(Note: Relevant article at the end)
If you’re
looking for a textbook, definitional account of the Financial Crisis, this is
not the book for you. Rather, Michael Lewis describes the onset of the housing bubble
and eventual crash using a dry-humored, story-like style. His book is both
entertaining and informative, especially for those (like me) who lack extensive
background in the development of the housing bubble. By telling the stories of
a few men who recognized the failure of the subprime mortgage bond market
before it happened, Lewis explains how subprime lending worked and why the
market essentially failed.
The Wall
Street “big shots” like Goldman Sachs, Merrill Lynch, Bear Sterns, Morgan
Stanley, and JP Morgan found themselves in the midst of a booming mortgage bond
market that took off in the 1980s. Mortgage bonds, as Lewis describes, were “a
claim on the cash flows from a pool of thousands of individual home mortgages”
(7). Investment banks structured mortgage bonds by “tranches.” The
lowest tranches were more risky, with higher interest rates, while higher
tranches had lower interest rates and lower risk. Subprime lending began as
lenders disregarded the fact that a low credit scored- borrower may not be able
to make mortgage payments, because as home prices kept rising, borrowers could
just pay off the mortgage by selling the house. As subprime mortgages became
packaged into bonds, investors relied on Moody’s and Standard & Poor’s
ratings to make their investment decisions, where riskier mortgage bonds would
receive lower ratings. Lewis, however, highlights a botch in the rating system,
found in collateralized debt obligations (CDOs). AIG insured CDOs, which
“disguise the risk of subprime mortgage loans,” by packaging them with “better
loans,” ultimately allowing them to receive a better rating (72). Stephen Eisman,
Michael Burry, Jamie Mai and Charlie Ledley not only recognized this “ponzi
scheme,” but they took advantage of it.
Lewis
introduces Michael Burry, a neurosurgeon with Asperger’s who was fascinated by
the bond market, specifically the subprime mortgage boom. Burry watched the
housing bubble grow, leading to his discovery and purchase of credit default
swaps (CDS)- “insurance against the failure of a mortgage bond” (72). Eisman, a fickle and hotheaded hedge fund
owner, saw disaster coming when Wall Street banks’ fixed-income departments
would package mortgage loans with “teaser” fixed interest rates into mortgage
bonds. He saw the rating inefficiencies and the potential for profits by betting
against (“shorting”) the bonds with the worst underlying loans. Ledley and Mai started Cornwall Capital Management
and executed investments based on predicted failures in certain markets. After
getting placed on Deustche Bank’s “institutional” trading platform, they bet
against (bought CDS) CDOs. By 2007, as defaults rose and CDOs began to fail in
large numbers, Burry and Cornwall Capital sold their credit default swaps and
heavily profited. The subprime mortgage- backed financial system collapsed as
housing prices fell and borrowers defaulted on their loans, bringing a series
of bankruptcies and acquisitions on Wall Street. Lewis ends with the startling
statistics, including the Fed’s announcement of a $85 billion towards AIG to
pay off its losses on the CDS sold to Wall Street.
I’ll start
with what I liked. I liked that Lewis used his book to describe the Financial
Crisis from a rare point of view; “rare” based on the fact that he followed
those few who predicted and benefited
from this economic catastrophe. Instead of saying “This is how the housing
bubble started, this is why it was bad,” Lewis takes a journalistic approach
(appropriate since he is a financial journalist) and includes quotes and
thoughts that these financial geniuses had as they watched the housing bubble
expand and pop. For example, Lewis quotes Ledley in his discovery of the
botched rating system, “The more we looked at what a CDO was, the more we were
like, Holy shit, that’s just fucking crazy. That’s fraud (129). By
including actual quotes and reactions of the “winners” in his book, Lewis depicts
their personalities and their ability to analyze a complex situation. Including the fascinating stories behind his
core characters, like Murry’s battle with Asperger’s, made learning about the
subprime mortgage crisis more personal, enjoyable and overall, readable. The insertion
of the “F Bomb” throughout the book made it feel like I was hearing a real
conversation between Wall Street honchos and big-time money managers.
While the
writing style and context of the book encouraged me to read more Michael Lewis
books (next on my list is Panic!),
I’m somewhat uncomfortable with his portrayal of these figures as “heroes.”
Eisman, Murry and the Cornwall brothers saw an opportunity and seized it. When
I was little, I had 10 pennies and gave my younger brother a proposition: “I
will trade you ALL of these pennies for that ONE, single dollar bill.” Naively,
he thought he struck gold. Does the recognition of an opportunity for personal
gain (and his loss) make me a hero? Yes, the housing crisis is far more
complex, dealing with numerous additional variables. The point is, the characters
in this book also recognized opportunity and seized it. Regardless of their
gain, thousands suffered from substantial losses (on the lending and borrowing
side). They benefited while everyone else suffered. This, in my opinion, may
make Eisman, Murry, Ledley and Mai clever, observant and financially talented—not
heroic.
Lewis
acknowledges the weaknesses in rating agencies, but for me, not enough. He
constantly points back to Wall Street and the big banks, the investors and
manipulation in bond structuring. According to Lewis, Wall Street firms were
able “to hide the risk by complicating it.” He includes an interaction between
Eisman’s partner and a woman from Moody’s: “How could you rate any portion of a
bond made up exclusively of subprime mortgages triple-A?” asked Eisman’s
partner. The Moody’s rep responded, “That’s a very good question” (103). Lewis
used this to point out that the banks convoluted the structure of subprime
mortgage bonds to facilitate more investment. However, reading this made me attribute
a large part of the blame to the rating agencies themselves. They have the
responsibility of evaluating and reviewing bonds in order to designate a
specific rating, meaning they should have reviewed all loans within the bonds
thoroughly. So, while I agree that the banks were manipulative in their
structuring of the CDOs, Moody’s and S&P are also a large part of the
issue.
Reading The Big Short: Inside the Doomsday Machine was
both critical in my understanding of the development of the housing crisis and
towards my ability to develop an opinion of those directly involved. Prior to
this book, I have not considered the position of the rating agencies, who I now
think play a substantial role in the mismanagement and mistakes behind CDOs and faults within the subprime mortgage market. Lewis took a darker view of Wall
Street, opening his book with discouraging words about working in finance and
banking. While I acknowledge that he is far more experienced than I am, I cannot
completely agree with the representation of his characters as “heroic” based on
the fact that they foresaw the explosion of the housing bubble and used this to
reap profits. As far as designating a victim, I still go back and forth between
investors and borrowers. Lewis presents his characters as sympathetic to the
borrowers. Personally, I can’t help but to feel that both the investors and the
borrowers acted without thinking in the long term.
Recent and relevant article about AIG: Former CEO Hank Greenberg files a lawsuit against the US Government for 'overstepping its authority in demanding a 79.9% equity stake in exchange for providing an $85 billion emergency loan." ....Mr. Greenberg, you accepted the bailout package and you needed it. There's no such thing as a free lunch.
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