The Big Short - Michael Lewis

Every time a part of the financial market goes kaput, you can find tens of 'experts' claiming that they told us so. It isn't usually difficult to spot these post-facto gurus in their fifteen minutes of fame (they are rarely right the second time) - they are being courted by the financial press, and are spouting intelligent sounding 'analysis' that tries to suggest that what happened was inevitable and that every newspaper headline in the last two years was pointing in that direction. In many ways, the spectacle is not much different from a market boom, in which some other 'experts' try to tell us how this time it is different.

In one sense, however, market crashes are different from market booms. When prices inflate, the 'experts' being interviewed on CNBC are money managers who are making a lot of money out of whatever asset class is booming right now. But in busts, the experts are usually academics, economists, financial journalists - people who are watching from the sidelines, rather than making bets in the market. They are rarely people making money out of the crash. They are rarely, in Wall Street lingo, shorts. In a crash, some people lose everything, some lose a little less - but everyone loses. Except those who don't - the shorts. These few are the heroes of The Big Short.

Michael Lewis burst into prominence, of course, with his 1989 book Liar's Poker. Lewis' intimate knowledge of the inner workings of Wall Street, and Salomon Brothers in particular, along with his breezy narrative style with the penchant for the graphic (remember 'Big Swinging Dick'?) made that book an all-time business classic. Over the last ten years, Lewis has been writing at the rate of a book a year - wayyyy too much in my opinion. Most of it, I am sorry to say, has been mediocre at best - The Oscar winning The Blind Side and the nerdily interesting Moneyball notwithstanding. So it was with some trepidation that I started reading The Big Short. After a long interval, this is Lewis coming back to the subject that first made his career - Wall Street shenanigans. Can he do it again? Can he pull off another Liar's Poker?

The verdict?

Ladies and gentlemen, Michael Lewis is back! This is by far the best, the most interesting book about the recession of 2008-2009 that I have read. (And as readers of Brick and Rope have probably learnt by now, I have read a lot of them - many more than anyone should have to!) This is it. The one Great Recession book you have to read.

The Big Short gets at the financial meltdown in a unique way. It tells us the story of a few big shorts in the mortgage market of the early aughts. Money managers who saw that the mortgage market was overheated, that the bubble was bound to burst, and bet big on the bubble bursting. These guys didn't just wring their hands in frustration at the other idiots making boatloads of money on the perpetually rising housing market. They bet indecent sums of money, their entire lives and careers on their assessment that house prices could not continue to rise, that subprime mortgage lending was dirty and bound to blow up. They don't need to say 'I told you so', because it is obvious from their trades - if they had bet along with everyone else, their financial lives would be over by now. Instead, they made for themselves filthy bucketsful of money. So yes, they did tell us so.

For long, I have heard about the trillions of dollars of losses caused by the subprime mortgage meltdown, and I must admit I have wondered about that. A typical subprime loan is about $200,000. So to make a trillion dollar loss, 5 million subprime loans have to go bad. So when people take of multiple trillions of dollars worth of mortgage related assets, I have always wondered how exactly that was possible. I knew that Collateralized Debt Obligations (CDOs) and Credit Default Swaps (CDS's) somehow created this mechanism, and this latter was what brought AIG down. But when it came right down to it, I didn't really understand what was going on inside all these three letter acronyms. Enter Michael Lewis.

[A CDO's] logic was exactly that of the original mortgage bonds. In a mortgage bond, you gathered thousands of loans and, assuming that it was extremely unlikely that they would all go bad together, created a tower of bonds, in which both risk and return diminished as you rose. In a CDO you gathered one hundred different mortgage bonds - usually, the riskiest, lower floors of the original tower - and used them to erect and entirely new tower of bonds. The innocent observer might reasonably ask, What's the point of using floors from one tower of debt simply to create another tower of debt? The short answer is, They are too near to the ground. More prone to flooding - the first to take losses - they bear a lower credit rating: triple-B. Triple-B-rated bonds were harder to sell than the triple-A-rated one, on the safe, upper floors of the building.
... [Goldman Sachs's] nifty solution to the problem of selling the lower floors appears, in retrospect, almost magical. Having gathered 100 ground floors from 100 different subprime mortgage buildings (100 different triple-B-rated bonds), they persuaded the rating agencies that these weren't, as they might appear, all exactly the same things. They were another diversified portfolio of assets! This was absurd. ... But never mind: The rating agencies, who were paid fat fees by Goldman Sachs and other Wall Street firms for each deal they rated, pronounced 80 percent of the new tower of debt triple-A.

This image, of a tower of mortgage loans being converted into a mortgage bond, a tower of bonds being converted into CDOs, CDS's being used to 'multiply' mortgage loans virtually ... keeps coming up in the book. And every time, the image gets a little clearer, the mechanics of what happened behind the scenes, comes more in focus.

Every market player comes for the withering attack of Lewis' cynicism. Particularly striking to me was his assessment of the caliber of people working at the rating agencies:

"You know how when you walk into a post office you realize there is such a difference between a government employee and other people," said Vinny. "The ratings agency people were all like government employees." Collectively, they had more power than anyone in the bond markets, but individually they were nobodies. "They're underpaid," said Eisman. "The smartest ones leave for Wall Street firms so they can help manipulate the companies they used to work for. There should be no greater thing you can do as an analyst than to be the Moody's analyst. It should be, "I can't go higher as an analyst." Instead it's the bottom! No one gives a fuck if Goldman likes General Electric paper. If Moody's downgrades GE paper, it is a big deal. So why does the guy at Moody's want to work at Goldman Sachs?"

Which makes another point about Lewis writing about Wall Street - The time for polite language describing the recession in clinical, academic terms is over. Lewis' language is the crude, macho language of a Wall Street insider. It is like nothing has changed in South Manhattan since Liar's Poker.

In the end, the image that endures is that of the shorts themselves. Market players who aren't just heartless monsters getting rich on the misery of ordinary Americans. The shorts, who believed the world was wrong, and were willing to bet that it would right itself.

His bets against subprime mortgage bonds were to him more than just bets; he intended them almost as insults. Whenever Wall Street people tried to argue - and they often did - that the subprime lending problem was caused by the mendacity and financial irresponsibility of ordinary Americans, he'd say, "What - the entire American population woke up one morning and said, 'Yeah, I'm going to lie on my loan application'? Yeah, people lied. They lied because they were told to lie." The outrage that fueled his gamble was aimed not at the entire financial system but at the people at the top of it, who knew better, or should have: the people inside the big Wall Street firms. "It was more than an argument," Eisman said. "It was a moral crusade. The
world was upside down."

I could go on and on. But I'll stop here and just say this - read the damn book!