The Big Short: Inside the Doomsday Machine is bestselling author Michael Lewis’ (Liar’s Poker, Moneyball, The Blind Side) look at the 2008 financial crisis and the events and adventures that created it. I didn’t get it. Or, more accurately, it wasn’t a very satisfying read.
The Big Short leaves you — at various points in the plot — intrigued, inspired, confused (a lot of times), hopeful, hopeless, happy, and angry. But mostly I walked away scratching my head. As a history text, I tried to read it for an answer to the question, “What can we do to prevent a similar collapse in the future?” And I’m not sure it was in there. The nature of the problem and it’s causes seem so complex and yet so financially lucrative, I’m skeptical that government regulation alone will be able to curb it.
In hindsight, of course the subprime mortgage crisis was easy to spot. There were plenty of warning signs and outspoken naysayers, but surprisingly few people put their money where their mouth was. Lewis casts these people as the central characters in the book, people who made huge bets against subprime loans. To me, these where the inspiring characters. I take very little interest in the stock market, pretty much invest in index funds and reason that thousands of people much smarter than make the market run efficiently. These guys took the opposite view: that the market was beatable if you found the right plays. And given the evidence they saw of impending doom in the housing sector, they took that gamble. Everybody thought they were crazy.
Here’s my basic understanding of what went down, and I had a hard time sorting through all the Wall Street lingo, so could be way off.
- Mortgage lenders popularize the “originate-and-sell” business model, meaning they sign the customer up for the loan, and then immediately sell the loan to some bigger bank.
- This ultimately leads to them not caring much about the credit-worthiness of the homebuyer, since they collect a fee upfront and quickly rid themselves of the (semi-unlikely to receive) stream of receivables.
- Homebuyers are offered an exotic array of home loan products, including low 2-year teaser rates, $0-down loans, interest only loans, negative amortizing loans, etc. All without verification of income!
- Since everyone can get a home loan now, demand for housing booms and prices skyrocket.
- Homebuyers (I think) understand their loans are unsustainable, but are told they can refinance in 2 years as long as prices keep rising. It’s a win-win, people keep their houses, loan originators collect a new fee, the bubble continues to grow.
- Wall Street banks package thousands of these subprime mortgages into bonds.
- Wall Street banks convince the ratings agencies (Moodys, S&P) the bonds contain loans that are significantly diverse enough to warrant high (AAA) ratings.
- A rating of AAA meant the bonds were essentially riskless, the same rating as US Treasury bonds.
- The sell them off to other big banks and investors.
- A few people recognized the bonds really weren’t riskless, given that one factor could cause huge numbers of these homeowners to default all at once: a decline in home prices.
- These people start buying insurance on these bonds, where the insurance pays out if the bond goes bad.
- Since these bonds are riskless AAA-rated bonds, the likelihood of them going bad is ostensibly very low, so the insurance is very cheap.
- AIG and other big companies end up being the insurers.
- The bottom drops out, the bonds go bad, the good guys get rich, and the bad guys lose their shirts.
- The government gives the bad guys their shirts back.
And the rest of saw our property values plummet, our retirement accounts cut in half, and unemployment spike above 10%. Lewis calls it the “most purely financial economic disaster in history.” A worldwide recession triggered by trading paper. Was it worth it?
I don’t know. Loved Moneyball, thought The Blind Side movie was good, just wasn’t that into this one. I think being on the losing side of the game as a homeowner, investor, and taxpayer jaded my opinion.
FTC Disclosure: If you buy The Big Short through the above link, Amazon will pay me 4% of the purchase price.
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