The Big Short: Inside the Doomsday Machine
Michael Lewis (2010, W.W. Norton)
Michael Lewis is the perfect person to explain to us just what happened when, in the fall of 2008, Wall Street brokers and bankers went down in an avalanche of credit default swaps; he can also explain what in the world credit default swaps are, and why people wanted to bet on them, one way or the other. Lewis, the author of Liar’s Poker (1989), about his own experience in the bond trading business--a business that brought us the financial crises of the nineteen-eighties (on a substantially smaller scale, though it felt sufficiently catastrophic at the time.) His Moneyball (on baseball) and The Blind Side (football) made the market forces in American sports delightfully clear, while keeping an eye on how those forces affect individual people.
Now he’s got the inside track on the biggest financial story of the past decade, how the sub-prime mortgage industry took on a life of its own, giving rise to a spectacularly large and long-lived housing bubble. The collapse of that bubble in 2008 took billions of dollars of value out of the worldwide financial system--where did that value go, and what did it consist of in the first place?
The Big Short is a high-resolution, super-slow-motion picture of the Wall Street avalanche at its critical moments. As you might imagine, it’s a story about greed, arrogance, ignorance, and stupidity; it’s also about a handful of people who saw the housing bubble for what it was, and put themselves in a position to profit from its implosion.
These mavericks at the heart of Lewis’s story are a quirky bunch: “All of them were, almost by definition, odd. But they were not all odd in the same way. John Paulson was oddly interested in betting against dodgy loans, and oddly persuasive in talking others into doing it with him. Mike Burry was odd in his desire to remain insulated from public opinion, and even direct human contact, and to focus instead on hard data and the incentives that guide future human financial behavior. Steve Eisman was odd in his conviction that the leveraging of middle-class America was a corrupt and corrupting event, and that the subprime mortgage market in particular was an engine of exploitation and, ultimately, destruction. Each filled a hole; each supplied a missing insight, an attitude to risk which, if more prevalent, might have prevented the catastrophe.”
These characters, and a few others, saw something all the other actors did not see, or refused to believe. Why? Was it greed? was it fraud? Was it a herd mentality, or willful obtuseness? Yes, yes, and yes. There’s a school of political thought that would have us believe that markets are always smarter than individuals, (to say nothing of the questions of whether they are fairer, kinder, or more honest; sometimes, maybe, but you shouldn’t count on it.) The Big Short shows us some ways markets can be seriously dumb, as well as opaque and fraudulent, or, of course, all three at the same time.
Lewis writes, “The subprime mortgage market had a special talent for obscuring what needed to be clarified.” A dazzling array of abbreviations and acronyms sprang up around the business of turning loans, especially mortgage loans, into bonds. The razzle-dazzle was partly aimed at investors, and partly at bond-rating agencies like Moody’s and Standard & Poors. It’s profitable to own the stream of income represented by other people’s debt--but only if those people are actually going to keep making payments. This is one thing if you’re talking about a government entity like a county or a state, and something else entirely if the debt is a mortgage, or collection of them, that are made with teaser rates, to people who had no money for a down payment.
Somehow--and Lewis actually knows how--some of the latter kinds of bonds, and bonds created from them by sleight of hand, received AAA ratings of quality from the rating agencies, (which had, to put it mildly, a conflict of interest); the salesmen of Goldman Sachs and its confreres made so much money selling the bonds that they caused dumber and dumber mortgage loans to be made, out there in the real world; and a form of bond insurance created by AIG Financial Products became a way to place bets on financial events. He writes, ”Financial markets are a collection of arguments. The less transparent the market and the more complicated the securities, the more money the tradings desks at big Wall Street firms can make from the argument.” In the end, because some bond dealers got confused by their own obscurity, they wound up mis-pricing the risks, and laying some enormous, terrible bets; the resulting avalanche is still playing out.
The lucidity with which Lewis presents all this is truly a joy. Because this is a popular new book, my library has some copies marked as Speed Reads, due back in one week rather than three. That won't be the problem--just don’t start it at bedtime.
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