Invest Like the Best with Patrick O'Shaughnessy - Bethany McLean - Business Gone Bad and the Art of Persistence - [Invest Like the Best, EP.96]

Episode Date: July 24, 2018

I’ve often heard that good investors are a bit like journalists: doggedly collecting evidence and building an understanding of how all the pieces of a company or investment fit together. My guest this week is one of my favorite writers and journalists, Bethany McLean. Across her career, Bethany has covered many of the most interesting stories in business and investing, including Enron (which became the famous book and documentary, the Smartest Guys in the Room), Valeant, Wells Fargo, SAC Capital, Fannie Mae and Freddie Mac, the great financial crisis, and most recently, fracking and the energy revolution. Given how deeply she has investigated all of these topics-- and thought about the common threads across them all--this was an amazing conversation. When talking to her, you can feel how much she cares and how diligent and fair she is when analyzing a topic. In addition to all of the great stories already listed, we discuss the art of persistence and other lessons she has learned about businesses and people gone bad. I especially loved her evolving take on housing in America. Please enjoy my conversation with Bethany McLean   For more episodes go to InvestorFieldGuide.com/podcast. Sign up for the book club, where you’ll get a full investor curriculum and then 3-4 suggestions every month at InvestorFieldGuide.com/bookclub. Follow Patrick on Twitter at @patrick_oshag   Links Referenced The Hunt for Steve Cohen   Books Referenced Free Radicals: The Secret Anarchy of Science Saudi America: The Truth About Fracking and How It's Changing the World Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy All the Devils Are Here: The Hidden History of the Financial Crisis   Show Notes 2:22 - (First Question) – Differences and similarities between investors and journalists 3:19 – What has more of an impact on business practices, exposing negatives or reporting positive 4:57 – first story that got Bethany intrigued with finding bad behaviors 6:19 – The process of getting to know the people who know more than the market 7:43 – Mindsets: Optimism vs. Complacency vs. Pessimism 8:18 – First short seller that garnered her interest 8:57 – The process that led to The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron 10:36 – How to ask questions 12:18 – Importance of preparation 14:20 – Difference between a visionary and a fraud 15:42 – Free Radicals: The Secret Anarchy of Science 16:23 – Any standout frauds that told a really compelling story 17:33 – Looking into Valient 19:32 –Writing about the #MeToo movement 19:34 - Disgraced ex-BofA exec raises uncomfortable questions about #MeToo 21:49 – Thoughts on the spectrum of chasing this story 23:26 – Ways journalist can fairly impact this movement 24:14 – The romance of owning a home in America and what it has meant for the market 24:34 – Shaky Ground: The Strange Saga of the U.S. Mortgage Giants 28:27 – What has changed on her thinking about housing 30:24 – What role does Fannie and Freddie have in the market today 31:13 – Her desire to look into energy 32:26 – Saudi America: The Truth About Fracking and How It's Changing the World 35:05 – What have been the changes in energy market in the US 34:40 – Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy 37:01 – Where are we in the life cycle of energy production 38:29 – Technologies that shaped industrial revolution in America 41:10 – Why is Peter Elkin the best investigative journalist 42:24 – Most relentless she has ever been 43:58 – Who is doing it right 44:38 – All the Devils Are Here: The Hidden History of the Financial Crisis 45:36 – Her take on reporting the The Hunt for Steve Cohen story 49:01 – How her views have evolved over her career and lessons learned 50:40 – Are there ways to prevent success from leading people down a bad path 53:48 – The role of empathy in her career 55:13 – Kindest thing anyone has done for Bethany’s career

This podcast is sponsored by CFA Institute, the Global Association of Investment Professionals whose mission is to lead the investment profession by promoting the highest standards of ethics, education, and professional excellence for the ultimate benefit of society. CFA Institute serves a global community of investment professionals working to build an investment industry where investors' interests come first, financial markets function at their best, and economies grow. The chartered financial analyst credential is the most respected and recognized investment management designation in the world.

The views expressed in this podcast do not necessarily represent the views of CFA Institute. Hello and welcome, everyone. I'm Patrick O'Shaughnessy and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, methods, stories, and of strategies that will help you better invest both your time and your money. You can learn more and stay up to date at investorfield guide.com. Patrick O'Shaunisee is the CEO of O'Shaunicee Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of O'Shaunsi asset management.

This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of O'Shaughnessy asset management may maintain positions and the securities discussed in this podcast. I've often heard that good investors are a bit like journalists, doggedly collecting evidence and building an understanding of how all the pieces of a company or an investment fit together. My guest this week is one of my favorite writers and journalists, Bethany McLean. Across her career, Bethany has covered many of the most interesting stories in business and investing, from Enron, which became the famous book and documentary The Smartest Guys in the Room, to Valiant, Wells Fargo, SACP, Fannie Mae and Freddie Mac, the Great Financial Crisis, and most recently, fracking and the energy revolution.

Given how deeply she has investigated all of these topics and thought about the common threads across the mall, this was an amazing conversation. When talking to her, you can feel how much she cares and how diligent and fair she is when analyzing a topic. In addition to all the great stories already listed, we discussed the art of persistence and the other lessons she has learned about businesses and people gone bad. I especially loved her revolving take on housing in America. Please enjoy this great conversation with Bethany McLean. I've heard a lot from a lot of investors, especially short sellers, that investing is kind of like journalism

in the sense that you're trying to understand and construct a narrative and understand sort of every aspect of it. Have you found it interesting to interact with investors, maybe even specifically short sellers, as you think about business? Oh, definitely. That's one of the great pleasures of doing this is all the highly intelligent and interesting people you get to meet. And I couldn't agree with that more. I think the process of thoroughly researching and investment is really analogous to what I do. I think the focus in the end is different. I'll have more of an interest in the characters and the narrative, whereas they, have to have more of an interest in the numbers. And then the real difference is just what's actionable at the end of it. For me, it's creating a story out of it, actually creating a narrative,

whereas for an investor, it's putting your idea to work. And I have never had any interest in that. Yeah. A common theme, you know, having went back, it was fun to go back and read your catalog, read articles, et cetera. Obviously, a common theme is business has gone bad or maybe even like negative type stories, people doing bad things. I'm curious philosophically if you think that that does a greater service and catalyzes more change than positive stories or journalism. Oh, I wish I had a larger philosophical thought like that driving what I do. But I think that my, I think you're right. I think I have made a career out of sort of business gone wrong. But it actually wasn't really intentional. And in a way, when I first started working at Fortune, I wrote this column called

Companies to Watch, which is essentially a stock picking column. And I was supposed to pick three stocks every two weeks that were going to double, triple, quadruple, in value, you know, in the next six months or so. And it was incredibly easy to do that because there were no shortage of people coming by fortune in those days, from executives who ran businesses to portfolio managers who own the stock, to analysts who had buy ratings on the stock. And I had no cynicism and no skepticism in those days. I thought somebody was saying it and they were smart, so it must be true.

And I'd write up these stories only to kind of watch in horror as the stock would go in the opposite direction. And sometimes my phone would ring and it would be someone who was short the stock who would be like, basically, you idiot. How could you write something like that? How could you be so clueless about this company that is clearly a fraud or, you know, clearly at best hope and dreams being sold as reality? I just don't like being wrong, I guess.

And so I've sort of accidentally developed this focus on business gone wrong. But I suppose it does play to play to part. I just like to figure things out. And so often when things have gone wrong or when things are going to go wrong, there's more to figure out. What was the very first business that met this marker that first got you intrigued about something that was going wrong? Oh, boy, I'm going to struggle to remember the name of it. But back in the day at Fortune, there was a telecom company that I did a short piece about. And I can't believe I'm not remembering the name, but it was during kind of the heyday of telecom companies in the late 1990s.

And there was something wrong with how this company was booking its fiber sales. And I remember doing this piece with the help of an investor had called and said, you should take a look at this. And it was satisfying to go against the grain and to feel like I was doing a service for people by putting out a viewpoint that they weren't able to get elsewhere. Whether that viewpoint was right or wrong, at least it was well-reasoned. And it was something that they weren't able to get by reading Wall Street research or reading the regular papers because that viewpoint was nowhere to be found. And I guess that is one of the things I've always found fascinating about this, is that. that we think this is a world that's awash in information. And it is, but selective pieces of information only travel in very small circles. And often when there's a skeptical thesis about a company,

it is well known in a very small circle of people who have done the work. And the story that's out there that's available to most investors is not that story. And so I do feel like it's a worthwhile service to put that out there. I'd love to talk through that process because it is amazing, given the amount of information that grows each year, that all of us investors have, access to data on companies, that there still are the Theranosus of the world constantly. And it just seems like that's never going to chain. There's always going to be these examples. So maybe talk through, generically, that process of, like, what are the early markers that you look for? You mentioned curiosity is kind of the original driver. But maybe you could use an example or just kind of talk

through it generically. The process itself of getting into that small circle of people who may know more than the rest of the market. Well, I think it started for me back in the late 1990s because I was just so tired of being wrong that I thought, well, if there is this, if there is another side to this, I want to know in advance. I want to figure that out. So I started trying to get to know short sellers. And I find them fascinating people because there is usually a highly emotional component to what they do, too. There's a sense of there's a crusader type element to the personality, a sense that, a sense of righteousness, which can be dangerous in and of itself. But usually for me, I guess it begins, with a company that's at the center of something and is being celebrated for something, and there's

something wrong under the surface. There's something that doesn't add up. Either people don't understand it, or there's something that isn't being explained. And it just never fails to amaze me how often it is people are willing to believe in what they don't understand. I read a fascinating piece by Morgan Hustle the other day, and he pointed out that to be an optimist, you have to believe in things that you don't understand, because sometimes the inexplicable is just, just the thing that's one step ahead of all of us. And so if you're never willing to believe in something you don't understand, maybe that's a problem too, or mark of a specific personality set, but it never fails to amaze me how often that is. So that's usually the sort of thing

that draws my attention. Yeah. Celebration as a marker is a really interesting idea. Certainly Theronos, obviously the CEO is all over the place and being celebrated like crazy. And I guess if you look back at a lot of the things you've written about, the same could be said. Pretty interesting. Who was the first shortseller that really caught your interest and you developed a close relationship with? I guess it was probably Jim Chanos and a guy who worked for him at the time who has since passed away named Doug Millett. And I met Doug and just hounded him relentlessly because this was, I guess, the late 1990s. And I knew who Jim Chanos was. And wow, I wanted to have access to how he thought.

And so I called Doug maybe every week for like six months. What are you guys working on? And he hadn't anything interesting? And finally he's like, oh, man, we're doing some work on this company called Enron. You tell me if you can figure out how it makes money. How long was that what became the smartest guys in the room? How long was that process start to finish? It was.

I guess in total it was a really lengthy process because I probably talked to Doug and then to Jim at the end of the year 2000. And I ended up publishing a piece in fortune, which I joked should win awards for the meekest title in business history, which is Enron overpriced. Yeah. Anyway, and I think that piece was published in February or March of 2001. And Enron went bankrupt in the fall of 2001. And I started working on my book with a co-author at Fortune and that was ultimately published in the fall of 2003. So I guess, and all told, it was about three years. Is that the most memorable of the many experiences you've had with individual companies or people when doing kind of deep reporting? That's hard to say. I think it was the first for me. So it ranks right up there. Because I had never really, until that point, I don't think I would have considered myself an investigative journalist at all. You know, I was wonky and numbers-based, and I had written sort of quantitative pieces. I also did one on IBM in the late 1990s that sort of looked at IBM by the numbers, and now I'm remembering, as we talk, I'm remembering doing that piece, too.

But they were a wonky kind of numbers pieces. They weren't going out there and finding former employees and actually finding the human narrative of what had happened. They were purely numbers-based. So the Enron book, and my first Enron story was that way too. It was really, you know, I didn't talk to former employees. It wasn't that kind of piece. It was purely a numbers driven. Here's what the documents say kind of piece.

So the Enron book was really my first experience with trying to get out there and finding people who could add color to the numbers. So one of the things I've been most excited to talk to you about, just given this format, given that I talk to somebody interesting every week in this format, is how to ask questions and how to extract information from people that may be. they aren't originally willing to give or give you a deeper, more contextual story that is sort of of the party line. So I'm just curious about how that process for you has evolved over the years. If you started with Enron and you've done a lot of that ever since, talk to a lot of people

about some complex and interesting businesses and topics. Maybe some thoughts on your views interviewing people and just talking to people. Sure. So I think it's different by person because people are really different. So I don't think there's a one size fits all recipe. But I think it starts with you have to really, really care. And if you really, really care what the other person has to tell you because you're passionately interested in what it is that they know, I think that comes through and people respond to interest. But then there are all sorts of variations in people. Some people really want to talk and they think in narrative form and they already have something they want to tell you and want to share. Some people don't like to talk and you have to draw them out with very

specific questions. Some people will only talk once you know enough to ask really good questions. And so then you have to feel it out as you go. I did have this instructive experience early on. I used to tape my interviews. I don't very often for various reasons anymore. But I remember listening to one of my tapes. This was early on in my journalistic career. And the person would start to say something really interesting. And I'd break in with my own observation or my own question. I was like, oh my God, this is terrible. And so the other thing, I try to remind myself, and it can be surprisingly hard, but it's just to be as quiet as possible. And when you need to say something, when you need to move the conversation along or circle it back or loop back, then you do,

but you try to be quiet. Somewhere in an interview, there was a great line which I thought a lot about sense, which is just this idea of preparation, like to really get something out of somebody, you need to know a lot about their world or them in particular. Do you still generally find that that's true? Do you do that amount of preparation all the time? I do. You need to know what's knowable about them because I think there's nothing more off-putting than how. having asked for somebody's time only to show that you haven't done your work and you don't know what is readily knowable. It just creates a barrier between two people that you don't want to be there. I'd love to talk about sort of the end of a lot of the roads you've gone down, which is people and people

doing bad things. And talk about their motivations and whether or not there are commonalities that you see across, whether it's hubris or greed or kind of what the driving forces are that lead people to do really bad things. Are there any commonalities across that you can kind of pull on? I think it's an endlessly interesting topic because it's human nature. And if it were ever as simple as people knowingly doing bad things because they wanted to extract money from others, the stories wouldn't be that interesting at the end of the day. But they are always a mixture of some level of self-delusion, rationalization, maybe greed, but usually greed in the service of ego, not greed for money per se. Maybe some,

maybe some outright corruption, maybe even some idealism. I think a lot lately about what separates a visionary from a fraudster. And sometimes I think it's actually as simple as whether it works in the end or not, whether you're able to get away with it because it works in the end. But when people convince others to believe, they usually believe themselves. And I remember saying at one point when I was working on the Enron book, I was really struggling with this because I said someone I was very close to. I said, but Jeff Skilling, he believed. I'm having trouble with this. He believed. And this person looked at me and said, Bethany, the worst crimes in human history have been committed by people who believed. And so these themes about human nature resonate, not through business, but through human

history. And that's why I find them so fascinating. You mentioned this idea between visionary and fraud. This is a really interesting binary. And I'm sure that people listening will think about people like Elon Musk, probably is the biggest one of the news today. He's the most prominent example of it today, for Sure. So maybe we could use the story of Tesla specifically and a company that short sellers love to talk about, a company that believers, equity holders love to talk about. I'm curious your take on this as it's kind of playing out live where we don't know the outcome yet. Obviously, you could paint a picture one of two ways. You could. I have not written about Tesla, so I don't know enough to know. But I do find it. Elon Musk obviously says all sorts of things that aren't true and makes all sorts of predictions that don't come to pass. In those details, he is somebody you could see getting in trouble down the road. And if you read Ashley Vance's great book on him, the first half of it just lays out all the ways in which he skirted the rules, essentially lied to people, but got away with it. And so I think in this case, one of the lines between the skeptics and the believers is he's lying. He's not telling the truth.

This isn't happening. And the believers who think somebody who's that brilliant and has that big a dream, well, they're just all these details don't really. matter. The details are unimportant. You, you know, grungy little detail-oriented people who can't see the big picture. And it's really fascinating because that is exactly the crux of this debate. I just finished this book called Free Radicals, which is a really interesting book about all the frauds basically perpetrated by great scientists. And there's this great line in it by Isaac Newton's biographer who talks about him throwing clouds, I'm going to get it wrong, but throwing clouds of exquisitely crafted fudge factor in the eyes of his scientific opponents and says, basically

some of his most famous work was deliberate fraud. He knew he was right about the idea, and he just didn't want to, didn't have the math skills to back it up. And it makes you realize that this theme is larger like everything. It's larger than the business world. This idea of storytelling or narratives in business is just amazing because of the power that it can create. Like literally, you can create something from nothing with a great story and create your own momentum. Looking back on all the things you've investigated, was there a moment where there's sort of this visionary fraud, like you're not sure that stands out in Is there a person or a situation where you really didn't know?

Well, I don't know that I can answer that at the moment in time, but looking back at it, it's fascinating if you think about Enron because Enron broadband, which was a fraud for all intents and purposes for the nitty-gritty reasons that short sellers focus on, reporting of profits that were basically manufactured out of thin airs, lies about the status of the business, but Enron broadband was Netflix. I find that incredibly interesting because if it hadn't been, for all the other manifold problems in Enron's businesses, perhaps they would have gotten away with it. And so it's unclear. I'm not sure. I wish I could identify that pivotal moment where you can tell

the difference between who's a visionary and who's a fraudster. But I sometimes think it's only clear in retrospect because the luck of whether or not at all works, whether or not you get the time for it to work, whether or not things break your way or don't break your way is often what determines it, not the actions themselves. That's a cynical view I know. And I'm still thinking through it, but I wonder about them. What was your experience looking into Valiant? The Valiant story is a fascinating one for me, because the big thing that is different about Valiant and Enron, even though they are similar in some ways, but the big thing that is different between the two is that in the case of Enron, what we usually think of as the smart money, the big

smart hedge funds, who we all know, they were all skeptical. In the case of Valiant, there was a big divide in the investment community. And some of the smartest investors out there were big believers and Valiant. And it was a part of the story that I couldn't understand as I was working on, and I still can't understand today. And when I say that Valiant and Enron were similar, what I mean is that they both had the same attitude toward the rules, which is that the rules were meant to be manipulated. The rules were meant to be used and manipulated and stretched to their limits, not followed in any kind of linear way. And of course, both Mike Pearson and Jeff Skilling were McKinsey alum's, which is another fascinating element. But that to me was the mystery of Valiant. I remember

sitting with an investor who was a believer in Valiant, a very smart investor. And it was right at the time the Martin Shacrelli stuff was breaking. And he was commenting on what an absolute jerk Martin Shacrelly was. And I said, but why is what Valiant's doing any different? Any thought for a minute? And he said, well, that's a really good question. And it was interesting that the behavior that in one person people saw as utterly reprehensible somehow was acceptable in the case of Valiant. And I think part of that is that Mike Pearson managed to spread this veneer of efficient capitalism over the whole thing. You know, we had these arguments, well, insurance is going to, if I raise the price of these drugs, insurance is going to pay for it. And for the people

who don't have insurance, we'll figure out a way to get it to them. And the cost of cyprine is still cheaper than the cost of a liver transplant. So in a capitalist economy, that makes sense. And those arguments just made people lose sight of this basic idea of right and wrong, which is sometimes more fundamental than any of the sophisticated arguments you can layer on top of it. You wrote a really interesting article. I think it was for Yahoo Finance recently on, I'm going to blank on his name, but I think it's Omid Malik at Bank of America. And the much more nuanced version of the stories that have emerged around this Me Too movement, would be fascinating to hear your perspective on writing that story, how difficult it was to kind of tow that line and what's

become, you know, obviously a really important, hopefully force for good, but maybe highlighting how complicated these things can be. Right. Well, that was an incredibly difficult story. And I tried to highlight in the piece that there was a lot I didn't know. I know I didn't know things. And I still worry that he is a much worse guy than I knew. But the piece raised some issues I am really interested in, which is this idea, can you be fair to women, for whom, particularly the world of finance, has never been at all fair to, and still be fair, or maybe a better way of putting it, can you be fair to the person who is the accuser and still give a fair process to the accused? What's the right degree of publicity around somebody who is pushed out for,

for Me Too reasons? Do they deserve to have their name splashed across the press and their chance of future employment completely destroyed in today's world, especially when it's not clear what the sin was. What's the line in all of these things? And how do we think through it? And I think the stakes are very, very high because you probably talk to people. I talk to people, particularly at smaller shops that are run by an individual founder who say, why would I hire a woman if there's a equally competent or almost as competent man? Why would I take that risk? And those comments are incredibly frightening to me. And if the process, if we don't figure out a fair process for dealing with this, and I've had women say to me, the world's been unfair for so long, what do you mean it has to be

fair? But I think the repercussions are high. So it's a whole bunch of very thorny philosophical issues that I've been wrestling with. I worry that the Omed-Mallet case is a very complicated one and perhaps was not the right issue to explore just because there's so much I don't know. It was a strange process because as I worked on the piece, I became more and more aware of what I didn't know. And that is the scariest thing for a journalist for anybody, right? When you know you don't know things. Yeah, rather than go into the details of the story, I would just highly encourage people to read the story itself. But it made me really think about this interesting spectrum of when you've got at core a movement, which is obviously about something right and something that needs fixing. And then the question is,

okay, how do you implement that change? And so I would just like to hear a little bit more about your thoughts on the spectrum, right? Because on one end, I guess the fears becomes McCarthyism. And on the other end, everything is done well and bad people are exposed. So do you have any philosophical thoughts on how to attack this problem or what we can be better? I wish I did. I think it's really complicated. And I'm worried that there's not a way to be fair to accusers and also be fair to the accused. Because if you are somebody bringing a complaint against somebody who's powerful, you don't necessarily want to be identified. You don't necessarily want the details to be public, it's really, really hard to speak up. Yet, on the other hand, if it's going to

destroy the person who's being accused, not only their current job, but their potential to get employment again in today's world, get them kicked off boards of charities that they've been involved in, et cetera, et cetera, shouldn't the details, shouldn't the specifics of the accusation be knowable so that the person can defend against it? And I think it's a really hard bar for the press, but I feel like you have to have, the details from somebody in order to report it, the specific details, even if they are anonymous, but at least you have to know the details instead of just generic. This person is part of the Me Too movement, but we don't really know why. But I think it's a really hard line to find,

and I worry there isn't a way to be fair to both. Apart from just very clear, detailed, honest reporting, do you think there are other ways that journalists or non-journalists can positively affect this entire movement? Well, I think it is, and I think it's up to the individual journalist, but I think by finding a line as to what should be reported and what shouldn't. And I guess in my mind there's a temporal aspect to it, quantitative aspect to it, and a severity aspect to it, by which I mean if something happened 20 years ago and it's one person and it's an allegation that they said something inappropriate,

you know what, maybe that doesn't need to be reported. If it's something that happened two years ago and it's really severe, and it's 10 people saying it, then yes, obviously. But again, where you find the line in those things, I don't know. So a common theme across, as I was reading your books and articles, is just the power of institutions, institutional inertia, complexity around institutions, et cetera. I'd love to talk about home ownership specifically.

This is a topic that I know you love and have explored in some great detail. I really enjoyed this short book you wrote on Fannie and Freddie. And this is a bit of a wonky topic, but I just think it's so interesting because beneath it all is this romance that the U.S. has with owning homes. And maybe we could start with that very high-level idea of that romance, where it came from why we are different than the rest of the world in our desire for homes, how we finance, how we finance, et cetera, and then talk about sort of the current implications of that.

Sure. So one of the things I was fascinated by when I did that book, and thank you for saying you liked it when I remember when I went to a Goldman Sachs conference on housing finance when I was reporting the book and the Goldman Sachs PR guy was like, what are you doing here? I was like, oh, I'm writing a book on Fannie and Freddie, and he was like, why? There is something about the topic that strikes most people is so wonky that even if they think they should be interested in it, they just can't. So anyway, but one of the things I was fascinated by is that this romance with homeownership really goes all the way back to the 1800s, the beginning of this country. It's been something

that president after president has stressed. And I think part of it was the belief that in a sprawling, disparate country, ownership of land and ownership of homes was something that would unite people and literally give them a mistake in this country. So I'm sure it has something to do with this being a nation of immigrants and a nation of immigrants from very different places that you actually, there was a need for a stake in the land itself in order to unite people. And then the creation of Fannie and Freddie and the ways in which our housing system essentially became sort of, and the irony of the world's most capitalist economy, at least in theory, having a government-supported housing system is huge, right? And the way in which that happened is fascinating,

too, because it's sort of accidental. And I always love things that have come to seem inevitable, but were actually accidental in the way they were structured. Can you describe what the accident was? So in the wake of the Great Depression, nobody could get homes, and there was this need to figure out the housing market. And mortgage finance had always been a huge problem in this country because it's so huge. So a local bank may not have the capital at one point in time to be able to extend a mortgage to people, whereas a bank somewhere else would have, but mortgage rates varied wildly by where you were located, the availability of capital was completely random. And so there is this idea that you could set up an institution that would buy all the loans and buy up all the loans

from all the lenders around the country making them, and therefore capital would always be available and interest rates would be more uniform. But the fascinating thing was, was it was supposed to be a private company, but the private market wasn't interested and wouldn't step up to the plate. So it became the government. And that's how Fannie Mae was born. And then Fannie Mae was essentially an arm of the government for a really long time. And it was privatized during the Vietnam War as a way to basically get it off the budget. So there were always these games with numbers that were part of it too. I mean, it wasn't privatized as any sort of grand philosophical thing. It was purely just strategic and not even really strategic, I mean purely just playing with the numbers,

right? And so out of that was born this oddly hybrid creature that had all these elements of the government, including this notion, which I think is just also one of the best things ever, which is this concept of an implicit guarantee, the idea that Fannie and Freddie were backed by the government, except they weren't really. I mean, how crazy in the annals of finance, right, The idea of an implicit guarantee is just insane. So I found the two companies just completely fascinating. And I've also been interested in my own evolution on them because I first wrote a really critical story about Fannie Mae in 2005 for Fortune when it had first come under fire for all these

accounting irregularities. And I thought there's absolutely no reason for these two horrible companies to exist. And some of that's true, but I've changed my mind about some of that. over the ensuing 15 years as well. What's changed specifically? What do you think they're going on? So I think one of the things I've realized is that it's a little bit like that old Winston Churchill quote, I think, which is that capitalism is the worst possible system

with the exception of everything else that's ever been proposed. And I think the same is sort of true about Fannie and Freddie as you think about. They're a horrible solution, but they're better than everything anybody else can come up with. At the end of the day, I think whatever you may think of this concept of homeownership, It's deeply ingrained in our psyche, but it's also deeply ingrained in our practical economic realities, which is that it is how most people have funded their retirement, right? And if they haven't funded their retirement, at least people have gotten to retirement with a place to live. And if you strip that away and you don't subsidize homeownership, but you continue not to have a European-like welfare net for older people, what do you do?

How do you take one away without replacing it with something else? And homeownership as a forced savings mechanism has actually worked pretty well until the financial crisis. And so if you're going to get rid of that or change it radically, you better have a plan for the whole rest of it. You can't just take it away and then say, great, we've gotten rid of this concept of homeownership and we don't have any government involvement in our housing finance system anymore. Aren't we great? So I think that's one aspect of it that I think about a lot. And the other is that Fannie and Freddie have also worked really well. And this could be a criticism in some ways, but to make mortgages a kind of egalitarian thing,

and yes, there are differences for jumbo mortgages. The very wealthy can get much lower rates than you could through a conventional mortgage, by which I mean a mortgage that can be sold to Fannie and Freddie. But overall, for the great swath of American homeowners, Fannie and Freddie have created a pretty uniform mortgage rate, no matter what your income level and no matter where you live. And I actually think that's an achievement. And again, one that if you're going to get rid of, you better think about what the social consequences are of that.

It's amazing when I was reading the book that homes are typically someone's primary asset. We spend an enormous amount of money on them, all of our time in them. But no one really understands the system behind them. There's a great line in the book that says, it was a quote from somebody, something like, you know, the rest of the world, which I think has much shorter duration, much more variable rate mortgages, is socialized health care, but then private market, homeownership, and we're sort of the inverse. And I'd never really thought about it in those terms, right?

These are incredibly important things. And it really is a differentiating aspect of U.S. economic structure and life. What percentage is of mortgages that are ultimately bought from the banks by Fannie and Freddie today? By lenders from Fannie and Freddie? I think it is close to, it is still close to 75, 80%. I haven't looked at the numbers and not just Fannie and Freddie, but the FHA and Jenny too. But it's a huge number. I mean, the private market, we're a decade out of the financial crisis and the private market,

by which I mean mortgages that are made and then sold to Wall Street in order to be packaged up into securities, that market really hasn't come back. And you can blame all sorts of things by that. But that's the other thing that the financial crisis showed, which is Fannie and Freddie always said, great, Wall Street, you can package up your own mortgages. But as soon as the economy turns bad, as soon as there's a crisis, you'll be gone. And we'll be the only thing that's left. And people who are skeptical of Fannie and Freddie always said, bullshit, that won't happen.

They'll always be a market for mortgages. And you know what? Fannie and Freddie turned out to be absolutely right. Because when the financial crisis hit, if we hadn't had Fannie and Freddie, the crisis would have been a million times worse because the entire mortgage market in this country would have shut down. People wouldn't have been able to move. They wouldn't have been able to sell their homes. It would have been of a magnitude worse. And so that actually turns out to be true, right? The private market likes the mortgage market in good times. And as soon as times turned bad and that money doesn't have to be here, it's gone. So I know you've just completed another interesting investigation into something like the housing crisis that has contributed to a lot of the volatility in markets and business in the last couple

of decades. And that's the world of energy, specifically U.S. fracking. I think the book's called Saudi America, which is a great title. I'd love to just hear a little bit about why you got interested in that. It sort of stood out in your list of things you've explored as somewhat unique and different from some of the other things you've looked into. So talk to me a little bit about what got you interested in that and maybe some of the major conclusions having investigated. It was funny. We were having a dinner party at our house,

and the subject of my book came up and my husband was just shaking. He said, only my wife, housing finance, and then fracking. Seriously? It was something I was always interested in. I found Aubrey McClendon, an incredibly compelling character. And I couldn't get to write about him, because I think there's this little bit of a barrier that everybody on the coast is fascinated by what's happening in Silicon Valley and sees that as the driver of the American economy. And I was like, No, no, wait, you guys, this thing that's happening in Texas and these grungy areas of the economy that we don't want to look at, this is far more important for the future of this country than what's happening in Silicon Valley. And so we need to look at this and delve into it and understand it. And I was looking for an excuse to learn more about it and to try to figure it out.

And I was fascinated by the contradictions in McClendon's story because he essentially most likely died broke after being a multi-billionaire, did so much to reshaping. the face of an industry, yet the company he left behind struggled to survive, and it burned through capital. I mean, it burned through extraordinary amounts of capital to the tune of, you know, tens, 20s, 30s, billions of dollars. And that, it's emblematic of this wider story and of a less understood aspect of the fracking revolution, which is how dependent it's been on low interest rates in the wake of the crisis and the availability of capital to fund it, because these companies don't produce free cash flow. They don't fund themselves. And that's just this fascinating conundrum at the heart of this, that this thing that is terrorizing the world and, you know, reshaping our economy,

hasn't yet proven that it's really a viable business. Can you give a little bit of an overview, maybe for those less familiar, of what that revolution has been? So we know how it's been funded, which is really, really cheap capital. But the energy situation in the U.S. today is drastically different from, I can't remember the name of the author that published the book on Twilight in the Desert on peak oil. And things have just literally could not have gone differently than he forecasted. So talk about what that change has been, what's driven it, and kind of why it's so interesting. Starting there, that's one of the things I learned, which is just so fascinating to me,

is that there is nothing like the energy market and the oil market and specifically to show up the fallibility of forecasts. Because everything anybody says is wrong. It's just the only thing you know about it is that it's likely to be wrong, no matter how solidly reasoned and totally thorough, it seems at the time. I'm wrong. So, yeah, when you think about the change over the last decade and it's really solely a result of this new technique of fracking, which is really kind of the combination of two techniques, which is horizontal drilling, having a drill go horizontally instead of vertically, and then fracking in order to get molecules to flow that wouldn't otherwise have been able to flow, has completely changed the global picture. We used to think we were running out, peak oil,

and we used to think we had no natural gas, and we're running out of natural gas. And now the estimates are we have enough natural gas to last 100 years. And we've started to export the stuff, both the natural gas and the oil, which was unfathomable a decade ago that we would ever have enough to export. And it's totally, the availability of cheap natural gas is completely changing power generation and industry in this country because the U.S. has one of the cheapest sources of natural gas globally. So it changes our industrial picture going forward. But there's this contradiction at the heart of the whole thing, and it's best summed up by a a quote I have in the book from my pal John Hempton.

He and his partner used to have this debate, and his partner would say, the oil and gas is real. It's there. And John would say, yeah, it's real, but the economics don't work. And so that's kind of the conundrum at the heart of this, which is that because the economics of fracking are tough, the decline rates on the wells are really high, so it requires constant, constant reinvestment.

It's really hard for these companies to produce free cash flow. And so they've required, in order for this fracking revolution, to take place and for the immense quantities of oil and gas to be coming out of our ground, it's required the availability of cheap capital, both in the form of debt, thanks to the Federal Reserve's low interest rate policy, but also in the form of pension funds desperate for a return, right, who have been willing to put money in private equity firms and into credit-oriented hedge funds that have helped supply capital to these companies. Where do you think we are in that life cycle now? I'm not asking you to make a prediction,

but maybe just a set of observations about, you know, the current state of things, maybe when you finished your research process kind of relative to that was that was a super frustrating thing about the book because I wanted to come up with an answer and that was part of the motivating factor behind it was okay how is this going to shake out and I realize that's totally impossible and it's totally impossible for a couple of reasons one is that you can't predict the price of oil or of natural gas so what doesn't work at $60 a barrel would work at $150 in barrel for sure right So to say this doesn't work is to say you can predict the future price of oil. And the one thing I learned is that I'm sure as hell not doing that.

And then the second component of it is, I guess there are actually three components. The second component component is there have been huge technological improvements in fracking and the technology of getting this stuff out of the ground and the cost does keep coming down. And so to say this doesn't work economically is also to say there will be no more technical progress. And that you can't do either. And then the third thing is that the history of the fracking revolution is that it has been way more resilient than its detractors ever believe. This was supposed to be done when Price has cratered in 2015 and 2016. And yet it came roaring back.

And so it's a short history. It's only a decade-long history. But the history so far shows don't underestimate these guys. I've finished an interesting book actually as part of the process for thinking about this conversation, which was the technologies that shaped the industrial. Revolution in America and this idea that the two most important things are our source of energy and what the author calls are prime movers. So the way that we basically move stuff. It used to be our own muscles and horses and it evolved to, you know, steam engine and steam turbines and the internal combustion engine and all these things. And I think people underestimate this whole

idea of fracking and energy, the importance of the fuel source, the importance of little boring things like air conditioning. And ultimately these are the drivers of maybe more so than the next Silicon Valley, you know, scooter company or whatever. These are the drivers of our economy. They are. And a person who was a fracking entrepreneur sent me a picture, a map of the economies of Haiti, I think, in the Dominican Republic, you know, one where there is energy and one where there is not much.

And the difference in living standards between the two countries. And whatever you say environmentally, it remains the case that hydrocarbons, energy, have been the surest way to change the standard of living of a population. throughout access to hydrocarbons. And so that's something. Think about however you wish, but it's a fact. For people that are, because this is an interesting investing question, right? Like if this continues, let's say that interest rates don't rise or the availability of capital doesn't crater so that, you know, we can continue to be, let's say, energy independent or even exporters of energy. And people are interested in how this might affect other things in the U.S., industry, other

sectors of the economy. Any other thoughts there or places that you might recommend people go to read because that could be an enormous sort of secular trend that affects people's investment. Well, it could. I think what people are struggling to figure out in people who are much more well versed in this than I am, because there's another thing out there that changes this entire picture, which is renewables, right? And what the onset of renewables and when it's coming, because as soon as it does, the price of both oil and natural gas goes into a secular decline, just as it did with coal. As soon as you can see the end of the era of non-renewables, then the whole picture changes. We can't see when that is, but we know it's coming. So that's another factor that

influences these. And the factors that go into when renewables will be able to take over the world are as immensely complicated and calculus as the price of oil. So there's no real way to figure that out. Did you spend time on that on renewables? I tried to. I spent a little bit of time, but that was one of the crazy challenges of this book, which is that every little piece of it, Instead of just being a paragraph, could have been a book in and of itself. So I went down way more of a wormhole than I had realized I was going down when I started it. So I'm going to take a jump because of a line that I saw somewhere in an interview that you gave, which I want to make sure I get the guy's name right.

You said a gentleman named Peter Elkin was the best investigative journalist you knew. I'm curious why that was the case. So I don't know who Peter is, but high praise. Peter was my co-author. I'm the smartest guys in the room, a longtime fortune guy. And when the Enron story broke, it was our mutual colleague, Joe Nocerra, who was like, you have to write a book. And I was, I think, 30 at the time and had done maybe a couple of 3,000 word pieces for fortune as the longest things I had ever written. And so if I've made one good decision in my life, it was not trying to do the book by myself.

Joe said, why don't you work with Peter? He's based in Texas, and he's a great investigative journalist. And I remember thinking, great, I'm going to learn all the shortcuts for doing this from Guy, Guy, who's the best. in the business. And one of the things, I guess the best thing I learned from Peter is just doggedness. You just, you call everybody who you think might talk to you. If they don't talk to you, you call them again. And you just don't give up. Just doggedness and relentlessness and just turning over every stone to see what you might find underneath it. And there's nobody better than Peter at that, to a degree that I can't copy, even though I watched him do it. But there is

nobody better than Peter. What is the most relentless that you've ever read? I guess I'm pretty relentless on almost everything I work on in terms of trying to find answers to how things work, I will give up on a specific person before I think Peter would. I'll call somebody a couple of times and then I'll call them again when I have more information that might get them to talk, but I won't just call them every day until they talk to me because they just want me to go away. I guess I was pretty relentless when I did a story on Microsoft. I had been told that Balmer and Gates were no longer talking to each other and there was a feud between them and this was a few years ago, but I couldn't use it unless I could learn it from myself. And it was very, very difficult to get Microsoft to cooperate with a story and to get to Balmer who had left a CEO a little bit before this piece. And I think I worked on that story for over a year. How did you get to him? I finally convinced Microsoft that I didn't have it in for them and that I was willing to listen.

And after spending time there, I got to meet Sacha Nadella. And I think for them, it paid off for them to have trusted me because a story that could have been how Microsoft is doomed actually ended up being quite a bit more nuanced and I think correctly so, because Nadele is an incredibly impressive leader and probably what Microsoft needed. And that helped me understand the culture and meet enough people that I was able to talk to Balmer finally. We've talked a lot about companies that have gone wrong.

What's the most impressive company that you've ever seen? You know, I'm almost frightened. I don't think I could answer that because unless I've really looked at it, you don't want to say. I mean, these past couple of years have been a string of the most admired companies that you would have thought were doing things right,

and we found out how hollow that was from Wells Fargo to General Electric, right? So I guess rather than answer that with a specific company, I would say that I think there are a lot of people out there, particularly in small businesses who are doing their best to do it right every single day. And I remember coming across when I was working on my book about the financial crisis and everything was negative. Coming across this guy named Dave Zitting, who ran the small mortgage broker out.

at the time small in Arizona. And he had gotten into subprime lending. And after about a year in it, he shut it down because he was just like, you know what, my borrowers, I can't, he was selling the loans onto a bigger buyer. And they were like, just get us the loans. We don't care. And he was re-underwriting them at his office. And he was like, but these, my borrowers can't pay these back.

These don't make sense. And so we shut down the business. And then he watched for like a year and a half as all of his peers totally eclipsed him and, you know, had private jets. We're buying islands and he was just plotting along in the regular old prime business. But he was right. He was right. And I think people make those decisions all the time in ways we never know about those

absolutely right businesses. They look at their customers and they say, this isn't right for my customers. This doesn't make sense and they don't do it. And we don't usually find out about most of those stories. We've talked about ego and wealth and all these interesting potential drivers of people doing bad things. There's probably nowhere in the world where that is more concentrated than in the kind of cutting edge of the investment world. People usually call this hedge funds. Maybe that's not the right

word, but it's more of a fee structure than an actual hedging happens at a lot of these places. You wrote a fascinating story on what was then called SAC, now 0.72. And I would love to hear your take maybe on that story specifically, but more generally speaking, your kind of general impression of or take on the very competitive, very aggressive hedge fund world as it stands today, maybe relative to your long experience with some of the smartest best investors in the world. And oftentimes when stories are written about places like this, I know a lot of people who have done stints at 0.72. And to a person, they are unbelievably smart, unbelievably impressive. And for the most part, you know, great people. So I'm curious your take on looking at that world today

as it stands relative to your experience with that world through time. I've always actually had a pretty good experience with most people who are part of that industry. People are incredibly smart and usually really interesting and really interesting to talk to. And I have the great luxury of most of the time not having to cover that world directly so I can appreciate people for who they are and the conversations I can have with them rather than having to worry about that world. I think it is competitive enough that if you aren't awfully good at what you're doing, it's not like incompetent people are sitting there raking in these mammoth fees, right?

If you can survive in that world, then you're really good at. what you do. And it is viciously competitive and it is the choice among people who give hedge funds that money to pay those fees and to invest in something that is essentially a fee structure rather than an asset class for the most part. So I don't have any grand philosophical takedown of the hedge fund industry. I thought the SAC story specifically was fascinating because there were always rumors throughout the world and throughout the very sophisticated world. It wasn't as if it was just clueless prosecutors in the U.S. Attorney's Office and journalists saying there's insider trading here, that was always the rap on SAC among very sophisticated people who knew the firm well.

But what is fascinating to me about the story is the line between what's legal and what's illegal and what's a legal way to get information and what's illegal edge. And I think that line is much murkier than most people think. And I get really annoyed when I hear anybody say as, as Prie Barra, the then U.S. attorney did at the time, which is that we want to make the market fair for individual investors. We want to level the playing field. It's never level. There are people who have access to better information than you do. They spend there all day on all night doing this. It's not going to be fair. And I think pretending that there's a level playing fields and level access to information is actually a lie in and of itself. And I thought the SAC story raised these really interesting issues because you could have argued it two ways at the time, right? One, one, was if you can't get this guy for doing something blatantly illegal himself, then do you try to go through the back door and destroy his firm? Or the flip argument is we've all been told, we've all known this guy is up against the line or across the line. Do you find any way you possibly can to take him down? And I could debate that either way.

If you reflect back on kind of your whole career and maybe ways in which your views in general or your methods have changed the most, I'm always interested by that, by people that do a lot of deep work and maybe start one way and end up with totally different set of beliefs about people or their process. Are there big lessons that you would be willing to offer people, especially those that might be different than when you started? Well, I think one big evolution for me, although it happened early on, was this idea of how much people matter, not just for storytelling, but how much the personal aspect matters for the truth of a situation. And I, like I said, was a math major. And I think I was just

much more numbers based and not really that interested in people when I started out. And so I think that's one way that I have changed immensely is that now I do see people much more because it's the people who make or make up the numbers at the end of the day, right? The numbers don't exist without the people. And so I think that's one big way that I've changed. I think I've become far more, far more nuanced. In my old age, I'm much less willing to condemn somebody and much more interested in what drives people, what makes them tick, what's the line between good behavior and bad behavior, how do otherwise good people find themselves doing bad things? Because at the end of the day, that's what's really interesting. Bad people doing bad things is not that interesting. Good people

doing good things is really great. I'm glad there are a lot of them, but I don't know. But good people doing bad things is and these human aspects of self-delusion and rationalization and the ways in which we fool ourselves, I think are endlessly fascinating to me. Do you think there are ways that that can be guarded against? This is something I think about a lot where success, it seems like, for many people, creates like the seeds of a lot of these problems. Are there systems of ethics or principles or things that maybe you found helpful to be guiding lights of sorts that come with success that maybe can reduce the likelihood of someone going wrong? Well, everybody says the way around this is to have people around you who challenge you,

right? And that's become kind of a touchstone of modern business. The problem with that is that it's way harder than it sounds. And most people who say they like to surround themselves by people who challenge them are completely full of it because nobody likes to be challenged. And the reality is the more successful you are, the less you like to be challenged. And so a big red flag for me is actually when people say, I really like to be surrounded by people who challenge me because I think you only think you're being challenged. You're actually surrounded by people who tell you what you want to hear

because otherwise you wouldn't like it. But I think really being able to put that in place, I mean really being able to put that in place is one great way. But man, that's hard because it's not only the person themselves being willing to be challenged, it's the people who surround them being willing to do the challenge. and human dynamics just don't allow for that very easily. So I think there's a whole interesting stew there that if you can get that right, that's one big way.

And then I think on an individual level, it's unpacking what makes you intellectually honest, and I'll give you a little example. I still today, Jeff Skilling was a master of two things. One was a sort of intellectual intimidation that made people pretend to get things even when they didn't. And the other was what somebody told me was the McKinsey data dump was just being able to spew an enormous amount of information when he was asked a question such that you just really couldn't stay with him in order to say, but you still didn't answer my question. And I, despite knowing those lessons, will still pretend I understand things that I don't, and we'll still go along with

things in a room because I don't want to be the person saying, I don't understand. But what makes me intellectually honest is when I sit down to write, I realize I didn't understand it. And that's what keeps me honest at the end of the day. I won't necessarily be honest in conversation. I'm Minnesotan. I'm not naturally confrontational, but I will be honest when I sit down and write, and I'll be forced to see, I don't understand this. It didn't make sense to me. And that's when I'll get tough and sort of dig in and go back to people and say, no, this doesn't make sense. And so I think whatever your method is, it doesn't have to be confrontation in the moment, but whatever your method is of knowing you didn't understand something or something doesn't sound right, you just have to find it.

It almost sounds like taking what you've learned and then building something that's your own from it and then opening that up to feedback. Like that's kind of the process. Yeah, that is. And for me, it's less, I guess it is feedback ultimately because it's going to be public. But it's also, for me, writing is an act of finding clarity and it's an iterative act in that you try to write. You realize you don't understand. You go back and try to figure it out. You try to write again.

You realize you still didn't understand something. But it's an act of finding clarity. I'd love any thoughts you have on the role that empathy has played in your career, in your style, in your effectiveness, or just thoughts on empathy in general. That's a really interesting idea. And I guess when I said earlier in the conversation that you have to care, that was my version of empathy. You have to really care and be curious and be open to what the person is telling you and what their point of view is. And even if you can see where they're skewed in their point of view, why it is that they would be skewed. And I think, I guess by nature, I think I am pretty empathetic. I don't have a, I often think that if I had ended up, if after I had left Goldman, which is where I worked right out of college before I went into journalism, if an executive recruiter had said to me,

well, not an executive recruiter, junior level recruiter, had said to me, there's this fascinating energy company down in Texas that is doing all sorts of neat things. And if I had ended up working at Enron in the finance department for Andy Fastow, would I have been the person doing creative structures or what I have said, no, this is a wrong. And I don't know the answer to that. I like to hope it would have been the latter, but I actually don't know. And so if you try to visualize, in order not to be empathetic, you have to really believe you're a lot better than other people. But a fascinating thing about listening and silence. My eight-year-old daughter just pointed this out to me, which I thought was great, which is that you can actually make silent out of listen. They're anagrams. And it's so great because in order to listen, you have to be silent, right? So anyway, from the mouths of babes.

So my closing question for everybody, which is always interesting, I get such a wide variety of answers is for the kindest thing that anyone's ever done for you. Can I do too? Sure. So I guess I'm going to pick probably Joe Nocerra taking an interest in my work, from a work perspective, Joe Nocerra taking an interest in my work early on at Fortune and helping me take the Enron story from a story into something that became a book and then, you know, a fundamental part of my career. and I don't think if it had been not for his level of interest and help along the way

and for less credit than he got in the sense that he orchestrated the book but his name isn't on it, I think the path of my career probably would have been different. And then on a personal level, I guess I would probably say my husband because he always rises above. and instead of taking petty little comments and making them into a big deal, he dismisses the petty little comments and rises above. And if you do that, that sets a precedent where both people rise above and see the good in the other person and the other person's comments rather than the bad. And it creates a virtuous cycle instead of a vicious cycle of swobling and it makes life

much better. God, I love that answer. Well, this has been full of of such interesting ideas kind of all over the map, which I know it would be. So thank you so much for your time and all you've done. Thank you so much for your interest. Hey everyone, Patrick here again. To find more episodes of InvestorFieldguide.com forward slash podcast. If you're a book lover, you can also sign up for my book club at investorfieldguide.com forward slash book club. After you sign up, we'll receive a full investor curriculum right away and then three to four suggestions of new books every month. You can also follow me on Twitter at Patrick underscore Oshag, OSHAG. If you enjoy the show, please leave a quick review for us on iTunes, which will help more people discover Invest Like

the Best. Thanks so much for listening.