Book Review: The Big Short: Inside the Doomsday Machine, by Michael Lewis
One-line summary: Do not attribute malice to Wall Street when stupidity will suffice.
Reviews:
Amazon: Average: 4.0. Mode: 5 stars.
Goodreads: Average: 4.17. Mode: 4 stars.
Truth really is stranger than fiction. Who better than the author of the signature bestseller Liar's Poker to explain how the event we were told was impossible -- the free fall of the American economy -- finally occurred; how the things that we wanted, like ridiculously easy money and greatly expanded home ownership, were vehicles for that crash; and how shareholder demand for profit forced investment executives to eat the forbidden fruit of toxic derivatives. Michael Lewis's splendid cast of characters includes villains, a few heroes, and a lot of people who look very, very foolish: high government officials, including the watchdogs; heads of major investment banks (some overlap here with previous category); perhaps even the face in your mirror. In this trenchant, raucous, irresistible narrative, Lewis writes of the goats and of the few who saw what the emperor was wearing, and gives them, most memorably, what they deserve. He proves yet again that he is the finest and funniest chronicler of our times.
This is a book about the collapse of the U.S. housing market that began in 2006-2007, leading to the economic meltdown of 2008 from which we have yet to recover. If that sounds boring to you, reconsider: The Big Short isn't an economic textbook. It's written in the style of investigative journalism, and more people really should be interested in how Wall Street lost several national GDPs worth of money by underwriting loans that allowed Mexican strawberry pickers to buy $750,000 homes. And if you think this is only of interest to Americans, keep in mind that Wall Street doesn't have a global monopoly on greedy idiots; the collapse of the U.S. housing market brought down pension funds from Germany to Japan along with it.
First, the writing: The Big Short isn't the only book on this topic. There have been several other books covering the same story from different angles and focusing on different people, such as Gregory Zuckerman's Greatest Trade Ever, but The Big Short is the most well known and best selling.
I haven't read Zuckerman's book, but it would be hard to get across the often complicated and arcane concepts in this story more effectively than Lewis does. Lewis writes in an informative but entertaining manner (Wall Street types are nothing if not blunt and colorful in their language), and he covers a cast of characters many of whom who were, until this event occurred, pretty small players. (Keeping in mind that in the Wall Street world, "small" means they were only dealing with tens of millions of dollars on a daily basis.)
The Big Short isn't a textbook, but it's not a light read: it abounds with terms like Credit Default Swaps, Asset-Backed Securities, Basis Points, Mezzanine CDOs, and Tranches. Not only does the book explain them, but it also explains why they sound like economic gobbledygook, as incomprehensible as Trekkies babbling about recalibrating the fromistat to synchronize with the Krexlor matrix. (Hint: it's deliberate. Wall Street doesn't want the general public to know what the hell they're talking about.)
I'll give you the really simplified summary here:
At its root, this is all about the "subprime lending" market. In other words, risky home loans to people who very likely won't be able to make their payments. Subprime home loans were extremely profitable in the early 2000s, and the booming housing market drove the entire economy. This led to inevitable excesses of greed and stupidity: banks couldn't hand out money fast enough, leading to such things as the No-doc loan (put a lump sum of money down and agree to a higher interest rate, and you can buy a house without showing evidence that you have a job or any other means of making future payments), the Adjustable Rate Mortgage (ARM) (get a low interest rate for the first few years, before the bank jacks it up), and the Interest-only mortgage (mortgage payments pay only the interest on your loan, none of the principal, which means you are not actually building equity and your debt never decreases).
If all of those things sound like bad ideas, they are, with few exceptions, and you need to actually know what you're doing if you want to count yourself as one of the exceptions. If they sound a bit confusing, they are (and I have simplified greatly). How many of the millions of home buyers with dreams of their very own McMansion on a schoolteacher's salary do you think actually understood what they were getting into? Especially since it wasn't in the lenders' interests for the borrowers to understand just how much interest they'd actually be forking over? The entire industry was shameless. (At least a loan shark tells you what you'll pay and what he'll do to you if you don't.)
Wall Street invested trillions of dollars in subprime mortgages. Now, here's where the trickery came in: by their very nature, subprime mortgages are risky investments. To justify investing so much money in them, the firms doing so had to figure out a way to obscure the fact that they were high-risk. Through means explained in more detail in the book, they came up with (perfectly legal!) ways to "launder" these loans so they could pretend they were putting your retirement fund in solid, economically-sound investments.
Now, the next thing to understand is that Wall Street really is just like Vegas: brokers and trading firms can bet on anything, and they do. Of course, they don't call it "placing wagers," they come up with all sorts of complicated financial instruments and call it trading in bonds and securities, but the bottom line is, some Wall Street speculator says "I think this will happen," and another speculator says, "Nuh-uh! Will not!" and they write up pieces of paper which turn this wager into a billion-dollar zero-sum game. Except that billion dollars isn't their money, of course: it's their investors' money.
And thus the stage was set for the economic disaster that unfolded when people started defaulting on their loans.
How clueless were the Wall Street money guys? In one chapter, a risk assessment officer at a major securities firm asks the trader investing in all these subprime loans to project what would happen if the default rate went as high as 10%. The trader thought this was absurd; such a high default rate was unthinkable. It would be economic armageddon. A year later, the default rate was over 40%.
The Big Short's title refers to a handful of people who predicted the collapse of the subprime mortgage market and placed bets accordingly: they shorted the market.
That part is interesting, but the real lesson to be learned here is that while most people take it for granted that Wall Street is greedy and corrupt (and it is), that's not the ugly truth. The ugly truth is that Wall Street is stupid. It's not just that they should have been able to see the disaster coming. It's pretty obvious in retrospect, of course, but from the rhetoric a few years ago, most of the country seemed to seriously believe that housing prices could and would rise forever. We've known what economic bubbles are and how they work for centuries. You might forgive Jane Average Home Buyer for being naive and optimistic, but one would think Wall Street traders would know better. They didn't.
Over and over again, Lewis shows us how most brokers, traders, and hedge fund managers literally do not even understand the nature of the investments they are making. They don't read their own paper. CEOs of Morgan Stanley, Bear Sterns, Lehman Brothers, UBS -- the list goes on -- had no clue. And nobody listens to the few people who do have a clue.
The Big Short is educational and (if you are a finance geek) interesting, but it's also a sobering wake-up call to those who believe in the inherent rationality of the market. Wall Street isn't rational because many (most) of the people who make the decisions are neither rational nor informed. People accept that politics is full of crazy, stupid people, but they think that at least in the financial world, there must be some grown-ups in charge. Sadly and frighteningly, this is purely wishful thinking.
Lewis's thesis is that Wall Street is actually more stupid than dishonest. There are, of course, alternate theories and a lot of people who take issue with his details. Most of the negative reviews of this book are written by people who think that Lewis didn't correctly apportion the blame -- whether it's the government, the market, the investors, or all those people who bought houses they couldn't afford, everyone has their own ideas about whose fault it is. But to critique Lewis on anything other than ideological grounds, you'll have to read quite a few more books.
Verdict: If you just cannot imagine being interested in the subprime mortgage industry and Wall Street bond trading (even though it's key to understanding just how badly we're all going to be fucked in the coming years), I won't lie and say that The Big Short is exciting enough to stand on the strength of Lewis's writing alone. You have to be willing to be schooled a bit in financial arcana. But Lewis writes for a general audience, so it's not that hard to follow even for an economics novice. I recommend this book for anyone who wants to see how sausages are made on Wall Street, or who'd like to know where their pension fund went.
Reviews:
Amazon: Average: 4.0. Mode: 5 stars.
Goodreads: Average: 4.17. Mode: 4 stars.
Truth really is stranger than fiction. Who better than the author of the signature bestseller Liar's Poker to explain how the event we were told was impossible -- the free fall of the American economy -- finally occurred; how the things that we wanted, like ridiculously easy money and greatly expanded home ownership, were vehicles for that crash; and how shareholder demand for profit forced investment executives to eat the forbidden fruit of toxic derivatives. Michael Lewis's splendid cast of characters includes villains, a few heroes, and a lot of people who look very, very foolish: high government officials, including the watchdogs; heads of major investment banks (some overlap here with previous category); perhaps even the face in your mirror. In this trenchant, raucous, irresistible narrative, Lewis writes of the goats and of the few who saw what the emperor was wearing, and gives them, most memorably, what they deserve. He proves yet again that he is the finest and funniest chronicler of our times.
This is a book about the collapse of the U.S. housing market that began in 2006-2007, leading to the economic meltdown of 2008 from which we have yet to recover. If that sounds boring to you, reconsider: The Big Short isn't an economic textbook. It's written in the style of investigative journalism, and more people really should be interested in how Wall Street lost several national GDPs worth of money by underwriting loans that allowed Mexican strawberry pickers to buy $750,000 homes. And if you think this is only of interest to Americans, keep in mind that Wall Street doesn't have a global monopoly on greedy idiots; the collapse of the U.S. housing market brought down pension funds from Germany to Japan along with it.
First, the writing: The Big Short isn't the only book on this topic. There have been several other books covering the same story from different angles and focusing on different people, such as Gregory Zuckerman's Greatest Trade Ever, but The Big Short is the most well known and best selling.
I haven't read Zuckerman's book, but it would be hard to get across the often complicated and arcane concepts in this story more effectively than Lewis does. Lewis writes in an informative but entertaining manner (Wall Street types are nothing if not blunt and colorful in their language), and he covers a cast of characters many of whom who were, until this event occurred, pretty small players. (Keeping in mind that in the Wall Street world, "small" means they were only dealing with tens of millions of dollars on a daily basis.)
The Big Short isn't a textbook, but it's not a light read: it abounds with terms like Credit Default Swaps, Asset-Backed Securities, Basis Points, Mezzanine CDOs, and Tranches. Not only does the book explain them, but it also explains why they sound like economic gobbledygook, as incomprehensible as Trekkies babbling about recalibrating the fromistat to synchronize with the Krexlor matrix. (Hint: it's deliberate. Wall Street doesn't want the general public to know what the hell they're talking about.)
I'll give you the really simplified summary here:
At its root, this is all about the "subprime lending" market. In other words, risky home loans to people who very likely won't be able to make their payments. Subprime home loans were extremely profitable in the early 2000s, and the booming housing market drove the entire economy. This led to inevitable excesses of greed and stupidity: banks couldn't hand out money fast enough, leading to such things as the No-doc loan (put a lump sum of money down and agree to a higher interest rate, and you can buy a house without showing evidence that you have a job or any other means of making future payments), the Adjustable Rate Mortgage (ARM) (get a low interest rate for the first few years, before the bank jacks it up), and the Interest-only mortgage (mortgage payments pay only the interest on your loan, none of the principal, which means you are not actually building equity and your debt never decreases).
If all of those things sound like bad ideas, they are, with few exceptions, and you need to actually know what you're doing if you want to count yourself as one of the exceptions. If they sound a bit confusing, they are (and I have simplified greatly). How many of the millions of home buyers with dreams of their very own McMansion on a schoolteacher's salary do you think actually understood what they were getting into? Especially since it wasn't in the lenders' interests for the borrowers to understand just how much interest they'd actually be forking over? The entire industry was shameless. (At least a loan shark tells you what you'll pay and what he'll do to you if you don't.)
Wall Street invested trillions of dollars in subprime mortgages. Now, here's where the trickery came in: by their very nature, subprime mortgages are risky investments. To justify investing so much money in them, the firms doing so had to figure out a way to obscure the fact that they were high-risk. Through means explained in more detail in the book, they came up with (perfectly legal!) ways to "launder" these loans so they could pretend they were putting your retirement fund in solid, economically-sound investments.
Now, the next thing to understand is that Wall Street really is just like Vegas: brokers and trading firms can bet on anything, and they do. Of course, they don't call it "placing wagers," they come up with all sorts of complicated financial instruments and call it trading in bonds and securities, but the bottom line is, some Wall Street speculator says "I think this will happen," and another speculator says, "Nuh-uh! Will not!" and they write up pieces of paper which turn this wager into a billion-dollar zero-sum game. Except that billion dollars isn't their money, of course: it's their investors' money.
And thus the stage was set for the economic disaster that unfolded when people started defaulting on their loans.
How clueless were the Wall Street money guys? In one chapter, a risk assessment officer at a major securities firm asks the trader investing in all these subprime loans to project what would happen if the default rate went as high as 10%. The trader thought this was absurd; such a high default rate was unthinkable. It would be economic armageddon. A year later, the default rate was over 40%.
The Big Short's title refers to a handful of people who predicted the collapse of the subprime mortgage market and placed bets accordingly: they shorted the market.
That part is interesting, but the real lesson to be learned here is that while most people take it for granted that Wall Street is greedy and corrupt (and it is), that's not the ugly truth. The ugly truth is that Wall Street is stupid. It's not just that they should have been able to see the disaster coming. It's pretty obvious in retrospect, of course, but from the rhetoric a few years ago, most of the country seemed to seriously believe that housing prices could and would rise forever. We've known what economic bubbles are and how they work for centuries. You might forgive Jane Average Home Buyer for being naive and optimistic, but one would think Wall Street traders would know better. They didn't.
Over and over again, Lewis shows us how most brokers, traders, and hedge fund managers literally do not even understand the nature of the investments they are making. They don't read their own paper. CEOs of Morgan Stanley, Bear Sterns, Lehman Brothers, UBS -- the list goes on -- had no clue. And nobody listens to the few people who do have a clue.
The Big Short is educational and (if you are a finance geek) interesting, but it's also a sobering wake-up call to those who believe in the inherent rationality of the market. Wall Street isn't rational because many (most) of the people who make the decisions are neither rational nor informed. People accept that politics is full of crazy, stupid people, but they think that at least in the financial world, there must be some grown-ups in charge. Sadly and frighteningly, this is purely wishful thinking.
Lewis's thesis is that Wall Street is actually more stupid than dishonest. There are, of course, alternate theories and a lot of people who take issue with his details. Most of the negative reviews of this book are written by people who think that Lewis didn't correctly apportion the blame -- whether it's the government, the market, the investors, or all those people who bought houses they couldn't afford, everyone has their own ideas about whose fault it is. But to critique Lewis on anything other than ideological grounds, you'll have to read quite a few more books.
Verdict: If you just cannot imagine being interested in the subprime mortgage industry and Wall Street bond trading (even though it's key to understanding just how badly we're all going to be fucked in the coming years), I won't lie and say that The Big Short is exciting enough to stand on the strength of Lewis's writing alone. You have to be willing to be schooled a bit in financial arcana. But Lewis writes for a general audience, so it's not that hard to follow even for an economics novice. I recommend this book for anyone who wants to see how sausages are made on Wall Street, or who'd like to know where their pension fund went.