Banking Critic David Einhorn

Image: Jeff Mermelstein

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In May 2002, the financial markets were mired in a grinding downturn, which is to say it was a great time to be a hedge fund manager. After the insanity of the dotcom era, company profits and balance sheets finally mattered again. Skeptics felt confident in taking their cases public. It was in this environment that David Einhorn, a lanky and boyish 39-year-old who heads the $6 billion firm Greenlight Capital, spoke to a charity investing conference.

His topic that day was the Washington, D.C., finance company Allied Capital, a lender to and investor in midsize companies. Einhorn methodically went after Allied, claiming that it had inflated its assets and overstated its worth and profitability. While Einhorn has developed a reputation for witty and incisive speeches, they tend to read better than they sound. After the speech, he received a smattering of compliments and went home. He figured that reality would eventually catch up with the stock, and he would move on to other investments.

He was wrong. The next day, Allied stock tumbled nearly 20 percent as word of Einhorn’s critique spread, setting in motion one of the nastiest Wall Street wars in recent memory. Over the next several years, Einhorn would learn firsthand what happens to people who question the accepted rules of engagement on Wall Street. His saga is part detective story, part cautionary tale, part master class in investing, and a case study in what’s wrong with regulators, Wall Street, and the financial media (including me, as I play a small role). “The steep decline was nothing compared to the plunge I was about to take, spending years uncovering what I view as a fathomless fraud,” Einhorn writes in his new book about the battle, Fooling Some of the People All of the Time.

More important, Einhorn’s experience illuminates our current crisis. Throughout the subprime mess, critics who questioned runaway credit or the way Wall Street marketed credit derivatives were dismissed as overly pessimistic. Regulators who could have headed off the problem took too long to act. Six years on, some of Einhorn’s allegations against Allied have been proved right. Yet Allied’s managers have stayed in their jobs, reaping millions of dollars in compensation. And Einhorn has had to spend time and money deflecting accusations that he was a dirty short-seller with an ax to grind, smearing Allied for profit.

Einhorn’s initial claim in the speech will sound familiar to anyone who has watched Wall Street’s swoon during the past year. He argued that the company kept hard-to-price illiquid investments at inflated values on its books. He would subsequently discover that a major Allied portfolio company, a small-business lender called Business Loan Express, had made all sorts of bad loans to dodgy customers—to the tune of tens of millions of dollars in losses.

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