The 2007 subprime mortgage crisis really shook the financial world and its repercussions are still reverberating across the globe. Scores of books have been written or will be written to explain how and why the crisis happened. But, The Big Short by Michael Lewis stands in a different league. The book does not offer any theory or model to explain the causes. Instead, the author chronicles the lives and actions of a group of maverick investors who predicted the sub-prime mortgage crisis and took full advantage of it. He says that though many individuals claimed to have predicted this crisis, this group of maverick investors actually foresaw what was coming and had the guts to bet on their vision.
Lewis became a legend when his first book Liar’s Poker became a classic on the workings of the Wall Street in 1980. Lewis states that he wrote that book to expose the greed and wrong-doings of the bond traders on the Street. But, ironically the book was used by youngsters as a guide to get rich quickly.
Lewis became a legend when his first book Liar’s Poker became a classic on the workings of the Wall Street in 1980. Lewis states that he wrote that book to expose the greed and wrong-doings of the bond traders in the Street. But, ironically the book was used by youngsters as a guide to get rich quickly.
In this book, though, he manages to convince the readers of the baseless and flawed workings of the bonds and securities salesmen. He essays the story of six men and how they forayed into the world of investing. He tracks their reactions to the changes in the U.S housing market and the overall macroeconomic conditions during that time frame.
The wise six
Steve Eisman, according to Lewis is at the top of the list of people who foresaw this crisis. Eisman is a second-generation Wall Street analyst who started as an equity analyst with Oppenheimer & Co. and got into working with mortgage-backed securities by chance. Eisman and his team knew the U.S. housing market inside-out and forecasted every event that happened. People never took Eisman seriously and dismissed him because of his weird personality. But, by the end of the book one is left in awe of his sheer genius.
Dr. Michael Burry, a physician-turned-investor started the hedge fund, Scion Capital. He suffered from Asperger’s syndrome, preferred to remain in solitude and was despised a lot by all his investors for his anti-social skills. Dr. Burry was the first to bet against the mortgage loans for he had the vision that homeowners’ will default on their payments and thereby went on to make billions. Next in line are the interesting trio of Charlie Ledley, Jamie Mai and Ben Hockett, who started a fund, Cornwall Capital, out of a garage in the California Bay Area and later moved into a shady room on top of a Greenwich studio. They were rank outsiders, unheard of, unknown and even had their requests to trade rejected by top banks. However, they picked the most complex synthetic collateralized debt obligations (CDO), bet against them and made a fortune for themselves.
The most interesting character among Lewis’ pick is Greg Lippman, a typical bond salesman from Deutsche Bank. He saw the sub-prime market would crash way back in 2005, pitched his vision to investors across the country, sold swaps and encouraged them to bet against the CDO’s the various banks including his very own were creating. In doing so, Lippman earned millions of dollars as bonuses. Through these stories Lewis shows the reader that a few people on all sides of the table foresaw this crash and cashed in.
Breaking down bonds
As Lewis mentions in the book, the bond market is full of complex terminologies. While he explains each concept at least once, it does take a while for an average reader, with no prior knowledge of bonds and securities, to grasp the real meaning. I think it is very important to know the definition of certain terms like credit default swap, CDO, tranches and selling short to appreciate the actions taken by this group of investors.
The description of credit rating agencies like Moody’s and Standard & Poor in detail is very interesting and the general perception of their low stature in relation to the big banks is startling. He says that people ended up at rating agencies since they could not get into the big banks. These people were like government employees, wore cheaper suits and were underpaid. Quoting Eisman, Lewis writes, “So, why does the guy want to work at Goldman Sachs? The guy who is the bank analyst at Goldman Sach should want to go to Moody’s. It should be that elite.”
The author makes a brilliant point when he contrasts the nature and workings on the stock market to the bond market. He says, “The stock market was not only transparent, but, heavily policed.” The presence of small investors had politicised the market and one could not use inside information and get away with it as “it had been legislated and regulated to at least seem fair.” On the other hand, the bond market was mainly comprised of big institutional investors; bond salesman could exploit insider information, say and do anything without the fear of being reported and “bond technicians could dream of complicated securities without the fear of any regulation.” And this precisely is the problem that needs to be fixed.
It was disturbing to read that workers on the streets of Las Vegas had multiple home equity loans; an immigrant strawberry picker owned a house worth U.S.$724,000 and Eisman’s South American maid’s family had six town homes in Queens’, New York – obviously, this was a system that was bound to go crash-bang-boom.