, and there's a war room. Meanwhile, Scholes is walking down in one row, I'm like, "Hold on a second, this is..."

So prior to the book coming out and the crisis, I actually got to meet the people and brilliant minds, obviously, and very good people. But that book changed the way, forever, that I or the incident and looking back, changed the way that I approach anything. It's that no trade is as good as it appears. Leverage will always bury you in the end if you have the wrong trade on. Egos always tend to get in the way of a very good story and eventually, those things always unwind. So there's a cycle of life, doesn't matter, again, what product you're trading. So it really changed the way that I viewed the world of investments. And again, leverage is the root of every demise. It is. It can work for you, for a long period of time, but when it works against you and there's a margin call like happened to Long Term Capital, it's over. And their portfolios are taken on the other side and those brokers willl turn on you in a second when they realize that they're now at risk. So I think understanding that the no trade's ever as good as it appears, that all good things must come to an end, to a degree, but it was more about, I think, the egos.

Again, so it doesn't matter that it's Russian ruble, it could be internet stocks, it could be subprime mortgages, it could be whatever. And the other thing is that, one of the things I really look for is how do people get paid? So if I'm looking at a company that has a sales force out there, that gets paid on commission, so forth, or gets paid by duping customers at the cash register to buy a warranty on a product, right? Those things aren't sustainable over a long period of time. These aren't real numbers, real earnings, they're more ill-gotten gains, so to speak, that aren't sustainable. So just to dive into one other sector, which I think is really interesting, is that one of the sectors which within specialty finance, although they hide in retail, is looking at retail companies that have a finance arm, that are really driven by their finance division.

Think about a Harley-Davidson, which it's not so much the motorcycle, it is how are they getting people into their motorcycle? Conns was an interesting name, C-O-N-N, which has had their issues. They were selling plasma televisions, mattresses, and so forth, and they were charging customers to finance these mattresses. Well, when you take a car off a lot, it's worth half. Take a mattress off a lot, it's down 99%, it's worth 0. But they were making the money on the finance. So if you took apart the earnings and the balance sheet and the drivers, it was late fees, it was finance charges, it wasn't the mattresses and the TVs. And those same TVs and mattresses were being sold much less at the counter but these were subprime people that were coming in and being taken advantage of. It wasn't that Conn was doing anything against the law at the time, they were within usury laws and so forth. It was more of it's not sustainable, because the credit. So finding things like that, ideas like that, when you see that. Harley-Davidson was a great example, I think it was in the book, where we found a motorcycle company that was just a finance company. And they had so much credit, they had credit issues on their balance sheet. So it can be any, but I go back to, again, it always turn out to be the same thing.o

Bottom-Up Evaluation Metrics

Patrick: [00:51:54] You mentioned value a few times, P/E ratios, I think it's very relevant, and at the market level, or by any measure, it's expensive. How did you think about valuation as part of the bottom-up framework? At what stage did you consider it? How much did it matter in your evaluation?

Danny: [00:52:08] Yeah, it matters. It matters, to your point, you and I talked earlier about something you guys do, which would be the growth and earnings and how do you apply a metric to that, how important is that. Starting, bottom-up evaluation, cashflow is always the most important thing. It doesn't matter. You can adjust earnings, to a certain level, you can have debt and not count that in your GAAP earnings and so forth, but cashflow's the most important component that we would look for, or that I would look for in a company. If you're producing cash, maybe you're paying a dividend and maybe you're not, but it's always a sign of health, so that's one thing we would certainly look at.

As far as other bottom-up metrics we would judge, it's tough to say that you can convince anyone to move a P/E multiple from 9 to 12, or 10 to 15, because as we discussed, it's arbitrary, right? Do you see something or do you think the market is underappreciating an asset or a product this company has? And, if so, even if they showcase it, will the market care? And that's why people pay 1.5 and 15, or 2 and 20 to find those types of companies. And then there's the next level, which we never do, which is activist investing.

I think there is a great place for activist investing when it's done correctly. But we've seen what can happen when it's not, and it's done out of greed and leverage. But sometimes, you need the activists. They're the ones that come in, find a company that is trading at an 8 P/E, see a lot of expenses that could be cut, but more so, just change the complexion of the company. So you'll see companies that were the same on Thursday as they were on Friday, but an activist got involved and the P/E went from 9 to 13. So to try to find something where you believe an activist will come along and maybe it'll be you that ends up doing it. Or you can sit on something ... I guess I would answer it this way. You're willing to sit on a stock for a long period of time if you're confident that the business plan is good, the management is good, and they know what they're doing, and there's an exit strategy down the road. Whether it's a special dividend that causes a stock to move higher, but you can't ignore it for a long period of time. That's why I mentioned cashflow being the most important component. You're going to do something with your cash. You can either buy back stock, you can issue a special dividend, you're going to make an accretive acquisition. So I think another long-winded answer to your question, I think starting with the balance sheet is the best approach. How healthy is it? And what is this company involved in? And then go from there. So work your way up off the balance sheet, out to what the company actually does, and then try to figure out what the long-term value is of the company.

Patrick: [00:54:36] As someone that tries to model valuation, just with data, without diving into individual companies, trying to come up with ways of comparing balance sheets, cashflow statements, net income, aggressively accounted for earnings, things of that nature is always very helpful to hear the fundamental perspective, because that always then informs the quant research, if you will. There's a lot of different kinds of quant research, there's the hyper-aggressive informational edge, with really short half-life signals. There's the much longer duration strategies, things like valuation, I would argue, will probably work, in some way, shape, or form forever, because I think there's a behavioral undercurrent to it. But it's helpful to hear the fundamental perspective because that informs the quant.

Danny: [00:55:17] One thing is that this use of non-GAAP is really nuts. Over two-thirds, at least, of S&P 500 companies report non-GAAP. Sometimes, it's valid, but most times, it's not. A lot of technology companies exclude stock-based compensation out of it. I don't understand how you can do that, it's a part of doing business and so forth. A lot of the in mergers and acquisitions, you extract out merger costs related to the greatest, rosy scenario of all time, only to add them back, later in time, over a period of time. And that's where you got to be really careful, in terms of your models, which I'm sure you guys do and looking at what is the real earnings growth.

I don't know the numbers, not in front of me, but the non-GAAP earnings of the S&P versus the GAAP earnings. The S&P is trading well above 20 on a P/E basis, on a GAAP basis. So we have forgotten. And once you're on the non-GAAP train, as a company, you have to stay on the non-GAAP train. And again, last year, the SEC was sending out letters, a couple of the larger companies have gone and I think Amazon has now moved to GAAP, or they're starting to move to GAAP. And so people are starting to move there, but that's going to be a rude awakening for people, when they go from a $12, non-GAAP, even though it's the same company and same earnings, to an $8 GAAP number, and then have to reassess the valuation. Nothing changed, other than the way you reported it, but the complexion changes. So identifying that. When does that trend stop? I don't know.

Patrick: [00:56:36] Yeah, one of the best examples of your idea, of just don't take any reported number or idea or word, take nothing at face value. That you have to dive deeper to understand what's really driving the business. It's amazing, how markets can just all be dancing to the same tune, the same number, even though the underlying truth is very different.

Danny: [00:56:55] And I think the current market, and it's so ETF driven, and quant driven, and so many different strategies, it's money flows, right? It's just about supply and demand and there's still money that's chasing the market. So there's nothing you can really do about it right now and I think each time we get a slight pullback, or there's a macro event that happens, geopolitical, whatever. And it's reinforcing I think, this false sense of non-fundamental stock market valuation. Because the money flows, just to touch on this for a second which I think is an important point, active can't beat passive if flows are going out of active into the benchmark the active is against. It's math. If I have a billion-dollar fund that is tracking a mid-cap growth ETF and the mid-cap growth ETF is attracting money at a billion dollars a month, at a clip. And that's my index, and I need to see the structure of that ETF before I even looked at bottom-up stock picking, because by definition, if money's flowing out of mine, into this, I lose. There is no way to outperform that unless you take cataclysmic chances and have a 12% stock position, which you're not really allowed to do in a mutual fund, so it's just reinforcing this false flow. Again, not O’Shaughnessy, not quant, you guys are perfect. But my point is that it's just reinforcing this and, at some point, it's got to go. You have ETF providers now closing ETFs because they can no longer put money to work. And then, to your point, there's ETFs on ETFs. It's insane. It's not going to end well.

Ira Judelson

Patrick: [00:58:18] Yeah, the relentless bids are crazy. So when we talked last, you told me a great story, I'd love for you to repeat it. About your friend Ira and the dinner you were at, during the financial crisis, I think.

Danny: [00:58:31] So one of my best friends is bail bondsman to the stars, Ira Judelson. And he's done everything from Plaxico Burress to Lil' Kim to any mobster family you can think of, in the New York area. It's a real treat to go to Rao's with him because you literally get lifted on a chair when you walk in. So during the crisis, so I think it was in 2008, I have to check the date, but Dominique Strauss-Kahn, who was the head of the International Monetary Fund, the IMF. Who was very central at the time to try to figure out what was going on worldwide, not just for the US financial crisis, globally, was arrested, as everyone knows, in Midtown. Actually, taken off a plane, after he had tried to leave after he had committed or supposedly committed a crime in a hotel.

Well, that night, I'm out with Ira and his wife, Blake, and my wife, Allison. The four of us are having dinner, and Ira gets a text on his phone and he looks at me, he goes, "I got to go to the city." And I go, "Why?" He goes, "The head of the AMF just got arrested." And I said, "The bowling league? There's a president of a bowling league? I don't understand, Ira." He goes, "I don't know, some guy, Kahn." And I say, "Dominique Strauss-Kahn?" He goes, "Yeah, some French, some guy, I got to go." I'm like, "Dude, I'm coming with you." I go, "Dominique Strauss-Kahn just got arrested in New York City and he's the head of the IMF and the global financial crisis is ongoing and what's going on?" So, I got a great look into his world. I stayed in the car. But this goes on for hours and hours. He ended up getting the judge to get him an ankle bracelet, allow him to be down in the Village somewhere, he had an apartment, and Ira doesn't judge the guilt or innocence of these people, he just follows the process. And so his clients are the criminal defense attorneys who rely on Ira to get their clients out as quickly as possible, and a lot of time Ira finds out about an arrest weeks ahead of when it's going to happen, "A racketeering charge is coming. Get ready, don't be out of town on April 4th."

So he and I world could not be any more different, but at the same time, during the time period I had off, between FrontPoint and Seawolf, in 2011, we created something called Bail Street, which trademarked and so forth. And we did one video, it was a 30 minute long, about my world and his world and often they do end up colliding. Now, many of the Wall Street crimes are federal and he's a bail bondsman on the state level. Does any state but it's all state crime. So it wouldn't be a hedge fund guy that's insider trading. It'll be a hedge fund guy that's in the Hamptons, he gets arrested for assault. That would be an overlap, potentially, if that hedge fund person turned out to be someone that was market moving. So there would be some overlaps like that. Or you could be a mobster that was involved in penny stock wringing. Again, doesn't affect my world, really, but it does affect the world of stock investing. So there's many times, but there's characters. What's funny is his characters and our characters are all just characters, right? So we've talked about doing something together, doing a podcast or a show called Bail Street. He had a book written about him, called The Fixer.

Patrick: [01:01:24] Well known book.

Danny: [01:01:25] Yeah, so it was interesting. So again, it's nice to have a friend that's not in my same walk of life.

Patrick: [01:01:31] So how does one become a hyper-successful bail bondsman? What is the skillset?

Danny: [01:01:36] Talking about work and hard.

Patrick: [01:01:37] It's a basic business. The math is pretty straightforward of what the service provided, so-

Danny: [01:01:43] Just like the book says, he's the fixer. So if a criminal attorney stakes his reputation on taking care of his clients, or group of clients, or gets a reputation for being able to get you out on bail quickly, processed quickly, through the system. So Ira knows the system well, he knows every clerk at every court, he knows which judge is friendly, which one isn't going into it. So the criminal attorney may call, "Hey Ira, I need you." Ira says, "Where's the guy? What court is it going to be in?" So forth, so he has all the information ahead of time. So Ira, before he even meets the client, is already doing all the backend work, calls the clerk, "I need to get this guy out." I don't know how, I'm not going to say how he does it. Maybe the guy's sitting in the front row of the Knicks game, the clerk, I'm not sure exactly, won't go there. But he has network of people and so people know that Ira will never drop the ball, that'll get him out. So again, if you're a criminal defense attorney, your first call is Ira. And not only that, Ira does things outside of that. So he'll work with you if you can't come up with the bail, right?

He'll go, "All right, do you have an aunt that has a house? Do you have something where I can get some type of collateral?" Or sometimes, he takes it in good faith, but he's an insurance provider, right? So he has an insurance company behind him that has to sign off on the bails itself. So there is a regulatory process within your world. And I won't mention names, but I had mentioned that there was a hedge fund person out there that was trying to help a friend that called on Ira. Got his name, and said, "Ira, I need your help." Ira helped him out, bail went on for six months, the case was actually dropped, ended up being dropped, and the money that was owed was like $7,200, that Ira was owed, in interest. And the hedge fund manager said, "No, it's $7,054," and Ira had to go back and say, "No, there's two days that have accrued that you didn't ... it'll be the first and the last." And so he tells me these stories about certain people like that, in our industry, and again, I'm not going to say who it is. But there are certain people who, you're like, "Really?" The guy's worth, obviously, uber, uber money. And so it's funny stuff.

Patrick: [01:03:42] It's a colorful world.

Danny: [01:03:43] Colorful. He'll call me every once in a while, "Hey, do you know so and so?" I'm like, "Yeah." He goes, "Okay, well their son's about to get arrested." And I'll never share that information or something like that, but I'm like, "Wow, that's going to be a scandal."

What's Next for Danny

Patrick: [01:03:54] It reminds me, I was reading Agassi's autobiography recently and there's a little scene in there about how Sampras is leaving a restaurant ahead of him or something like this. And they're semi-friends, like frenemies, or something, and he goes to the guy, the valet guy, and asks, "How much did Sampras tip you?" And it was like a dollar, or something crazy, like, "What the hell? Come on." So what's next for you? You mentioned this fun idea of Bail Street. What has your interest right now? Where do you think you'll go from here?

Danny: [01:04:24] Yeah, I've a couple products that I've actually patented and working on. They aren't blackjack games, they're something else. There's potentially doing some type of podcast or something in the entertainment world. There's a reality show that I really want to get started and I talked to Michael Lewis about it and it's an interesting idea, has to do with former insider traders or white-collar criminals, putting them with blue-collar criminals, so to speak, and seeing how those worlds mix. Something like that.

Some of these private equity investments, I'm helping the companies either try to raise capital or stay in touch and, really, I got to tell you, 20 years on Wall Street, with a two month break in between, the entire time, took a toll on me, physically, psychologically. I'm literally spending ... I've been out of it now, for almost two months, and so I'm just getting back into shape and spending time with the family and so forth. So right now, I'm just taking it easy, but I always have something going on.

Patrick: [01:05:19] I'm curious what you think about ... talked a bit about sports broadcasting too, something that you're interested. Maybe you could touch on that for a second, but it sounds like you're interested in media, generally speaking. So what's the root of that interest?

Danny: [01:05:30] So I grew up in the south, and my dad had an accent. He was from southern Georgia, you wouldn't believe the accent. My mom's from Greenville, South Carolina and so I always thought that I'd end up with this southern accent, which would be fine. Except for the fact that from a very early age, listening to University Georgia football games, there was a broadcaster, Larry Munson, who was always my idol. He has some famous calls against Florida, obviously, who I hated growing up, I hated the Gators growing up. And I would always find myself imitating him, or some other sports broadcaster, or doing my own show. So I'd watch games and I would basically sit there and I would do my own play by play. And so when I got to Emory, I went to Emory, I got an internship at CNN and I worked in sports, and it was when Fred Hickman and Nick Charles were the rage. This was before ESPN really took off, but also the sports show was 11:30 at night, every night. So I was a senior at Emory and then I was interning and I really felt that this was going to be my calling. That I was making tapes and I've made some sports tapes before, on-air, that never got released to the public, but on-air.

And then when it came down to it, getting out of Emory in May of '91, all my friends were moving to New York City and everyone was coming back and going to get Wall Street jobs or whatever, going to law school somewhere. And I went into CNN and I could have stayed as a production assistant, I probably done that. But I was given advice to go to the Midwest and go cover a high school football, be a local sports anchor. And at that point, I decided, I chose that maybe I'll come back to this later in life, but I wanted to go be with my friends in New York City and live that life, versus doing that. So I made that choice at the time, it's always been a passion of mine to not necessarily be on-air, but doing something in media because I think it's fun, you meet great people, and so forth. So, it's still something I may want to go back to, in time, whether it's a version of this, or a talk show, or something, but I don't know. It's being around people and living life to its fullest. It has something about it, that when you can touch other people's lives and have an impact on it. And if it's entertaining at the same time, like sports is, and was, for me, at the time, even better, your passion. But it was really a passion thing for me, back then, and then I moved to Wall Street and that was also a passion, and it quickly became more of a passion, but you can always go back to that.

Patrick: [01:07:44] The last question I always ask everyone is the kindest thing that anyone's ever done for you?

Danny: [01:07:49] Okay, in life or in business?

Patrick: [01:07:51] You can interpret it however you want, or both.

Danny: [01:07:53] Wow, that's a tough one. You got me. We went from Bulldog football and Long Term Capital to the kindest thing. I've been given big breaks, and so anyone that says, wherever they are in life, that they weren't given an opportunity, I think it's what you do with the opportunity. I would say I was lucky to have the parents that I had, but secondly, there was a particular person, John Race , in my life. He runs a fund, DRZ, DePrince, Race & Zollo, down in Florida. He was the guy I looked up to, a good friend of my father's, a little bit younger than him, and he got me my job at Friedman, Billings, and Ramsey, at the time. Basically made a phone call for me and it was really out of kindness, because he knew I was a good sales guy and so forth, so that turned out to be the biggest break of my life. And he's always been that kind of guy for me, that's the guy I look up to, my mentor in this business, so I would say that was one of them

I'm trying to think what else. My wife does kind stuff for me all the time, I would have to mention that, or I'd be in deep trouble, but you got me on that one. Many people have been great to me. And again, I would go back to, people can open the doors for you, and it's what you do with it once you get it. And I'll be the first to say, my aunt got me my first job, but she didn't get me the promotion, she didn't get me ... So there's always been people that've opened doors for me, but I think people should never take that for granted and then always do the most with the opportunities that they get.

I broke my leg in 1984 and Miss Sweden, who had just won the Universe pageant, signed my cast, that was probably one of the kindest things anyone's ever done for me.

Patrick: [01:09:23] That's a good one.

Danny: [01:09:24] So there's many great people in my life.

Patrick: [01:09:27] Awesome. Well, I like to end on a Swedish Miss Universe, that's a good wrap.

Danny: [01:09:30] Yes, exactly. Yvonne Ryding was her name.

Patrick: [01:09:32] This has been a blast, thank you. Thanks for your time. Hopefully we can do it again.

Danny: [01:09:35] Thanks, Patrick. Enjoyed being here.

Created by @_Nick_Diller