Bethany McLean — Enron, FTX, 2008, Musk, frauds, & visionaries

This was one of my favorite episodes ever. Bethany McLean was the first reporter to question Enron’s earnings, and she has written some of the best finance books out there. We discuss: * The astounding similarities between Enron & FTX, * How visionaries are just frauds who succeed (and which category describes Elon Musk), * What caused 2008, and whether we are headed for a new crisis, * Why there’s too many venture capitalists and not enough short sellers, * And why history keeps repeating itself. McLean is a contributing editor at Vanity Fair (see her articles here https://www.vanityfair.com/contributor/bethany-mclean) and the author of The Smartest Guys in the Room https://www.amazon.com/Smartest-Guys-Room-Amazing-Scandalous/dp/1591840538, All the Devils Are Here https://www.amazon.com/All-Devils-Are-Here-Financial/dp/159184438X, Saudi America https://www.amazon.com/Saudi-America-Truth-Fracking-Changing/dp/0999745441, and Shaky Ground https://www.amazon.com/Shaky-Ground-Strange-Mortgage-Giants/dp/0990976300. Watch on YouTube https://youtu.be/m3oM69YHLeo. Listen on Spotify https://open.spotify.com/episode/79idBisQbkXEXD1Al355M2?si=GSNC1WiJTNGrhY19fO2CyQ, Apple Podcasts https://podcasts.apple.com/us/podcast/bethany-mclean-enron-ftx-2008-musk-frauds-visionaries/id1516093381?i=1000590865940, or your favorite podcast platform. Follow McLean on Twitter https://twitter.com/bethanymac12. Follow me on Twitter https://twitter.com/dwarkesh_sp for updates on future episodes. Timestamps (0:04:37) - Is Fraud Over? (0:11:22) - Shortage of Shortsellers (0:19:03) - Elon Musk - Fraud or Visionary? (0:23:00) - Intelligence, Fake Deals, & Culture (0:33:40) - Rewarding Leaders for Long Term Thinking (0:37:00) - FTX Mafia? (0:40:17) - Is Finance Too Big? (0:44:09) - 2008 Collapse, Fannie & Freddie (0:49:25) - The Big Picture (1:00:12) - Frackers Vindicated? (1:03:40) - Rating Agencies (1:07:05) - Lawyers Getting Rich Off Fraud (1:15:09) - Are Some People Fundamentally Deceptive? (1:19:25) - Advice for Big Picture Thinkers This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit www.dwarkesh.com https://www.dwarkesh.com?utm_medium=podcast&utm_campaign=CTA_1

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Speaker 00

  This line between a visionary and a fraudster, you know, you think that there are two opposite ends of the spectrum. But in reality, they're where the ends of the circle meet. But somebody has the ability to put a vision forward like Jeff Skilling did at Enron, like Elizabeth Holmes did at Theranos, like SBF did. Then you're particularly susceptible. Self-delusion is such a strong component of all of these stories of business gone wrong. The line between what happened at Enron and what happened in the global financial crisis, it's not a matter of black and white. Well, do you believe in the associate market hypothesis?

• 0:33Dwarkesh Patel?

  The rapid implosion of a company worth tens of billions of dollars, insider dealing and romantic entanglements between sister companies, a politically generous CEO who is well-connected in Washington, the use of a company's own stock as its collateral, the attempt, the short-lived attempt to get bought out by a previous competitor, and the fraudulent abuse of mark-to-market accounting. We are not talking about FTX. We are talking about Enron, which my guest today, Bethany McLean, first broke the story of and has written an amazing and detailed book about called The Smartest Guys in the Room. And she has also written a book about the housing crisis, All the Devils Are Here,

• 1:18Dwarkesh Patel?

  a book about Fannie and Freddie, Shaky Ground, and a book about fracking Saudi America, all of which we'll get into. She is, in my opinion, the best finance nonfiction writer out there. And I'm really, really excited to have this conversation now. So Bethany, thank you so much for coming on the podcast.

• 1:33Speaker 00

  Thank you so much for the probably undeserved. Thank you for having me on the show.

• 1:40Dwarkesh Patel?

  My first question, what are the odds that SBF read The Smartest Guys in the Room and just followed it as a playbook, given the similarities there?

• 1:48Speaker 00

  You know, I love that idea. I have to, I have to admit, I guess I love that idea. I don't know, that would make me responsible for what happened. So maybe I don't work that idea. Let me take that back. Anyway, but I actually think that even if he had read the book, it would never have occurred to him that there was a similarity because self-delusion is such a strong component of all of these stories of business gone wrong. It's very rare that you have one of the characters at the heart of this who actually understands what they're doing and understands that they're moving over into the dark side and thinks about the potential repercussions of this and chooses this path anyway. That's usually not the way these stories go.

• 2:32Speaker 00

  So it's entirely possible that SBF studied Enron, knew all about it, and never envisioned that there were any similarities between that and what he was doing.

• 2:41Dwarkesh Patel?

  Oh, that's fascinating. Which I guess raises the question of what are we doing when we're documenting and trying to learn from books like yours? If somebody who is about to commit the same exact kind of thing can read that book and not realize that he's doing the same exact thing, is there something that just prevents us from learning the lessons of history that we can never just get the analogy right and we're just guided by our own delusions?

• 3:06Speaker 00

  Wasn't there the great quote that history rhymes but it doesn't repeat? I'm wondering on who it is who said that, but I think that's absolutely true. I think it's important for all of us, those of us who are not going to find ourselves at the center of a giant fraud, or so I hope. I think my time for that has passed, maybe not you, but I think it's important for all of us to understand what went wrong. And I do think these, I do think just there's a great value and greater understanding of the world without necessarily a practical payoff for it. So I think when something goes wrong on a massive societal level, it's really important to try to explain it.

• 3:45Speaker 00

  Human beings have needed narrative since the dawn of time, and we need narrative all the more now. We need to make sense of the world. So I like to believe that that process of making, trying to make sense of the world has a value in and of itself. Maybe there is some small deterrence aspect to it in that I often think that if people understand more the process by which things go wrong, that it isn't deliberate, that it's not bad people setting out to do bad things, it's human beings at first convincing themselves even that they're doing the right thing and then ending up in a situation that they never meant to be in.

• 4:26Speaker 00

  And maybe on the margin, that does, maybe on the margin, that does help because maybe it has deterred some people who would have started down that path but for the fact that they now see that that's the usual.

• 4:41Dwarkesh Patel?

  Yeah, yeah, that actually raises the next question I wanted to ask you. Bert Hohbert, he's a finance writer as well. He wrote a blog post about, I mean, this was before FTX, obviously. And he was talking about Enron and he said, "In the end, it actually looks like we fixed the precise problem Enron represented. Nobody I know solely looks at GAAP financials. Everybody ultimately models based on free cash flow. We're much more averse to companies that set up a deliberate conflict of interest between management and shareholders." And I guess there's a way in which you can read that and say, oh, doesn't FTX prove them wrong? But you know, there's another way you can look at it is that FTX deliberately set up outside the US. So there's a story to be told that actually we learned the lessons of Enron. And you know, Sarbanes-Oxley worked. That's why, you know, they were in the Bahamas.

• 5:26Dwarkesh Patel?

  And we haven't seen that scale of fraud of that scale in, you know, the continental United States. Do you think that the FTX saga and I guess the absence of other frauds of that scale in America shows that the regulations and the changed business and investment practices in the aftermath of Enron have actually worked?

• 5:45Speaker 00

  Well, I think they probably worked narrowly, Rick, in the way in which the writer you quoted articulated. I think it would be very hard for the CFO of a publicly traded company who set up other private equity firms that he ran that did all their business with his company because everybody would say that's Enron. And it would be completely on the nose. And so in Sarbanes-Oxley, in the sense of, in the sense of helping to rein in corporate fraud of the sort that was practiced by Enron, which was this abuse of very specific accounting rules. I think, I think that worked. But you know, you say there hasn't been fraud on a scale like Enron up until perhaps FTX,

• 6:28Speaker 00

  but you're forgetting the global financial crisis. And in the end, the line between what happened at Enron and what happened in the global financial crisis, it's not a matter of black and white. It's not a matter of one thing was clear cut fraud and one thing, great, we love these practices. Isn't this fantastic? This is the way we want business to operate. They're both somewhere in the murky middle. You know, a lot of what happened at Enron wasn't actually outright fraud. I've coined this phrase, legal fraud, to describe. To describe what it is that that that that happened at Enron and a lot of what happened in the global financial crisis was legal, hence the lack of prosecutions. But it's also not behavior that that leads to a healthy market or for that matter, a healthy society.

• 7:13Speaker 00

  And so there's a reason that you had Sarbanes-Oxley and what was it, eight short years later, you had Dodd-Frank?

• 7:19Dwarkesh Patel?

  Yeah.

• 7:20Speaker 00

  And so, writ broadly, I'm not sure Sarbanes-Oxley did that much good. And what I mean by that is when President George Bush signed it into law in the Rose Garden, he gave this speech about how investors were now protected and everything was great. And your ordinary investors could take comfort that the laws were meant to protect them from wrongdoing. And you compare that to the speech that President Barack Obama gave eight years later when he signed Dodd-Frank into law in the Rose Garden, and it's remarkably similar, that now ordinary investors can count on the rules and regulations keeping themselves from people who are preying on their financial well-being. And I don't think it was, it's it's true in either case, because our markets, particularly

• 8:04Speaker 00

  modern markets, move and evolve so quickly that the thing that's coming out of L'Asile to get you is never going to be the thing you are protecting against.

• 8:12Dwarkesh Patel?

  Mm-hmm. But given the fact that Enron, as you say, was committing legal fraud, is it possible that the government, when they prosecuted Skilling and Faustow and Lay, they in fact were not, they prosecuted them to a greater extent than the law as written at the time would have warranted? In other words, was there something legally invalid in the quantity of sentence that they got? Is that possible?

• 8:38Speaker 00

  It's, it's, I get what you're asking. I think it's a really tricky question, because I think in salute terms, Enron needed to be prosecuted and needed to be prosecuted aggressively. And while I say it was legal fraud, that is, for the most part, there was actually real fraud around, around, but it's on the margin. It doesn't entirely, it doesn't explain the entirety of Enron's collapse. Much of what they did was using and abusing the accounting rules in order to create an appearance of economic reality that had nothing to do with actual, with actual reality. But then there was actual fraud, in the sense that Andy Faustow was stealing money from these partnerships to benefit himself, and they were

• 9:22Speaker 00

  If you believe the core tenet of the prosecution, which was this agreement called Global Galactic that was signed by, that was between Andy Zastow and Jeff Skilling, where Jeff agreed that Andy's partnerships would never lose money, then that invalidated all of the accounting. And that's the chief reason that Skilling was convicted, was that the jury believed the existence of this agreement, that one set of insider stock sales, which we can talk about, which was also a really key moment. Relative to the, so in absolute terms, I don't know, it's hard for me to say, there was such, Enron was such, to a degree that is still surprising to me, such a watershed

• 10:05Speaker 00

  moment in our country, far beyond business itself. But it caused so much insecurity that about our retirements, our retirement asset safe, can you trust the company where you work? But I think the government did have to prosecute aggressively. But relative to the financial crisis, where a lot of people made off with a lot of money and never had to give any of it back, doesn't seem fair that Jeff Skilling went to jail for over a decade and no one involved in a major way in the financial crisis paid any price whatsoever. People didn't even really have to give up that much of the money they made, then it seems a little bit unfair, yes. So I think it's an absolute versus a relative question.

• 10:49Dwarkesh Patel?

  Yeah, yeah. By the way, who do you think made more money? The investment banks like Goldman Sachs and Morgan Stanley, from doing, providing their services to Enron as the stock was going up? Or Jim Chanos from shorting the stock? In absolute terms, who made more money?

• 11:06Speaker 00

  Oh, I think the investment banks, for sure. I mean, they made so much money in investment banking fees from Enron. But you know, it's a good question. It's a good question, actually, because I think Jim made a lot of money too, so.

• 11:22Dwarkesh Patel?

  Yeah, yeah. I mean, you've spoken about, I guess, the usefulness and the shortage of short sellers as a sort of corrective on irrational exuberance. And I'm curious why you think that shortage exists in the first place. Like, if you believe in the efficient market hypothesis, you should think that, you know, if some company has terrible financials and implausible numbers, then people would be lining up to short it, and then you would never have a phenomenon like Enron. And so it's, you know, it's so odd that you can have, you know, reporters who are basically ahead of the market in terms of predicting what's going to happen. How do you score that with like the efficient market hypothesis?

• 12:00Speaker 00

  Well, do you believe in the efficient market hypothesis?

• 12:03Dwarkesh Patel?

  I'd like to, but I'm like trying to wrap my head around Enron.

• 12:07Speaker 00

  I'm not sure how you can unless you, unless you adopt Warren Buffett's point of view, and I'm going to mangle the quote because, but it's that the market in the short term is a voting machine, and in the long term, it's a weighing machine, right? The other way around. Anyway, the idea is that the market may be very efficient for a long, very inefficient for a long period of time, but, but it does actually, rationality does actually work in the end. And I think I might believe that. But isn't John Maynard Keynes, who said the market can remain irrational for a lot longer than you can remain solvent? And so I think that's true, too. I think believing that the market is efficient and rational in the short term is just obviously wrong.

• 12:51Speaker 00

  But back to your question about short sellers, which is, which is interesting. I think part of it is that there is still this, there certainly was a couple of decades ago, and I think it still exists, this idea that owning stocks is mom, American, and apple pie, and short stock somehow is bad and evil and rooting against America.

• 13:13Speaker 00

  And I remember going back to the Enron days, someone, people criticizing me, even other people in the press saying, but you took a tip from a short seller, they're biased. And I, I would say, but, but, but wait, the analysts who have buy ratings on stocks and the portfolio managers who own those stocks are biased too. They want stocks to go up. Everybody's biased. So the trick as a journalist is getting information from all sides and figuring out who you think is right and what makes sense. But it's not avoiding anybody with any bias. But it was really interesting that people saw the bias on the part of short sellers and did not see it on the part of, of, of longs. And I think there is that preconception that exists broadly, that somehow you are doing something wrong and you're somehow rooting for a company's failure.

• 13:56Speaker 00

  And that this is, I don't know, anti-American if you, if, if you short a stock. And so I think that's part of why there's, there's, there's a shortage, a shortage of, of, of short sellers. I think also, I mean, we've had a incredible unprecedented bull market for the last four decades as a result of falling interest rates. And especially in the decade before the pandemic hit, it was very, very difficult to make money shorting anything because everything went to the moon. Didn't matter if its numbers were good, as it was eventually unmasked to be somewhat fraudulent. And it, it stocks just went to the moon anyway. The riskier, the better. And so it is only diehard short sellers that have managed to stick it out.

• 14:39Speaker 00

  And I, I think lastly, Jim Chaney said this to me once, and I, I think it's true, that he could find dozens of people who were skilled enough to come, smart enough to come work for him. There's no shortage of that, people who are technically skilled and really smart. But being able to be contrarian for a long period of time, especially when the market is going against you, is a different sort of person. But it requires a completely different mindset to have everybody in the world saying you're wrong, to be losing money because a stock is continuing to go up. And to be able to hold fast to your conviction. And I think that's another, uh, part of the explanation for why there are fewer short sellers.

• 15:18Dwarkesh Patel?

  Yeah, and that raises an interesting question about venture capital, for example, where or private markets in general, at least in the public markets, there's the shorting maybe in shortage, but it is a possible mechanism. Whereas I'm a programmer. So you know, if like one guy thinks the company is worth $100 million and everybody else thinks it's not, you know, the company will still be so the price will still be set by them. You know, the person who is a believer. Does that increase the risk of some sort of bubble in venture capital and in technology? And I guess in private markets generally, if they're not public, is that something you worry about that there could be incredible bubbles built up if there's a lot of money that's floating around in these circles?

• 15:58Speaker 00

  Well, I think we're seeing that now. Right. And I don't think it's a coincidence that FTX and Theranos were not publicly traded companies. Right. There's a certain sort of black box quality to these companies because people aren't shorting them and are and are, you know, whispering to journalists about that that there's something wrong here. And there aren't publicly available financials for people to dig through and look, look and look at the numbers. So now I don't think that's a coincidence. And I do think this gigantic move into private assets has been probably not great for that, for the, for the, for the, for the, for the safety of the system. And you'd say, well, it's just institutional investors who can afford to lose money, who are losing money. But it's really not because

• 16:43Speaker 00

  institutional investors are just pension fund money and some cases now mutual fund money. So that distinction that the people who are investing in this stuff can afford to lose it is not really true. So I don't, I don't like that rationalization. I think we're going to see how that plays out. There was just a really good piece in The Economist about private equity marks on their portfolio companies and how they are still look to be much higher than what you would think they should be, given the carnage in the market. And so all of what, what actually things are really worth in private markets, both for venture capital firms and for private equity firms. Is absent another another bubble starting starting in the market? I think we're going to see how that plays out over over the next year.

• 17:27Speaker 00

  And it might be a wake up call for for a lot of people. You know, all that all that said, it's an interesting thing because investors have been very complicit in this. Right? In the sense that a lot of investors are absolutely delighted to have pride to have their their private. Their private investments marked at a high level. They don't have to go to the committee overseeing the investments and say, look, I lost 20% of your money. The way they might if if the numbers were public. And so that the ability of these private investors to smooth, as they call it, the the returns is is it's been. It's been part of the appeal. It hasn't been a negative. It's been a positive. And so I would say that investors who wanted this moving are are are might be getting what they deserve. Except for the point I made earlier that it isn't.

• 18:12Speaker 00

  It isn't their money. It's it's the money of of teachers and firefighters and individual investors around the country. And that's that's problematic.

• 18:21Dwarkesh Patel?

  Yeah, yeah. Being in the world of technology and being around people in it has made me shocked when I read about these numbers from the past. For example, when I'm reading your books and they're detailing things that happened in 90s or the 2000s. And then you realize that the salary that Hank Paulson made as CEO of Goldman or that Skilling made as, you know, CEO of Enron. You know, it's like I have friends who are my age, like 22 year olds who are raising seed around that are as big as like these people's salaries. And so it just feels like these books where you have 50 billion dollar frauds or, you know, hundreds of billions of dollars have collapsed. And the individuals there, it just feels like it's missing a few zeros because of the delusion of the private market.

• 19:02Dwarkesh Patel?

  But but speaking of short sellers and speaking of private equity, I think it'd be interesting to talk about Musk. So, you know, your 2018 Vanity Fair article, I thought was really interesting about, you know, Musk's factory in Buffalo. How do you think back on Tesla and Musk now, given the fact that the stock did continue to rise afterwards? And the factory, I believe, was completed and it's hired the 1500 or so people that it promised New York State. Is Musk just a fraud who can pull it off? And so he's a visionary. How do you think about Musk in the aftermath?

• 19:35Speaker 00

  So I don't think that's right about Buffalo and I have to look, but I don't think they ended up. I mean, the SolarCity business at Tesla has pretty much collapsed. I don't think people haven't gotten their roofs. There was just a piece about how they're canceling some of their roof installations. So Musk has repeatedly made grand visions about that business that haven't played out. And I will check this for you, post the podcast, but I don't think if there is employment at that factory in Buffalo, it's not because they're churning out solar, solar, solar products that are, that are, that are doing what was, what was originally promised. So I guess I think about that story in a couple of ways. It definitely, it was not meant to be a piece about Tesla. It was meant to

• 20:18Speaker 00

  be a piece that shone a little bit of light on how Musk operates and his willingness to flout the rules and his reliance on government subsidies, despite the fact that he presents himself as this libertarian free, free, free market, free marketer, and his willingness to lie to, to, to on some level enrich himself, which also runs counter to the Elon Musk narrative that he doesn't care about making money for, for himself. Because the main reason for Tesla to buy SolarCity was that SolarCity had, main reason, was it Tesla, was that SolarCity had, that Musk and his, and his, and his relatives had extended these loans to SolarCity that were going to go bankrupt, that were going to be, all the money

• 21:01Speaker 00

  was going to be lost if SolarCity went bankrupt. And by having Tesla buy it, Musk was able to bail himself out as, as, as well. And I also think a good reason for that, for the, for, and it brings us to the present time, but the reason for the acquisition was that Musk knows that this image of himself as the invincible, invulnerable, who can always raise money and whose companies always work out in the end was really important. And if SolarCity had gone bankrupt, it would have cast a big question mark over, over Musk, over, over the Musk narrative. And so I think he literally couldn't afford to let SolarCity go bankrupt. All of that said, I have, I have been and was, I, I was quite skeptical of Tesla and I thought about it in, in, in, in.

• 21:45Speaker 00

  I always believed that the product was great. I just wasn't sure about the company's money-making potential. And I think that that is something I started thinking about back around the SolarCity time, maybe earlier, but this line, something I've talked about before, but this line between a visionary and a fraudster. You know, you think that they're on two opposite ends of the spectrum. But in reality, they're where the ends of the circle meet. The characteristics of one, one has that many of the characteristics of the other. And sometimes I think the only thing that really separates the two is that the fraudster is able to keep getting money, raising money in order to get through the really difficult time where he or she isn't telling the truth. And then that person goes down in history as a visionary.

• 22:27Speaker 00

  But because no one ever looks back to the moment in time when they were lying, the fraudster gets caught in the middle. So Enron's lost access to the capital markets, lost access to funding. As the market collapsed after the dot-com boom, then people began to wonder whether Skilling was telling the truth about Enron's broadband business. And then there were all the disclosures about Andy Fast's partnerships. If Enron had been able to continue raising money, this business of Enron's called Enron Broadband might well have been Netflix. It was Netflix ahead of its time. So Enron just got caught in the middle and all the fraud, all the fraud got exposed. But that's not because Jeff Skilling wasn't a visionary who had really grand plans for the future.

• 23:09Speaker 00

  So I think Musk falls somewhere in that spectrum of fraudster and visionary. And what's going to be really interesting, why I said that we bring it to the present time about what happens to the Musk narrative if something fails is what happens. Does the world watch as Twitter implode? What does that mean then for the Elon Musk narratives overall?

• 23:29Dwarkesh Patel?

  Yep, yep.

• 23:31Dwarkesh Patel?

  Going back to the smartest guy in the room, the title obviously suggests something about

• 23:36Dwarkesh Patel?

  The, I guess, in general, the ability and the likelihood of very smart people committing fraud or things of that sort. But, you know, Garrett Jones has this book called Hide Mind, where he talks about how the smarter people are more likely to cooperate in prisoners' dilemma-type situations. They have longer time preference. And one of the things you've written about is the problem in corporate America is people having shorter, you know, doing too big time discounting. So, given that trend we see in general of greater cooperativeness and other kinds of traits of more intelligent people, do you think the reason we often find people like SBF and Skilling running big frauds just by being very intelligent? Is it just that, on average, smarter people are maybe less likely to commit fraud, but

• 24:20Dwarkesh Patel?

  when they do commit fraud, they do it at such gargantuan scales and are able to do it at such gargantuan scales that it just brings down entire empires? How do you think about the relationship between intelligence and fraud?

• 24:30Speaker 00

  That's interesting. I'm not sure I know a coherent answer to that. Smartest Guys in the Room, as the title, was a little bit tongue-in-cheek. It wasn't meant to say these guys actually are the smartest guys in the room. It was, it was a little bit, it was a little bit ironic, but that doesn't take away from the really good question that you asked, which is, what is that relationship? I, I mean, I think if you look at the history of corporate fraud, you are not going to find unintelligent people having been the masterminds behind this. You're going to find really, really, really smart, even brilliant, people having, having, having been, been behind it. Maybe some part of that is this linkage between the visionary and the fraudster, that so

• 25:12Speaker 00

  many of these, of these corporate frauds are people who have qualities of the visionary. And to have the qualities of a visionary, you have to have a pretty, pretty, pretty, pretty high intelligence. And I do think so many of these stories are, are about then self-delusion. So I don't think smart people are any less likely to suffer from self-delusion than dumb people, and they're probably more likely to, because you can rationalize. You know, the smart person's ability to rationalize just about anything they want to rational, rationalize is pretty profound. Whereas perhaps someone who doesn't have quite the same, the same brainpower, isn't going to be able to create a narrative under which their actions are blameless and

• 25:54Speaker 00

  they're doing the right thing. So I think sometimes, so maybe there is some sort of relationship there that somebody more qualified than I am would have to study between smart people's ability to, to, to rationalize just about anything as a way of, as part of the path to self-delusion and part of the path by which these things happen.

• 26:15Dwarkesh Patel?

  Yeah.

• 26:15Speaker 00

  That's completely, that's completely, that's nothing theory. There's absolutely nothing to back that.

• 26:22Dwarkesh Patel?

  Let's do some more speculation. So one of the things John Ray talked about in his testimony, was it two days ago, where he said that, you know, FTX had done $5 billion of investments and deals in the last year, and most of those investments were worth a fraction of the value that FTX paid for them. And we see this also in, obviously, in Enron, right, with broadband and with DABU, is that how you pronounce it? But basically, their international department. What is this, this obsession with deal making for its own sake? Is that to appease investors and make them think a lot's going on? Is that because of the hubris of the founder of just wanting to set up a big empire as fast as

• 27:03Dwarkesh Patel?

  possible, even if you're getting a bad sticker price? Why do we see this pattern of just, you know, excessive deal making for its own sake?

• 27:11Speaker 00

  That's an interesting question, too. I'm not sure that that's limited to companies that go splat dramatically. There's a lot of, a lot of deal making in, in corporate America has that same frenzied quality. I haven't seen an updated study on, on this in a, in a long time, but I began my career working as an analyst in an M and A department at Goldman Sachs and.

• 27:35Speaker 00

  Definitely, deals are done for the sake of doing deals. And I once joked that synergies are kind of like UFOs. A lot of people claim to have seen them, but there's no proof that they actually exist. I haven't seen an updated study on this, but there was one years back that showed that most M and A transactions don't result in increased value for shareholders and most synergies, most prominent synergies never materialize. Just getting bigger for the sake of getting bigger and doing deals for the short-term value of showing Wall Street a projection that earnings are going to be so much higher even after the cost of the debt that you've taken on and that there are these great synergies that are going to come about from combining businesses.

• 28:15Speaker 00

  So I don't know that either the frenzy deal doing or deal doing, deals gone wrong is solely limited to people who are committing fraud. I think it's kind of across the spectrum.

• 28:30Dwarkesh Patel?

  Well, one thing I find interesting about your books is how you detail that, and correct me if this is the wrong way to read them, but that incentives are not the only thing that matter. You know, there's this perception that, you know, we've set up bad incentives for these actors and that's why they did bad things. But also, the power of one individual to shape a company's culture and the power of that culture to enable bad behavior, whether scaling at Enron or with Clarkson, right, at Moody's?

• 28:57Dwarkesh Patel?

  Is that a good way of reading your books? Or how do you think about the relative importance of culture and incentives?

• 29:02Speaker 00

  I think that's really fair, but incentives are part of culture, right? If you've set up a culture where how you're valued is what you get paid, I think it's a little, it's a little difficult to separate those two things out because, because the incentives do help make the culture. But for sure, culture is incredibly, incredibly compelling. I've often thought and said that if I had, when I was leaving my short-lived career in investment banking, if I had, if I had gotten in some of the headhunters I was talking to, if one of them had said, there's this great, really energetic, interesting energy company down in Houston. What do you there? If I had gone there, would I have been a whistleblower or would I have been a believer?

• 29:45Speaker 00

  And I like to believe I would have been a whistleblower, but I think it's equally likely that I would have been a believer. Culture is so strong. It creates us, what's right, maybe on the asthma that you can't see outside. I remember a guy I talked to who was a trader at Enron, really smart guy. And he was like, after the, after the bankruptcy, he said, of course, if we're all getting paid based on creating reported earnings and there's all this cash going out the door in order to do these deals that are creating reported earnings. And that's the culture of the entire firm. Of course, it's not going to work economically. He said, I never thought about it. It just didn't, it didn't, it didn't occur to me. And I think the more compelling the CEO, the more likely you are to have that kind of mass delusion. I mean, there's a reason cults exist, right?

• 30:29Dwarkesh Patel?

  It's, it's, it's.

• 30:30Speaker 00

  We are as human beings remarkably susceptible to quote visionary leaders. It's just, it's the way the human brain is wired. We, we want to believe. And especially if somebody has the ability to put a vision forward like Jeff Skilling did at Enron, like Elizabeth Holmes did at Theranos, like SBF did, where you feel like you're in the service of something greater by helping this vision actualize, then, then you're particularly susceptible. And I think that is the place where incentives don't quite explain things. It's, is, there is this very human desire to matter, to do something important, to be doing something that's going to change the world. And when somebody can tap into that desire in people, that feeling that what you're

• 31:13Speaker 00

  doing isn't just work and a paycheck and the incentives you have, but, I mean, I guess it is part of the incentive, but that you're part of some greater good, that's incredibly powerful.

• 31:23Dwarkesh Patel?

  Yeah.

• 31:23Speaker 00

  What we all want, right? We all want to matter.

• 31:26Dwarkesh Patel?

  Yeah. Speaking of people's psychology, uh, crime and punishment, underrated or overrated as a way to analyze the psychology of people like Skilling and SBF? Or maybe FTS specifically because of the utilitarian nature of SBF's crime?

• 31:39Speaker 00

  Um, I think it's, I think it's underrated, overrated. I'm not sure anybody.

• 31:46Speaker 00

  I'm not sure anybody has ever proven that jail sentences for white collar criminals do anything to deter subsequent white collar crime.

• 31:54Dwarkesh Patel?

  Mm hmm.

• 31:54Speaker 00

  And I think one part of this is the self-delusion that I that I talked about. Nobody thinks, oh, I'm doing the same thing as Jeff Skilling did at Enron. And if I and if I do this, then I too might end up in jail. Therefore, I don't want to do this. I just don't think that's the way that the the the thought process worked. I think Elizabeth Holmes at Theranos probably for the most part convinced herself that this was going to work and that if you just push forward and push hard enough and keep telling people what they want to hear and keep being able to raise money, it's going to work. You know, if if you pause to think, well, what if it doesn't work and I lied and I go to jail, then then you'd stop, right? Right then and there. So I think that I think that that I'm not I'm not sure it's much of a deterrent.

• 32:37Speaker 00

  I remember, and partly I'm I'm biased because I remember a piece my co-author Peter Alkaid and I wrote out right after Jeff Skilling and Ken Lay were were convicted. And we wrote a piece for Fortune in which we said that the entire world has changed now, that corporate executives are are are put on high alert, that behavior in the gray area will no longer be tolerated and that it will be aggressively prosecuted. And this was spring of 2006 and the events that caused the global financial crisis was pretty well underway. It didn't do much to prevent the global financial crisis. Enron's Enron's jail time didn't do anything to present prevent Elizabeth Holmes, doesn't seem to have done anything to change what SBF was doing. So I just I I just I'm I'm I'm not sure.

• 33:19Speaker 00

  I'm sure a psychologist or somebody who specializes in studying white collar crime could probably make a argument that refutes everything I said and that shows that it has had a deterrent effect. But I just I just don't think that people get themselves into this situation consciously think this is what I'm doing.

• 33:37Dwarkesh Patel?

  Yeah, yeah. Speaking of other incentives, stock options, you've just spoken about how that creates short-term incentives for the executives who are making decisions. If you wanted to set up an instrument that aligned an executive or a leader's compensation with the long-term performance of a company, what would that look like? Would you have the options vested in 10 years instead of a year? How would you design it? How would you design a compensation scheme to award long-term thinking?

• 34:04Speaker 00

  If I could do that, I should rule the world, I think. Very smart. I think that is one of the really tough problems confronting boards or anybody who is determining, anybody who is determining stock options and that almost anybody who is determining compensation and that most compensation schemes seem to have really terrible unintended consequences. They look really good on paper. And then, as they are implemented, it turns out that there was a way in which they accomplished exactly the opposite of the thing the people who designing them wanted, wanted them to accomplish. I mean, if you think back to the advent of stock options, what could sound better? Right? Giving management a share of the company such that if shareholders did well, then do well.

• 34:48Speaker 00

  Nobody envisioned the ways in which stock options could be repriced, the ways in which meeting earnings targets could lead to gaming, the ways in which the incentive of stock-based compensation could lead to people trying to get anything they could in order to get the stock price higher and cash out when they're, as soon as their stock options vested. So even there was, there was, the whole Valeant saga was fascinating on this front because the people who designed Mike Pearson's compensation package, the CEO of Valeant, they were convinced that this was absolutely the way to do it. And he got bigger and bigger stock option incentives for hitting certain, for having the stock achieve certain levels. But of course, that creates this incredible bias to just get the stock to go up, no matter, no matter what else you do.

• 35:34Speaker 00

  It does seem to me that vesting over the long term is, is, is a much better way to go about things. But then do you create incentives for people to play games in order to get the stock lower at various points where there's about to be a stock option award? So they have a better chance of having their assets be worth, be worth something over the long term? And do you, particularly on Wall Street, there is this, or in firms where this sort of stuff matters the most, there is this There was this clearing of dead wood that happened where people got paid and they got out of the way and made way for younger people. And I don't know, it was a harsh culture, but maybe it made sense on some level. And now, at least I'd been told with much longer vesting periods, you have people who don't want to let go. And so you have

• 36:18Speaker 00

  more of a problem with people who should have retired sticking around instead of clearing out. And then it also becomes a question of how much money is enough. So if somebody is getting millions of dollars in short-term compensation and they have a whole bunch more money tied up in long-term compensation, do the long-term numbers matter? At what point do they really matter? I mean, if you gave me $5 million today, I'm not so sure I'd really care if I were getting another $5 million in 10 years.

• 36:48Dwarkesh Patel?

  Yeah.

• 36:49Speaker 00

  So I think all of that is, I'm not sure there's a perfect compensation system. All things considered, though, I think longer term is probably better, but...

• 37:01Dwarkesh Patel?

  Yeah, I didn't think about that downside of the longer vesting periods. That's so interesting. I guess there is no free lunch. So with Enron, it was clear that there was a lot of talent at the firm and that you had these companies and these trading firms launch in the aftermath by people who left Enron, Kinder Morgan and John Arnold, Centaurus, that were wildly profitable and did well. Do you think we'll see the same thing with FTX? That while SBF himself and maybe his close cadre were frauds, there actually was a lot of great trading and engineering talent there that are going to start these very successful firms in the aftermath?

• 37:37Speaker 00

  That's interesting. And just for the sake of clarification, Kinder Morgan was actually started years before Enron's collapse. Glenn Rich Kinder, who was vying with Jeff Skilling in a sense to become Chief Operating Officer, Ken Lay picked Jeff Skilling and Kinder left. And took a few assets and went to create Kinder Morgan. But your overall point, I'm just clarifying your overall point holds. There were a lot of people who left Enron and went on to do to have pretty, pretty remarkable careers. I think the answer with FTX, I bet there will be some for sure. But whether they will be in the crypto space, I guess, depends on your views on long-term viability of the crypto space.

• 38:16Speaker 00

  And I have never, it's funny, as crypto exploded over the last couple of years, I was, I've been working on this book about the pandemic and it's been busy and difficult enough that I have not lifted my head to think about my doubts. And I always thought, I don't get it. I don't understand. I mean, I understand the whole argument about blockchain being valuable for a lot of transactions. And I get that, but I never understood crypto itself. And I thought, well, I just need to, as soon as this book is done, I just need to put a month into understanding this because it's obviously an important enough part of our world that I need to figure it out. But now I think, oh, maybe I didn't understand it for a reason. And maybe, maybe there isn't anything to understand. And I've just saved myself the time because it's all gone.

• 38:59Speaker 00

  And you have people like Larry Fink at BlackRock saying, whole industry is going to implode. It's done. And certainly with the news today, this morning, a finances auditor basically saying, we're out. I don't, I don't know how much of it was, how much it was Ponzi scheme. You might know better than I do. And so I don't know what's left after this whole thing implodes. It's a little bit like, there is an analogy here that when Enron imploded, yes, a lot of people went on to start other successful businesses. But the whole energy trading business is practiced by kind of undercapitalized energy firms went away and that never came back. And so I, I don't, I don't know. I'm, it'll be, I don't know. What do you think?

• 39:42Dwarkesh Patel?

  The time to be worried will be when Bethany McLean writes an article titled, is Bitcoin overvalued?

• 39:50Speaker 00

  My moment on that.

• 39:52Dwarkesh Patel?

  Yeah, for the audience, that was, I believe the first skeptical article about Enron's stock price.

• 39:58Speaker 00

  Yeah.

• 39:59Dwarkesh Patel?

  And it was titled, is Enron overvalued? Aftermath, understated title.

• 40:03Speaker 00

  Yeah.

• 40:05Speaker 00

  Joke that that story should have won, won, won awards for the neatest title in business journalism history. But the company was bankrupt six months later. It's overpriced.

• 40:15Dwarkesh Patel?

  Um, let me ask you a bigger question about finance in general. So finance is 9% of GDP, I believe. How much of that is the productive use and thinking and allocation of the capital towards their most productive ends? And how much of that is just zero sum or negative sum games? If you had to break that down, like, is 9% too high, do you think? Or is it just right?

• 40:42Speaker 00

  I think it's too high. I have no idea how to think about breaking it down to what the proper level should be. But I think there are other ways to think about how you can see that in past decades, it hasn't been at the right level. When you've had all sorts of smart kids, leaving, leaving business school and leaving college and heading into finance and hedge funds and private equity is their career of choice. I think that's a sign that that finance is too big when it's sucking up too much of, of, of the talent of the country. And when the rewards for doing it are so disproportionate relative to the rewards of, of, of doing other things. The counter to that is that there have also been a lot of rewards for starting businesses. And that's probably, I think, how you want

• 41:24Speaker 00

  it to be in a productive, in a productive economy. So I think the number is, is too high. I don't know how to think about what it should be, other than what I, actually, a former Goldman Sachs partner said this to me when I was working on All the Devils Are Here. And she said that finance is supposed to be like the, the substrata of our world. It's supposed to be the thing that enables other things to happen. It's not supposed to be the world itself. So the, the role of a financial system is to enable businesses to get started, to provide capital. That's what it's supposed to be. It's the lubricant that enables business. But it's not supposed to be the thing itself. And when it's become the thing itself, you've, you've, you've, you've got a problem. Um, and I think the other-

• 42:04Dwarkesh Patel?

  There's your article about crypto. That paragraph right there.

• 42:08Speaker 00

  There you go. That's, that's a good. And I think, I think the other way you, you can see it, perhaps this is way too simplistic, but the other way I've thought about it is that how can it be, if you can run a hedge fund and make billions of dollars from a-

• 42:23Speaker 00

  And have five people, 10 people, whatever it is. Versus starting a company that employs people and changes the neighborhood and provides jobs and, you know, provide the product that, that, that, that, that improves people's lives. It, it is a shame that too much of the talent and such a huge share of the financial rewards are going to the former rather than the latter. And that just can't mean good things for the future.

• 42:47Dwarkesh Patel?

  Yeah, yeah. And I, you know, when people criticize technology, for example, for the idea that, you know, these people who would have been, I don't know, otherwise teachers or something, they're, you know, making half a million dollars at Google. Um, and I think like when I was in India, people were using Google Maps to get through the streets in Mumbai, which is, which is unimaginable to me for going there that, you know, you would be able to do that with a service built out of Silicon Valley. And so, yeah, I think that actually is a good allocation of capital and talent. I'm not sure about finance.

• 43:16Speaker 00

  I think I, I, I agree with you. I think there are other problems with Google and with the, the social media giants. But, but they are real businesses that employ people that make products that have had a huge impact on, on, on people's, on people's lives. So in, in that sense, it's very different than a private equity firm, for instance, and especially private equity, even more so that hedge funds draws my ire. Because I think one of the reasons they, that it, I, they've been able to make, part of the financialization of our economy has been due to super, super low interest rates. And low interest rates that have enabled so many people to make so much money in finance are not, they're just a gift.

• 43:57Speaker 00

  It wasn't because these people were uniquely smart. They just found themselves in a great moment in time. And the fact that they now think they're really smart because it makes me crazy.

• 44:08Dwarkesh Patel?

  Are Fannie and Freddie America's special purpose entities? Are they our Alameda? It's just a way we hide our debt and, uh,

• 44:15Speaker 00

  Interesting.

• 44:16Dwarkesh Patel?

  Yeah.

• 44:17Speaker 00

  Well, I guess we, you know, I don't know anymore because so I last wrote about them. When was it in 2016? And I don't know now. No, you're right. Their debt is still off, off, off balance sheet. So yeah, in a lot of ways, they, they were, I would argue though, that the old Fannie and Freddie were structured more honestly than, than the new Fannie and Freddie, that it really is conservatorship that has made them, that have made them America's off balance sheet entities. Because at least when they were their own independent entities, yes, there was this odd thing known as the implicit guarantee, which is, when you think about, back to your point about efficient markets, how can you possibly believe there's a thing as an efficient market when their Fannie and Freddie had an implicit guarantee?

• 45:02Speaker 00

  Meaning it wasn't real. There was no place where it was written down that the US government would bail Fannie and Freddie out in a crisis. And everybody denied that it existed. And yet it did exist.

• 45:13Dwarkesh Patel?

  Yeah, no, but I feel like that confirms the efficient market hypothesis, right? Because the market correctly thought that mortgages backed by Fannie and Freddie would have governments uh, father, and they did.

• 45:24Speaker 00

  You might be right. I, I think what I was getting at, you may be right. I think what I was getting at is that it is such a screwed up concept. I mean, how can it possibly? When I first, when people were first explaining this to me, when I first wrote about Fannie and Freddie, I was like, no, wait, this is American car. No, when you, what? Um, um, so yeah, but I, I, I think that Fannie and Freddie, at least with shareholders that were forced to bear some level of, of the risks, were actually a more honest way of going about this whole screwed up American way of financing mortgages than, than the current setup is.

• 45:59Dwarkesh Patel?

  What is the future of these firms? Are they just going to stay in conservatorship forever? Or is there any developments there? What's going to happen to them?

• 46:07Speaker 00

  The lawsuit, the latest lawsuit that could have answered that in some ways ended in a mistrial. Uh, I don't think, I don't, I don't think unfortunately, anybody in government sees any currency in, and I mean currency in the broad sense, not in the literal sense of money, in, in taking this on. And unfortunately, what someone once said to me about it, I think remains true, and it's really depressing, but is that various lawmakers get interested in Fannie and Freddie. They engage with it only to figure out it's really, really goddamn complicated. And that any kind of solution is going to involve angering people on one side of the aisle or another and potentially angering their constituents and they slowly back away

• 46:52Speaker 00

  from doing anything that could that that could affect change. But I think we have a really unhealthy situation. I don't think it's great for these two entities to be in conservatorship, but at this point, I'm not sure it's going to change.

• 47:05Dwarkesh Patel?

  Yep. Speaking of debt and mortgages, so total household debt in the United States has been climbing recently after it's like slightly declined after 2008. But I think in quarter three alone, it increased $350 billion and now it's at $16.5 trillion, the total US household debt. Should we be worried about this? Are we going to see another sort of collapse because of this? Or what should we think about this number?

• 47:31Speaker 00

  I don't know. I don't know how to think about that because it's too tied up in other things that no one knows. Are we going to have a recession? How severe is the recession going to be? What is the max unemployment rate that we're going to hit if we do if we do have a recession? And all of those things dictate how to how to think about that number. I don't think consumer debt is embedded in the bowels of the financial system in the same way mortgages were. And in the end, the the the problem with the financial crisis 2008, it wasn't the losses on the mortgages themselves. It was the way in which they were embedded in the plumbing of the financial system in ways that nobody understood. And then the resulting loss of confidence

• 48:14Speaker 00

  from the fact that nobody had understood that slash lies had been told about about that. And that's what caused that's what caused everything to to collapse. Consumer debt is a little more visible and seeable. And I don't think that it has that same that same opaque quality to it that that mortgage backed securities did. I could be wrong. I could be wrong. I haven't I haven't I haven't dug into it enough enough to understand enough to understand that that you can see the delinquencies starting to climb. I mean, I guess you could on on mortgages as well. But there was this, there was this profound belief with mortgages that since home prices would never decline, there would never be losses on these instruments because you could

• 48:57Speaker 00

  always sell the underlying property for more than you had paid for it and therefore everything would be fine. And that's what led to a lot of the bad practices in the industry is that lenders didn't think they had to care if they were screwing the home buyer because they always thought they could take the home back and, and, and, and make more money on it. And consumer debt is, is unsecured and so it's, it's, it's different. I think people think about it differently. But I'd have to, I'd have to, I'd have to do some more homework to understand where consumer debt sits in the overall architecture of the financial industry.

• 49:29Dwarkesh Patel?

  I, I'm really glad you brought up this theme about what does the overall big picture look like? I feel like this is the theme of all your books, that people will be so obsessed with their subsection of their job or, or that area, that they won't notice that broader trends, like the ones you're talking about, and in Enron, it's like, why, why do we have all these special purpose entities? What is the total debt load of Enron? Or with the, you know, mortgage backed securities, a similar kind of thing, right? What, what, maybe they weren't correlated in the past, but what's that? Do we really think that there's really no correlation between delinquencies across the country? So that, that kind of big picture thinking, whose job is that today? Is it journalist? Is it short sellers? Is it people

• 50:13Dwarkesh Patel?

  writing on Substack? Who is doing that? Is it anybody's job? Is it just like an important role with nobody assigned to it?

• 50:21Speaker 00

  I think it's the latter. I think it's an important role with nobody, with nobody assigned to it. And there, there is a limit. I mean, hate to say this, it is not, it is not an accident that many of my books have been written. That's probably not fair. It's not true of my book on fracking, but that some of my books have been written after the calamity happened. So they weren't so much portaling the calamity as they were unpacking the calamity after it happened, which is a different role. And as I said at the start of our conversation, I think an important one to explain to people why this big bad thing took, took place. But it's not prediction. I don't know as people that were very good at prediction. They tried to set up, what was it called? In the wake of the global financial crisis, they established this thing called FSOC.

• 51:06Speaker 00

  And now I'm forgetting what the acronym stands for, Financial Security Oversight Committee. And it's supposed to be this, this body that does think about these big picture risks, that thinks about the ways, the ways, for example, in which mortgage-backed securities were, were, were, were, were, were repopulating through the entire financial system and ways that would be, cause a loss to be much more than a loss, that it would just be the loss of money and that security would echo and magnify. And so that there are people who are supposed to be thinking about it. But I think, I think it's, it's, it's really hard to see that. And in an increasingly complex world, it's even, it's even harder than it was before because the reverberations from things

• 51:50Speaker 00

  are really hard to map out in, in, in advance. And especially when some part of those reverberations are a loss of competence, then all bets are off. Because when competence cracks, lots of things fall apart. But how do you possibly analyze in any quantitative way the, the risks that, that competence will collapse?

• 52:11Dwarkesh Patel?

  Mm hmm.

• 52:12Speaker 00

  So I think, I think, I think, I think it's difficult. That said, and of course I am talking my own book here. I don't think that the lack of, the, the increased financial problems of journalism really helped matters in that respect. Because in an ideal world, you want a lot of people out there writing and thinking about various pieces of this. And then maybe somebody can come along and see the various pieces and say, oh, my God, there's this big picture thing here that we all need to be thinking about. But there's, there's a kind of serendipity in the ability to do that. One, the one, the chances, I guess the best way to say that is the chances of that serendipity are dramatically increased by having a lot of people out there doing homework on, on the various pieces of the puzzle. And so I think in a world,

• 52:55Speaker 00

  particularly where local news has been decimated, the chances of that sort of serendipity are, are definitely lower. And people may think, oh, it doesn't matter. We've still got national news. We've got the Washington Post. We've got the Wall Street Journal. We've got the New York Times. I would love to have somebody do a piece of analysis and go back through the New York Times stories and see how many were sparked by a piece in a local paper that maybe you wouldn't even notice from reading the New York Times piece because it'd be in like the sixth paragraph that, oh yeah, credit should go to this person at this local paper who started writing about this. But if you no longer have the person at the local paper who started writing about this, you know, it's, it's, it's, it's less likely that the big national piece gets written. And I think that's a part of the implosion of local news

• 53:38Speaker 00

  that people, a part of the cost of the implosion of local news that people don't really understand. The idea that the national press functions at, at the same level without local news is just not true.

• 53:49Dwarkesh Patel?

  Yeah. And, but even if you have the local news, and that's a really important point, but even if you have that local news, there still has to be somebody whose job it is to synthesize it all together. And I'm curious, what is the training that requires? So you, I mean, your training is, you know, math and English major and then working at, working in investment banking. Is that the, I mean, obviously, the anecdotal experience n equals one seems that that's great training for synthesizing all these pieces together. But what is the right sort of education for somebody who is thinking about the big picture?

• 54:22Speaker 00

  I don't, I don't know. And there may be, there may be, there are probably multiple answers to that question, right? There's probably no one, one right answer. For me, in, in the end, my, my math major has proven to be pivotal, even my mother dug up these, my parents were moving and so my mother was going through all her stuff and she dug up these, my math work from, from college. And literally, if it weren't for the fact that I recognized my own handwriting, I would not recognize pages of math formulas and proofs. And they're like, get gibberish to me now. So, but I, but I still think that math has, so I do not want to exaggerate my mathematical ability at this stage of the game. It's basically no. But I do think that doing math proofs, any kind of formal, any

• 55:04Speaker 00

  kind of training in logic is really, really important. Because the more you've been formally trained in logic, the more you realize when there are pieces missing and when something isn't quite, isn't quite adding up. It just forces you to think in, in a way that is, that in a way that connects the dots. Because you know, if you're moving from A to B and B doesn't follow A, you understand that B doesn't follow A. And I think that that that that kind of training is is really, really important. It's what's given me, whatever kind of backbone I have as a journalist is not because I like to create controversy and like to make people mad. I actually don't. It's just because something doesn't make sense to me. And so doesn't make sense to me because I'm not getting it, or it doesn't make sense to me because

• 55:48Speaker 00

  B doesn't actually follow follow A and you're just being told that it does. And so I think that I think that training is is really, really important. I also have often thought that another part of training is realizing that basic rule that you learned in kindergarten, which is, you know, believe your imagination or, you know, you're mad, follow your imagination, because the truth is, anything can happen. And I think if you look at business history over the last couple of decades, it will be the improbable becoming probable, becoming true over and over and over again. I mean, the idea that Enron could implode. One of the biggest, supposedly most successful companies in corporate America could be bankrupt within six months.

• 56:31Speaker 00

  The, from its year from its stock price high. The idea that the biggest, most successful financial institutions on Wall on Wall Street could all be crumbling into bankruptcy without the aid of the US government. The idea that a young woman with no college degree and no real experience in engineering could create

• 56:53Speaker 00

  could create a machine that was going to revolutionize blood testing and land on the cover of every business magazine and that this whole thing could turn out to be pretty much a fraud. The entire idea of FTX, I mean, over and over again, these things have happened. Forget Bernie Madoff. If you told people a year ago that FTX was going to implode six months ago, three months ago, people would have been like, no, no, no, no, no, no. And so I think just that, that, that, that knowledge that the improbable happens over and over again is also really fundamental, fundamentally important.

• 57:24Dwarkesh Patel?

  If we're continuing on the theme of FTX, I interviewed him about four or five months ago.

• 57:29Speaker 00

  What?

• 57:30Dwarkesh Patel?

  And this is one of these interviews that I'm really, I don't know if embarrassed is the right word, but I knew things then that I could have like asked, poked harder about. But it's also the kind of thing where you look back in retrospect and you're like, if it had turned out well, it's not obvious what the red flags are while you're in the moment. There's things you can look back at the story of Facebook and how, you know, Mark Zuckerberg acted in the early days of Facebook. And you could say if the thing fell apart, that this is why, or you know, this is a red flag. So I have a hard time thinking about how I should have done that interview.

• 58:01Speaker 00

  Clichés are often clichés for a reason, and the one about hindsight being 2020 is, is, is one of the best clichés ever. And I am so fundamentally annoyed by stories that say, here were all the red flags. Why didn't anybody see it? Well, oftentimes the person writing that story didn't see the red flags either. And it's really easy in retrospect to pick up all the signs that there was, that there was a problem. And it's really hard in the moment. There's, there's a little bit of a, of a, of I think in all of us, a subconscious sense that this doesn't sound quite right. But getting the subconscious suspicion to rise to the level of conscious thought is, is also really difficult.

• 58:41Speaker 00

  So I think, I think again, there is, there is, it is one value of, and I hope we're coming back to a world that appreciates old people because I'm getting older, but there is, there is some value in having, having seen it before, that I think the red flags do maybe tend to rise to the level of conscious, conscious thought. That said, if I had gotten interested in crypto a year ago, would I have seen the problems with FTX? Doubtful. I don't know. You just, you just, you just can never know. Sometimes these things also depend on the way in which they're presented to you and by whom. And I think that shouldn't be, I think it's not, not intellectually honest. But if somebody you really respect comes to you and tells you this business is the next greatest thing,

• 59:23Speaker 00

  and this person is brilliant, chances are that preconception is going to be lodged in your mind in a way that's going to make it really hard for you to see the red flags. Whereas if first you've heard of this company with somebody coming to you, somebody really smart you like coming to and saying, I don't, I don't think this makes sense. These, these are my problems with this. You're going to be far more apt to see the red flags. And I say it's not, that's not the right way, not the right phrase. I say it's not intellectually honest or not smart, because really you kind of want to strip that away. You want to strip those biases away, because even really smart people make mistakes all the time. And so you want to the extent possible to think for yourself, but, but of course, it's, it goes back to math, right? Order of operations.

• 1:00:05Speaker 00

  The order in which information is presented to you unfortunately is going to have an effect on how you see that, how you see that in information.

• 1:00:13Dwarkesh Patel?

  Yeah. Let's talk about fracking. So in this year, I think quarter two, was it the first time that fracking and shale finally became profitable?

• 1:00:26Dwarkesh Patel?

  Were the fracking investors right that there would be an oil shock and now it is actually profitable? Or how do you think about Saudi America in the aftermath of the events this year?

• 1:00:37Speaker 00

  Well, I, at least from my understanding of it, and again, because I have been up to lunch on this difficult book I'm writing. I haven't actually, I'm not as up to date on this as I should be. So take what I'm saying with, with a grain of salt. But I think actually it proves the underlying thesis, because fracking is profitable, but at a much smaller scale than it was when people were saying this is, this is going to change the world. So it hasn't, the idea that US shale oil was the swing factor in world oil prices. I don't think anybody believes that anymore, because it can't possibly produce the amount of oil required for it to be the major force that it was, that it was supposed to be. So I think what has happened actually proves the point, instead of negating the point.

• 1:01:22Speaker 00

  And for, for how long it can be profitable and at what level of oil prices is also, was also part of the under, the under, the underlying thesis, which is how much oil is there actually that can be extracted at, at, at this price? And so the fact that very high oil prices, there is a certain amount that can be extracted profitably. That's, that's not, that's not surprising. Think the way in which the Bucks thesis would be wrong is if it turned out US shale oil could be the swing producer for the world and we could be the world's largest oil producer and there could the Permian could continue to grow whatever it was 20% a year and grow

• 1:02:03Speaker 00

  profitably. And then I would have to say, I, yeah, that the investors were right, or the people who believed in this were right. So.

• 1:02:11Dwarkesh Patel?

  Yeah, yep. If you could have a Robert Caro like biography of anybody in finance in the last 100 years, especially somebody who we feel hasn't been talked about or covered enough, who would it be? Who do we need a thousand pages about?

• 1:02:25Speaker 00

  A thousand pages. I don't know that we need a thousand pages about anybody.

• 1:02:31Speaker 00

  And who would I like to write about? Um, think about that. There are, there are some books I've been mulling over that I'd like to do, but I'm not sure I, I think I might prefer to keep those to myself for, for, for a little while. I don't know. I'm also always going to be at least, I'm trying to change my orientation, but I'm always going to be biased toward the, the thing that went badly wrong rather than the thing that, that, that worked out. I don't know. Maybe that betrays some underlying darkness in my personality, but I always find that more fun. So I'm, I'm probably not the right person to ask about a, a, a glowing biography. I don't, you know, I don't, I don't know. You could say, you could say Warren Buffett, but plenty has been written about Buffett.

• 1:03:14Speaker 00

  I don't know if there's anything to be at its back. So let me think. If I come up, if I come up with a great answer that I'm prepared to share, I will, I will tell you. I don't know that, maybe it goes back to your question about how big a role that finance should play in our economy overall too. Maybe I just don't think that anybody in finance is necessarily worthy of that, of that kind of, of that kind of, that kind of sustained focus.

• 1:03:41Dwarkesh Patel?

  Yeah. Um, I want to talk about the rating agencies because they have featured heavily in both the story about the housing crisis and Enron. And as a libertarian leading person, that, that's really been, um, that, that's been kind of devastating in the sense that, you know, there's a hope that you can maybe replace things like the FDA or at least functions of it with agencies, private agencies that are tasked with like rating, how good is this food? Or, uh, you know, how safe is this airplane? Things like that. And. I'm curious if you think that there is any possibility of having any private agency that is being paid by the person they're evaluating, being able to give fair evaluations?

• 1:04:23Dwarkesh Patel?

  And this even brings us, it doesn't even have to be rating agencies, it can be things like, you know, now we have the big four accounting firms. I'm curious how much trust you put in them in terms of being able to do evaluations fairly? Do we think, have we passed through the Arthur Andersen days? How credible are these institutions?

• 1:04:40Speaker 00

  Look at EY's rolling wire card, right? And then from the scandals PWC has been involved in over the last bunch of years. I think, yeah. It is, it is a really good question. I thought you were going to go somewhere different with the rating agencies, which is why in a supposedly free market, you have so many investors who rely on credit ratings.

• 1:05:01Dwarkesh Patel?

  That's a good question.

• 1:05:02Speaker 00

  And I, and I do think that there's, this is another perhaps counter to your efficient market theory, or maybe counter to a libertarian view of the world. But, you know, a lot of big investors who complain about the rating agencies after there's been a disaster, really want the cover provided by the rating agencies because they can say, well, you told me this was AAA, I bought it, therefore I can't be blamed. And so, once the crisis has passed, the appetite of big investors to reform the rating agencies are due away with them, meaning then they would have to do their own work and not just say, well, I bought a AAA rated security, is really next to nil. And that's a good part of the reason why reform doesn't, doesn't happen. I mean, remember, the credit rating agencies were reformed in 2006 in the wake of Enron.

• 1:05:47Speaker 00

  The credit rating agency reform was passed, and yet the rating agencies sat at the center of the global financial crisis, like just a few years later. They, I'm not sure they, I'm not sure they really, they can be reformed, but I'm also not sure there is a perfect.

• 1:06:04Speaker 00

  Maybe it goes back to your question about the ability to see the big picture and foresee a problem. I'm not sure there is a perfect regulator who wasn't being paid by companies who could then do a better job. You'd like to believe that's true, that if there were a government agency in charge of credit rating and they weren't paid by the companies and the securities, they weren't, they weren't, they, and they weren't paid by the companies, that that would lead to better ratings, would it? I don't know, right? So I'm not, I'm not sure there's, I guess another way of saying this is very easy to criticize the current system as really problematic. And it's certainly the fact that credit

• 1:06:48Speaker 00

  rating agencies were making so much money by rating subprime mortgage-backed securities for sure played an enormous role in what happened. But then if you ask the next question, well, what's the alternative? That's what it starts, that's when it starts to get, to get pretty complicated.

• 1:07:03Dwarkesh Patel?

  Yeah, yeah. Now that we're going to have this long proceeding on FTX in terms of compensating the people who are harmed, looking back at Enron, I mean, that was a long process. And I think you said in the book that a billion dollars of the remaining sum that should have been doled out to the victims was actually spent in legal fees and the procedures, if I'm right about that number?

• 1:07:27Speaker 00

  I think so. I'm not sure. I admit I don't remember, but it was some enormous. Yeah.

• 1:07:33Dwarkesh Patel?

  So what should be the procedure when an implosion like this happens? Because it seems suboptimal that so much, I mean, it goes back to their finance discussion, right? Like so much of the capital that these people are supposed to be doing out is just going to themselves. Do we need something like the FAA when the plane crashes, they have a body of experts that kind of figures out what happened? Do we need a completely non-legalistic or a different sort of procedure in these kinds of situations? How should the FTX, the disbursement of the remaining assets and so forth, how should that be done?

• 1:08:04Speaker 00

  It's a really interesting question and a really interesting analogy and something people have brought up to me that I've never really dug into, which is the incredible success of the FAA in cutting down on problems with planes because of the incredibly thorough job they do in investigating the cause of a crash afterwards. And so maybe somebody's written about this, but to really get inside that process and the incredibly powerful and profound role it's played, might provide an interesting roadmap for corporate America and how to do this sort of thing and how to prevent it in the future. Maybe, maybe the analogy doesn't hold up in some kind of, in some kind of subtle way. But for sure, that's, that's, that's, that's a really, that's a really interesting question because you do, you, you need this to happen, right?

• 1:08:48Speaker 00

  You need the bankruptcy, you, you need the, you need the excavation. And even if it costs a great deal of money, just for all of us, the worst possible outcome would be for everybody to throw their hands up and say, okay, it's done. Nobody, no, no. Because, because the truth of the matter is even journalists who excavate, who try to excavate this stuff, we depend on the work done by, by others. I mean, I could not have written my Enron book if it weren't for the Justice Department investigating in their indictments for the role of Congress in getting all these documents from, for all these internal documents from Enron, including, by the way, the list of executives and their cell phone numbers, which turned out to be incredibly valuable.

• 1:09:31Speaker 00

  But you can't, you, the role of the bankruptcy examiner and getting in there and really uncovering all of what Enron was doing in order to manipulate its, its earnings, there's no way that a journalist, you could do that without, without all of that data provided by all of these entities that are doing their own investigation because as a journalist, you don't have subpoena power. You can't, you literally can't do this and it becomes an incredibly important part of, of, of telling the overall story. So it's hard for me to say when it's a calamity like this that those dollars are wasted, but is there a better way to go about it? Maybe. Yeah.

• 1:10:07Dwarkesh Patel?

  Uh, another similarity between Enron and FTX is that the bankruptcy is being overseen by John Ray. And this is a rather mysterious person. I believe the, one of the first times you see in a photo of him is when he appeared in front of Congress a few days ago. Um, and I checked the index of the smartest guys in the room. Um, and I, I don't think he was mentioned in the book. Who is this guy? What's his deal?

• 1:10:34Speaker 00

  I don't actually really know. I feel like people have made a really big deal over the bankruptcy administrator being the same person. I'm not really sure how much that, that matters.

• 1:10:44Dwarkesh Patel?

  Okay.

• 1:10:45Speaker 00

  The bankruptcy administrator, when people, it was all over the press, you know, he says this is a bigger disaster than, than whatever it was. I can't remember the exact, but that's his incentive to say that because then any money that he can recoup looks like due to his genius in administrating this thing and bankruptcy. If you say, oh, this wasn't that big a deal, everybody's going to get their money back and then they don't. Then you've got a huge problem, right? You say, this is the, this is, this is terrible and it's awful and there will be no money left because then any money you get back, people are like, look what a great job he did. So I, I, I, I don't know. I don't know. I don't remember him being a really pivotal figure in the, in, in, in, in the, in the excavation of Enron.

• 1:11:27Dwarkesh Patel?

  Yeah, yeah. Um, I, I want to ask you a bit about your writing process. Do you go into the book with some sort of thesis about the actors? And if so, is it often that you realize that somebody you thought was a bad actor is actually one of the good guys? And, or the other way around, or is basically the, your initial picture confirmed by further investigation?

• 1:11:50Speaker 00

  Well, I guess that's a tough question about the books I've done because the books I have done, especially the two big ones. Were after the fact and it was pretty clear, A, that something went badly wrong. And B, that the people who were in power had to be responsible for it because they weren't responsible. Who else was? The way in which they were responsible and the degree to which they were responsible. Open questions that I don't think I had a view on going in. And yeah, to that point, on the financial crisis, I actually ended up changing my mind pretty radically. I wrote a piece in the early stages of the financial crisis, saying that basically homeowners were equally to blame

• 1:12:30Speaker 00

  because homeowners had cashed out, homeowners took out risky mortgages and without personal responsibility, what were lost? And homeowners had also cashed out and people had made a lot of money. So the idea that this was all the fault of the banks was absurd. And I still think that's true to some extent because without personal responsibility, we are lost. But I remember coming across this presentation that had been given by Washington Mutual where they were, which was one of the big lenders at the time, no longer exists. And they were trying to get people to take out, it was a whole internal presentation about how you got someone to take out a risky mortgage. When what they really wanted was the same 30 year fixed rate mortgage that their parents had had. And it was all the tactics and tips you could use to twist their arm to take out this riskier mortgage.

• 1:13:15Speaker 00

  Because those are the ones that were in demand to be packaged up into subprime mortgage backed securities. And so WAMMA could turn around and sell those mortgages for more money to Wall Street than they could the fake 30 year fixed rate mortgages. And then I remember thinking, there's just something wrong with the world where all of the responsibility is on consumers to understand. And none of the responsibility is on the people selling the product, to be honest, about what this thing is. So anyway, that was a case where I changed my mind over the course of reporting a book. I try to, I try not to work on, for stories, I try not to work on stories where there has to be an answer. Because. Because if you're working on a story where it has to be one way for it to be a good story, then if it's not that, then you're biased to want to see it one way.

• 1:14:00Speaker 00

  And if it's not that way, you no longer have a story. So I always prefer to work on things where it's just really interesting. And whatever you end up thinking or saying about it, it's still a really interesting story. So I can't say it's always been. So I guess one of the last stories I did for Vanity Fair was when David Sackler of the, of the, of, wanted to talk to me about what did the Sacklers in Purdue and the opioid crisis want to talk about his view of what had gone wrong. And that in a way is, it was, it was a weird story for me because usually I'm working from the outside in, I don't get stories where people want to cooperate with me. I guess a lot of these reasons. But, um, but in a way it was my favorite type of story because it was really interesting

• 1:14:44Speaker 00

  that he was willing to speak publicly. And if I had ended up thinking the Sacklers were totally blameless in the whole opioid crisis, I could have written, because it was really interesting that he was speaking publicly. And so I like, I like stories where that's where, where it's a story, no matter how you end up viewing the main characters and how you end up viewing the arc of the thing. Does that make sense?

• 1:15:05Dwarkesh Patel?

  Yeah, yeah, it does. And I guess the reason another question is that the people you've studied in your books and your journalism, have you concluded afterwards that, you know, there's some people who are fundamentally deceptive and there are some people who are, you know, ethical and that there's sort of this line, or do you feel like if anybody was put into skilling shoes at the time or SBF shoes, there's a good chance they would have done the same kinds of things?

• 1:15:31Speaker 00

  I think we all have the capacity to be deceptive. I think it's part of human nature. Some people are more inclined toward truth telling and transparency than other people. Maybe just by, by, by nature, maybe by nurture and what's been rewarded in your career and your life inclines you to either be open and honest or to try, to try to hide things. And maybe that's, maybe that's more the experiences that you've had, but I think we are all capable of a fundamental level of deception for. For CEOs, whenever people look at a Jeff Skilling or Angela Mazillo or any of these characters and say, I could never have done that. I mean, there's a fundamental rationalization

• 1:16:11Speaker 00

  that Skilling by manipulating Enron's money was, and Enron's earnings was trying to keep the stock price, stock price high. So he didn't hurt investors by having the stock go down the way it would have been if he had been radically honest about all of Enron's problems. And so we're all capable of that kind of rationalization that what we're doing is really in the long-term interests of somebody else and really in their best interest, even if it's, even if it's not telling the truth. And I think, I think to say that you're not capable of that, I mean, I don't know, I almost think that's more dangerous than admitting that you're capable of it because

• 1:16:47Dwarkesh Patel?

  Yeah, yeah.

• 1:16:48Speaker 00

  If you admit that you're capable of it, then you can make a fundamental choice to either behave that way or, or, or not to behave that way. But there's also another component of human nature that I think is more prevalent in some people than others. And it's not, I don't know if you'd characterize it as dishonesty, but it's very deeply believing something in the moment and convincing other people because you so deeply believe it. And a month later, you don't believe it anymore because you're somebody who changes their mind. So is what you told people a month earlier a lie? Or was it a truth at its moment in time? And so there's, there's that too, that makes it more difficult to label somebody fundamentally deceptive, right? And they look like a lie to the person who believed

• 1:17:32Speaker 00

  what that person was saying and acted on that person's advice and belief. And a month later finds out that the person sold their stock or no longer believes that. But was, was the person being dishonest in their, in that moment?

• 1:17:43Dwarkesh Patel?

  Yeah. And it raises the interesting question of moral luck. I'm sure there were tons of CEOs, and there are tons of CEOs today, who are like Ken Lay, who are just basically disconnected from the business they started and are kind of hanging on. And it just so happened that Ken Lay was the CEO of the one that was committing massive fraud. But it, it, it's kind of like texting and texting and driving where lots of people do it. One guy crashes and obviously he should be punished, but He's no more culpable than the rest of us who do it.

• 1:18:13Speaker 00

  I like that concept of moral luck. I think that's incredibly true. It goes with the concept of, you know, somebody who was an investor over the last forty years. Sure, probably most people did, did really, really well, right? With the tailwind of declining interest rates, does that mean that these people were brilliant? Or that they lucked into the right field? And of course, some people didn't luck into it. They saw what was going on and chose it. And, and, you know, so there, so there's that too. But, but maybe that trivializes your, your question because I think that's a very profound question. I think there really is, there definitely is such a thing as moral luck. And the only way in which you can tip the scales is by trying to be aware of bad people and bad situations and keeping yourself clear of them.

• 1:18:57Speaker 00

  Because back to your earlier question about culture, it's a trite cliche, but you are who you, you surround yourself with, either in a job or in your friendships. And so if you want to have the best chance possible of, of, of steering clear of accidents, you do have to be careful about the situations you choose to put yourself into.

• 1:19:16Dwarkesh Patel?

  Yep.

• 1:19:16Speaker 00

  Because the, the idea that you can remain an island in a, in a bad situation is, is not true as most of us.

• 1:19:23Dwarkesh Patel?

  Yep, yep. Uh, final question, or I guess second to final question. What advice would you give to people who want to do something similar to what you've done over your career? Whether that's investigative journalism or some other role in maybe finance or technology that involves putting together the big picture? What advice do you have for them?

• 1:19:43Speaker 00

  That's, it's an interesting question. I can't give advice for journalists anymore because the world in which I grew up no longer exists. I once would have told anybody to go work on, and maybe that's, maybe, maybe that's leading me to the right answer. But the world in which I grew up, the journalism, no longer exists. And so to go off and be a writer, um, back when I did it, you know, you could get a job at a magazine and you could take home a paycheck that would enable you to cover your rent. And if you were like me and didn't have any family money, then you needed that. And so the idea now of telling somebody to go off and pursue a career as a writer, well, you don't have any other source of, um, source of extra support. That it's, it's a lot more difficult than it, than it, than it, than it once was.

• 1:20:24Speaker 00

  But actually, from me, I think that does lead to a better and deeper answer to your question, which is that, right, don't allow yourself to be seduced by the quick ease of PowerPoints and. Putting together bullet points, force yourself to, when you're dealing with something complicated, force yourself to write it out. And maybe that would be different for other people, but for me, writing forces a level of intellectual honesty and a clarity about the big picture that nothing else does. It's really hard work. I've never understood people who say, I just love to write. It's so fun. It's difficult things you can do because to write clearly requires thinking clearly. And thinking clearly is really, really hard

• 1:21:06Speaker 00

  things for me. But it is, it is really only in writing that I realized that I didn't understand something that I was pretending to understand. And so it's really easy to pretend to yourself that you understand something. And if you have to write it and write it clearly in a way that somebody else can understand it, that often forces you to, that forces you to realize your own, your own lack of comprehension. And I think that exercise in terms of an understanding of the world and a chance of seeing the big picture is really, really critical. Maybe there's something for somebody else that would work that isn't writing. Maybe it'd be trying to turn the world into a math booth, you know, but, but there is, I, for me, that's what it is.

• 1:21:48Dwarkesh Patel?

  Yeah, yeah. And final question, what is your next book about? And when will be, when will we have the pleasure to read it?

• 1:21:56Speaker 00

  I hope it's a pleasure. I'm not sure at this point it's going to be a pleasure. So I'm writing it with Joan O'Sara, again, who I wrote All the Devils Are Here With. And we set out to write about the economic consequences of the pandemic, but it's really become a broad look at how capitalism is and isn't functioning in our, in our modern society. And then underneath that, a look at how government is and isn't setting the right rules for capitalism to function. Because back to your point about being a libertarian.

• 1:22:27Speaker 00

  I do think there's this lovely idea that markets exist independently of the rules set for them by society, but I'm not really sure that that's true. If you think about everything from the existence of a limited liability corporation to bankruptcy law, these are all rules laid down by society that dictate how the market functions. And so in the end, if the market isn't functioning the way we want it to, chances are it's the result of the improper conditions having been set. So that's what the book is turned into, is a way of looking at the flaws in capitalism, even leading up to the pandemic, and how those were exposed and exacerbated by the pandemic.

• 1:23:06Dwarkesh Patel?

  Yeah, okay, I'm really excited to read it. That's an exciting piece. Do you know when it's going to be out, by the way?

• 1:23:12Speaker 00

  October 2023, yes.

• 1:23:14Dwarkesh Patel?

  Okay, you'll have to come back on the podcast.

• 1:23:17Speaker 00

  I would love that.

• 1:23:19Dwarkesh Patel?

  Awesome.