"...the powers that be might step in at any time to prevent individual American subprime mortgage borrowers from failing. The powers that be never did that, of course. Instead they stepped in to prevent the failure of the big Wall Street firms that had contrived to bankrupt themselves by making a lot of dumb bets on subprime borrowers."
A one-eyed physician with Asperger's, a socially tone-deaf hedge fund trader who's a born skeptic, a new generation's Gordon Gekko bond salesman and a trio of young men who approach running money in the spirit of "let's put on a play" were all major winners in the Great Meltdown by taking huge bets against the mortgage bond market. Michael Lewis' new book--The Big Short: Inside the Doomsday Machine-- tells the tale of The Fall and the respective paths to riches of a handful of people in a narrative that reads like an adventure novel. We are left wondering if they are heroes - unsung prophets who won big because they did their homework and saw things that others didn't - or villains for profiting from the financial disaster that has touched all of us.
These larger-than-life characters are joined by a variety of people who don't understand the complex instruments related to mortgage-backed securities: investment bank CEOs, heads of trading desks, rating agencies and financial regulators. On one hand, this is a tale of greed, stupidity, arrogance and the human tendency to ignore reality and invoke magical thinking; on the other hand, it's a story of tenacity, a search for the truth and the patience to uncover an unvarnished and unpalatable reality.
A little over a year ago, we were on the edge of the cliff. It appeared that the global banking system was toppling, and after Lehman and Bear Stearns had seemingly been sacrificed, it wasn't clear that iconic banks like Goldman and Morgan Stanley would make it through the wringer. After a tense political game with the House and Senate, billions of dollars were injected into the banking system and life began to return to something akin to less than normal but not as disastrous as it could have been. Most of us are still scratching our heads in wonder: what caused the chaos? How could things have gotten so out of control? How could so many smart people have been so terribly wrong?
Michael Lewis's story about the crisis puts a very human face on the major actors in the drama as well as the relatively unknown players who placed huge bets against the banking system and won billions of dollars. The Big Short is a page-turner with powerful characters and an improbable narrative that is, at the end, very real. We all know how things ended - not well.
Lewis has been telling the tales of the excesses of Wall Street since the success of his first book, Liar's Poker, an unflattering but accurate picture of a Wall Street boys-gone-wild bond trading culture, written from the viewpoint of an insider. He worked at Salomon Brothers, left to write books and has emerged as the premier chronicler of the world of finance. One of his talents is making this elitist, seemingly impenetrable world accessible for the rest of us.
The Big Short begins with a description of the prediction regarding Citigroup's mismanagement by Meredith Whitney, a relatively obscure analyst from Oppenheimer and Company, anticipating the subprime mortgage cataclysm in October of 2007. At that point, general public perception was that housing prices were continuing to rise and that mortgage backed securities were a relatively safe and lucrative asset class. So were there any contrarian investors out there who were putting their money on the line and going against the tide with the belief that the real estate market was a black hole that would ultimately topple the financial instruments linked to it? Lewis called Whitney and learned about Michael Burry of Scion Capital, Steve Eisman of FrontPoint Partners, Greg Lippmann of Deutsche Bank and Jamie Mai, Charlie Ledley and Ben Hockett of Cornwall Capital, all of whom subsequently shorted mortgage-backed securities and related instruments and made a killing.
"The big Wall Street firms, seemingly so shrewd and self-interested, had somehow become the dumb money. The people who ran them did not understand their own businesses, and their regulators obviously knew even less. Charlie and Jamie had always assumed that there was some grown-up in charge of the financial system whom they had never met; now, they saw there was not."
Lewis goes to great lengths to make mortgage-backed securities, credit default swaps and CDOs, or collateralized debt obligations, understandable. In many ways, this book is a primer on how credit derivatives were structured and sold over the last ten years. But it's not dry stuff, because he tells us about the impact of these instruments:
"The CDO was, in effect, a credit laundering service for the residents of Lower Middle Class America. For Wall Street it was a machine that turned lead into gold."
And what becomes clear is that much of it was based on the idea that banks or consumer loan businesses could reap huge profits by selling unconventional loans - no down payment required, no income documentation required, no interest - to people who couldn't possible pay them back and were, in fact, likely to default. Much of this house of cards was built on the premise that housing prices would continue to rise and that inevitable refinancing on a higher assessed value would result in highly profitable fees for the banks.
You will find yourself chortling, fuming and sometimes close to crying as you read The Big Short. But if you're going to read one book about the financial crisis, read this one and understand that we have barely begun to address the underlying causes of the deep hole we dug for ourselves. The hole that we are still in.