Saturday, October 31, 2020

#33 [2020/CBR12] "The Big Short" by Michael Lewis

Cannonball Bingo: Money!

I've had a fun time figuring out what books fit for what squares in Cannonball Bingo, but I didn't know what to read for "Money!" Although I'm a fan of having money, and I'd definitely like enough that I don't have to work and can travel all over the world, the topic doesn't hold my interest. So, I went on a Google search to find a good book on a topic that I often find tedious. And I found The Big Short: Inside the Doomsday Machine (2010) by Michael Lewis.

I listened to the audio book of The Big Short, which I'm sure made the discussions of Wall Street, stocks, bonds, short selling, CDO's, and credit default swaps even more impenetrable. Fortunately, Lewis does a very good job in using the main characters to drive the narrative. He also excels at using metaphors to describe the gist of what's happening in the market without becoming mired in dense detail. I found myself very interested in the characters, invested in their success, and still understanding the basics of the financial markets.

In The Big Short, Lewis explains what caused the financial crisis of 2008 through the people who first saw what was happening. As someone who was a bond trader in the 1980's and 1990's (apparently he wrote about this experience in his first book), he has something of an insider's knowledge. Essentially, banks were giving home loans to people with bad credit or no credit (sub-prime mortgages). So interested in the fees they gained from these transactions, they often did little to no investigation on whether the borrower would be able to pay. These loans were often fraudulently misleading and included variable interest rates or low initial interest rates. The banks would sell these loans to large, Wall Street banks, and the loans would be bundled into bonds. Because of intentional obfuscation (fraud) and lack of oversight, 80% of these subprime loan bundles would be rated AAA--essentially riskless--even though they were full of loans that were pretty much guaranteed to fail. Even the 20% that were initially discarded, could be grouped in with other loans and potentially be rated AAA. On top of that, an entirely new market sprung up, betting whether the new housing loans would default or not. This new market magnified the already disastrous consequences of the sub-prime loans.

It seems that most of the people involved didn't really understand what was happening or the financial risk they were facing. The rating firms did not have the resources or will to delve too deeply into what was happening, and they didn't want to lose business. A lot of others involved were just going with the flow. The housing market had been so stable up to that point that most thought it was a sure thing. However, there were those that saw something was amiss. Dr. Michael Burry was a doctor who discovered an interest in finance. He started his own investment firm, Scion Capital, that was wildly successful financially. He looked deeper into the sub-prime mortgage loan bonds and discovered that they were bound to fail eventually, and he began betting against them. Steve Eisman was a refreshingly honest, but often rude and direct man who also figured out what was happening. Finally, Cornwall Capital was an investment firm started with $110,000 in a garage that bet against the grain.

Eisman, Murry, and the partners of Cornwall Capital drive the story. They are underdogs, vastly outnumbered in their understanding of what is to come. I loved hearing details about their lives and how they were able to come to their conclusions. 

As a newbie to this Wall Street business, I was shocked by how much money was involved, how much money was lost, and how this was allowed to happen. We tout the wonder of the free market, but the market broke down--even as default rates increased, the insurance rates stayed the same. And instead of allowing the banks to fail as deserved, the government stepped in and taxpayers bailed them out. Even more infuriating was that the people responsible for losing billions and billions of dollars walked away with millions of dollars for themselves. Howie Hubler from Morgan Stanley lost $9 billion in a single trade (with Morgan Stanley losing $58 billion in the financial crisis total). Instead of being fired, he was given the option to resign, and he left his job with $10 million in back pay. You f*ck up your job worse than anyone in history, and you earn $10 million? How is this fair? Obviously it's not, but I'd like a little more fairness and justice.

I found this book so surprisingly interesting that I'm contemplating learning a little more about financial markets...someday.

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