Planet Money - The Bond King

Episode Date: March 30, 2022

Investing legend Bill Gross revolutionized the bond market, built an empire, and lost it all. Our very own Mary Childs talks about her new book, The Bond King. | Subscribe to our weekly newsletter here.Learn more about sponsor message choices: podcastchoices.com/adchoicesNPR Privacy Policy

This is Planet Money from NPR. Nearly eight years ago, early in the morning on September 26, 2014, a giant announcement shocked the financial world. An earthquake here in the asset management and bond world. Bond king Bill Gross has left PIMCO. Yes, that was announced just moments ago. Bill Gross, this legendary investor, was leaving PIMCO, one of the most influential money management companies on the planet. The company he co-founded in the 1970s. A number of people very close to PIMCO had no idea. This is shocking and surprising.

There had been talk of infighting at the company, but no one expected Bill Gross to actually leave. His departure caps the year of turmoil at the company, in which it was riven by destructive tensions at the top. Bill Gross was known as the bond king because before him, bonds were this steady financial tool, the backbone for your retirement savings and mine. Bill Gross helped to revolutionize our financial system,

making the bond industry exciting and cutthroat, with enormous consequences. Bonds are one of the main ways companies fund themselves, and the modern bond market is much bigger than even the stock market, worth trillions of dollars more. And the entire idea of it being a market of actively trading bonds, that wasn't even a thing until Bill Gross. Hello and welcome to Planet Money. I'm Mary Childs. And I'm Amanda Aronchik. For this episode, I'm going to channel my inner Terry Gross, an interview co-host and now author, Mary Childs. She just published a

book about Bill Gross and the bond market and talked to, I don't know how many people? I think it was about 240 by the end, including but not limited to Bill Gross himself. including but not limited to Bill Gross himself. Today on the show, the Bond King. How one man made a market, built an empire, and lost it all. Wait, that's my book tagline. It's very good. Oh, thank you.

Our story starts back in the early 1970s, when Bill Gross is a gangly young guy from Middleton, Ohio. He's just finished up his MBA at UCLA. It is kind of a tough job market. He's graduating into a recession. But his mom sees an ad in the newspaper for a job as a credit analyst at this local insurance company, Pacific Mutual. And she's like, yeah, you should apply. So he does.

Oh, no kidding. So his mom finds him a job, essentially. Yeah, she hooks him up, yeah. What's the job? It's as a credit analyst. This is his first real job. It's in Southern California. He's working for this insurance company. And Bill's job is to evaluate risk.

But a lot of his work revolves around these little slips of paper, basically coupons he'd exchange for interest payments that he has to go fetch from the company basement. You know, they kept them in the vault and he would go down and tear off the little coupons of interest payments and mail them in to the company saying, OK, here's my little coupon. Can I have my interest payment? And that was obviously really boring. You know, that's literally just like scissors and paper. The coupons were attached to fancy certificates that were basically IOUs. These are bonds.

Pacific Mutual has a lot of bonds. Now, when I hear the word bonds, I think of good old government savings bonds. You know, one of those certificates you'd buy at the bank. An investment for the future. It takes you, time, and good, solid financial planning. United States savings bonds should be part of those plans. You hold on to it for 20 or 30 years, and generally the interest adds up. Then you get to redeem it.

Now, when a company buys a bond, it's a little different. They're buying bonds issued by entities including governments or other companies like AT&T or IBM. The fundamental idea is the same. They give their money to, you know, AT&T, and AT&T promises to give it back at some later date. But in this case, the company holding the bond gets interest payments along the way. That gives them a predictable, steady stream of income in the form of those regular interest payments. Pacific Mutual buys bonds because they have a lot of money from all the insurance payments that they're collecting.

They know that they'll have to pay out claims down the road, but for now, they want to put that money somewhere and earn a little money off of it. So bonds are good for them. They're steady, stable, predictable, boring. But Bill Gross is about to change that. So while Bill Gross is at Pacific Mutual clipping coupons and being bored, this guy in the area, Howard Rakoff, has gotten this like bee in his bonnet about bond trading. So inflation is super high. And that means that the bonds in the vaults, the little coupons that Bill Gross is clipping, those are just kind of losing value by day. You know, if a company has promised to pay you $20 a year forever, that $20 gets less and less and less and less as inflation goes up and up and up.

So Howard Rakoff is like, wait, why aren't we trading these bonds? Why aren't you able to get rid of that bond and get a new bond? To him, it seemed like common sense. Just because you bought that bond, why do you have to hold on to it? Like, what if there is a better one? Why do you have to hold on to it? Like, what if there is a better one? What if you want to sell one that matures in 15 years and buy one that matures in five years?

Or maybe you think the bond issuer is going south, and this other guy thinks, yeah, those bonds still look good. He likened it to driving on the freeway. You know, L.A., famous for its traffic. He's driving through L.A., and he's like, OK, if I stay on this one lane, if I just don't move, this is like buying a bond and holding it. But if I get into this lane and I pass these people, I get home a little bit faster. And that's price appreciation. This is trading bonds. Driving on the highway and changing lanes, that's trading bonds. But to make it all work, Howard needs other people who are also interested in trading bonds. The critical thing here is you need people to trade with. You can't, you know, Howard can't just trade by himself. So he's going across the country talking to people at banks, at insurance companies, anybody who has money that can invest it, being like, we should be trading bonds. Do you want to trade bonds with me?

Most of the people he pitches are not interested, including Bill Gross's boss. But the boss is like, nah, well, feel free to pitch these guys who work for me. And when Bill Gross hears Howard's pitch, he's like, oh, an opportunity. Bill's boss winds up giving him and this other guy at Pacific Mutual a little company within their company and $5 million to play with, just to see what happens. Then, within a few years, the bond trading vision pays off. That little company within Pacific Mutual starts to prove itself. Once they kind of got their footing and got that track record of performance, then they could get more clients. And the more clients you have, the more, you know,

management fees you can charge those clients, which means more money coming in that makes the business worth it to the parent company. Is this basically the start of PIMCO? It's basically the start of PIMCO. PIMCO, Pacific Investment Management Company. This life insurance company is branching out, starts managing people's retirement funds. And they have great timing because that's right around 1974 when at that time the money management industry gets formalized. Companies are coming out of the woodwork looking for someone to manage their pensions for them. And PIMCO is like, here we are. Call me. So PIMCO grows and they make a ton of money and people start to know them for being kind of scary smart.

And people start to know them for being kind of scary smart. There's this one trade in particular in 1983 where PIMCO reads the fine print on this one new financial product, a derivative tied to mortgage bonds. And they figure out that there were problems in the contract that no one else had spotted. Problems that they could exploit. So PIMCO is able to quietly buy up a ton of these contracts, basically cornering the market. In the end, they make a ton of money. What does this trade do for their reputation? This trade ended up cementing their reputation as just super shrewd and kind of terrifying. Like that if you were going to trade with PIMCO, you have to be ready. And this

demonstrates how far they've come, even in a little over a decade. From, you know, steady-eddy, boring certificates in the basement, to conducting a fancy, elaborate derivatives trade based on extreme complexity. PIMCO is profiting, but the bond market they've helped to create is already more speculative. It's riskier. And remember, a lot of the money they're managing is pensions, ordinary people's retirement accounts. So now client money is pouring into PIMCO, and they are putting that money into the market and turning it into more money. Meanwhile, Bill Gross started to get kind of famous. People find him charming, adorably Midwestern, and he likes the stage. Good evening, I'm Louis Rukeyser. This is

Wall Street Week. Welcome back. This show was on every Friday night on PBS, Lou Rukeyser. It was what everybody who was anybody watched. And Bill Gross was kind of the representative for the bond market. I know you take a close interest in the bond market. What do you expect to see there? Well, I think the Federal Reserve has got to move quickly, and I think they will over the next several weeks. I think they will lower short-term interest rates. And that helped to make him into kind of an industry leader and a little mini celebrity. In 2002, Fortune magazine crowns Bill Gross the bond king. PIMCO is an undisputed industry leader. Still, outside of the world of finance, people aren't really paying that much attention to bonds, but they're about to hit it big.

So what was the bet that PIMCO makes going into the mortgage crisis? So what was the bet that PIMCO makes going into the mortgage crisis? So they basically bet that there was going to come a point when borrowers, when homeowners who had taken out these enormous mortgages, wouldn't be able to make their payments. PIMCO makes a huge bet on this, that people have borrowed too much, the housing market is overheating, heading for a big crash. So PIMCO scales way back on risk. But they start doing this in like 2006, which is pretty early, well before the crisis really starts. PIMCO is just twiddling their thumbs waiting, which means they're also missing out as the market keeps going up and up. What was Gross thinking during that time while they're like waiting for things, while they're sort of sitting back? Internally, he's kind of nervous, right?

Like you can't time the market. No one can time the market perfectly every time, right? So he's got these internal doubts. He's kind of wondering if he's lost his touch, if he's totally wrong. And he's kind of wondering if he's lost his touch, if he's totally wrong. And he's kind of just waiting. When the financial crisis does hit, Bill Gross and PIMCO are proven right. Suddenly, they have enormous power. The federal government needs giant debt buyers like PIMCO to step in, buy up all those distressed mortgages.

Because that is what will stop the spiral of the crisis. But PIMCO wants some assurances. It has an ask of the government, which Bill Gross makes at every available opportunity. He does it in writing, on TV. The government, and I say this unfortunately, the government is part of our future in terms of not only the mortgage market and the housing market, but other markets as well. We need the government balance sheet. So he says this little campfire can turn into a forest fire and that, you know, somebody needs to step in. Somebody with, you know, unlimited buying power.

Who could it be? Who is the only entity in the entire universe that has unlimited buying power? could it be? Who is the only entity in the entire universe that has unlimited power? So Bill Gross is saying very clearly, you know, we're just going to sit on our hands until somebody comes in and helps to stop the spiral in the market. We're not going to buy this new debt unless. And so it's like super clear at this point that Bill Gross is like a little bit playing chicken with the U.S. government. And so what happens? So they basically, PIMCO wins this game of chicken. I think three days after they were on CNBC, lo and behold, the Treasury Secretary said

that the government would put Fannie and Freddie in conservatorship. So PIMCO got its way. Yeah, the federal government says, okay, we've got this. We will be the backstop. We won't let these government-sponsored mortgage giants, Fannie and Freddie, go bust. So before and after the crisis, PIMCO does incredibly well,

having bought up all these assets at enormous discounts. And Bill gets even more famous. Bill Gross from PIMCO. We've been discussing his sterling year, a sharp ratio over three, Bill Gross from PIMCO. We've been discussing a sterling year, a sharp ratio over three, which is, folks, that's like to die for. So would you say, like, is this PIMCO and Bill Gross at the height of their powers? I think so. Yeah. They're basically telling the U.S. government what to do in the middle of this enormous and super consequential crisis. You know, this has implications for taxpayers, for homeowners. Yeah, in my view, this is kind of the big moment. This is where they're absolutely the most powerful.

Buying up all of these distressed mortgage bonds that the government has now promised to back, and then later selling them for more money? These trades were a slam dunk. PIMCO made a lot of money for clients that year and the next year. At this moment, they look untouchable. But after the break, Bond King loses his crown. Coming out of the financial crisis, PIMCO was riding high. Bill Gross had gained a new level of respect on Wall Street, even though they're in Southern California. And by the end of 2012, PIMCO was managing $2 trillion of assets and employed 2,000 people.

They were bigger than ever. of assets and employed 2,000 people. They were bigger than ever. But this required layers of management and new business strategies that Bill Gross didn't always agree with. He couldn't be the center of everything anymore. Bill's the star trader, right? He's the star bond king. And he's in many ways the face of the firm. But Bill Gross was supposed to be just in charge of investing. And he didn't want to do the client stuff and he didn't want to do the like business management stuff. But there's also a whole company to run, right? So there was always someone else running the show from like a CEO perspective. And in 2007, that became Mohamed El-Erian.

Mohamed El-Erian. He was brought in to be Bill Gross's successor, sharing the role of chief investment officer. He also became the company's CEO. Now, Alarion is polished, formal. He went to Oxford and Cambridge. Their personalities are totally different. Their approaches to management are totally different. Their approaches to investing and thinking about investing and arriving at investment decisions are totally different. By 2013, this relationship is really starting to fall apart. And they're sending like passiveive emails to each other.

And so by the summer, it starts to kind of spill out. Like, they're not able to contain it anymore, even in, you know, professional meetings with other people present. And in January 2014, Muhammad Al-Aryan quits. It isn't exactly a clean break. And this turns out to be the beginning of the end for Bill Gross at PIMCO. A few weeks later, a story comes out in the Wall Street Journal that everyone in finance stops what they're doing and reads. It's that kind of story.

It said, Bill Gross is kind of a jerk. I mean, it was really shocking for people across Wall Street. If you didn't know PIMCO super well, you kind of had no idea that Bill Gross was this intense and that Muhammad Al-Aryan and Bill were not getting along like this. The ugly version of Bill Gross that came out in the story was bullying and vengeful. Not at all like his adorably Midwestern image. Bill Gross had spent decades building up this brand, this reputation as the Bond King. And his public persona was folksy and really self-effacing. So to have this enormous shift in the way that he's perceived, I think that was super destabilizing for Bill Gross. And that sets him on this kind

of spiral, this really self-destructive trajectory where he spends the next couple months trying to figure out who the sources were, hunting down the moles who talked to the journalists and other people at the top of PIMCO, the management. They're like, what? This is not at all professional. Like, what are we? What if clients hear about this? Like, he's not showing up to work as a professional person anymore. And that brings us to June 2014. Bill Gross is the keynote at this big conference in Chicago called the Morningstar Conference. It's attended by basically every client and potential client in the universe,

all gathered in this enormous ballroom. And Bill Gross goes rogue. He's up at the podium to give this big speech about investing, but he keeps going off topic. It sort of reminds me of a movie. This is the movie called The Manchurian Candidate. And there have been two, most recently with Denzel Washington, but the first one with Frank Sinatra. He gives the entire plot summary. And everyone in the crowd is primed to listen, right?

Like maybe he could have survived a little bit of rambling, but he keeps going on and on. I was there, I was sitting in the back, and at some point people in the audience start looking at each other like, is this guy okay? Is my money still safe at PIMCO? You don't need to know the rest of the story. You probably know. This was kind of a turning point where it, like, cats out of the bag. People are starting to really wonder if he's lost it, if he's lost his touch, if he's just a different person than they knew. And this is the moment where all of that cracks open.

From there, Bill Gross keeps wrangling with the rest of PIMCO's management over everything. Over the direction of the firm. Over how to handle people leaking stories to the press. Over how he can scale back his responsibilities and prepare PIMCO for a future without him. By September 2014, the rest of PIMCO's management is just done with Bill Gross. They start laying plans to fire him. And he can feel it coming. So ever the master of his own destiny, he blindsides them by leaving first and joining a much smaller competitor. Even other finance legends were blown away, including the founder of investing firm Vanguard, Jack Bogle.

Well, I don't shock easily, but I was surely shocked when I heard that. He's a true giant in the industry. He's a true legend. He's earned all that. There aren't so many people in my field that actually measure up to that test. Bill would be right at the top of that list. Bill Gross's departure moved the markets. He managed so much money and people assumed that a lot of that money would follow him out the door. So traders scrambled to get ahead of that, to trade around it. And regulators started to worry that this was going to be a systemic event, something that would knock the

economy off course from the still shaky post-crisis recovery. That didn't actually end up happening, but that's how big of a deal this was. To me, the big thing is, thanks in incredibly large part to Bill Gross, the bond market is now a wild, profitable playground for hedge funds and private equity firms. And some of the money these firms are investing is ours. It's money from pensioners and people planning for retirement. Now, if we pick the right manager, we might do better. But the people who definitely make money are those people managing the money, Are those people managing the money?

The Bill Grosses of the world. Mary's book is called The Bond King. How one man made a market, built an empire, and lost it all. Quick question. Have you ever shopped online and used a buy now, pay later app like Afterpay or Klarna? If so, have you ever missed payments, gotten a call from a collection agency or had it affect your credit? We want to hear how people are using these services and what happens when things don't go according to plan. Email us at planetmoney at NPR.org with the subject line buy now, pay later. And we were also on Instagram, Twitter, Facebook, and TikTok at Planet Money.

Today's show was produced by Willa Rubin. It was mastered by Isaac Rodriguez and edited by Molly Messick. Planet Money's executive producer is Alex Goldmark. I'm Amanda Aronchik. And I'm Mary Childs. This is NPR. Thanks for listening. And a special thanks to our funder, the Alfred P. Sloan Foundation,

for helping to support this podcast.