BOOK REVIEW: Michael Lewis's The Big Short

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Back in 1989 while a freshman in college, my investment banker father passed along to me his copy of Michael Lewis's Liar's Poker. Heavily read inside and outside of finance, Lewis's account of his three-year stint in Salomon Brothers' fixed-income division made some cringe, and a great deal more extremely eager to follow in his footsteps.

Though Lewis intended for his book to be a cautionary tale about an irrational and certainly ephemeral financial period during which a twenty-four year old "with no experience of, or particular interest in, guessing which stocks and bonds would rise and which would fall" made huge sums of money advising institutional investors, subsequent history would reveal that Lewis's predictions of Wall Street's death were greatly exaggerated. As he soon found out, the proverbial Ohio State Buckeye meant to read the book, and be turned off by high finance, instead contacted him about how to secure the kind of work he eagerly turned his back on in 1988. This writer remembers well how fellow MBA students in the late ‘90s, perhaps eager to create a campus facsimile of the legendary Salomon trading floor, would stage their own liar's poker contests, albeit concerning sums of money a microscopic fraction of those Lewis witnessed amid the halcyon days of late ‘80s finance.

Fast forward twenty years, the Wall Street that Lewis long ago left for dead was still churning out big profits in pursuit of its essential function of capital allocation; deciding "who should get it and who should not." One major difference between the two periods concerned bonuses; the once nosebleed $3.1 million payouts that Lewis chronicled long ago having risen exponentially. 

It is the modern world of finance that Lewis seeks to address in his new, and highly engrossing account of the financial decade just passed, The Big Short. Much as Liar's Poker achieved an audience including but not limited to money types, so will his latest attract readers with little to no experience in the capital markets. Whatever one's background, the book promises to entertain.

Lewis's story of 21st century finance is told in endlessly interesting fashion through the eyes of the skeptics, or "deniers" who did not buy into the view that the decade's financial wizardry meant to securitize seemingly everything - from mortgages to credit card debt to health club dues - redounded to the broad economy, not to mention the low earners this financial alchemy was meant to serve. First up we have Steve Eisman, a former subprime-lending analyst (and frequent cheerleader in the ‘90s) for Oppenheimer who, shattered by the death of his newborn child, grew increasingly skeptical about the lenders he was charged with covering.

Sensing something amiss, he famously did what analysts rarely do whereby he started "naming names" when it came to poorly run firms in his space. In one memorable scene recounted in the book, Eisman shouted to the Oppenheimer trading floor the names of eight lenders whose shares would soon go to zero. The prediction proved correct.

And then, this former Republican turned "socialist" hired accountant Vincent Daniel to make sense of mortgage-lending practices that on their face did not. Daniel was charged by Eisman with analyzing a database of mortgages, and told simply to "Go into that room. Don't come out until you've figured out what it means." Daniel concluded what Eisman long suspected, that what passed for high-grade debt was nothing of the sort, and thus was eventually born a hedge fund meant to unmask a profitable line of finance for Wall Street.

Around the time that Eisman was growing skeptical emerged "a medical student with only one eye, an awkward social manner, and $145,000 in student loans." Though Michael Burry initially made his investment name decrying the booming Internet stocks of the late ‘90s, it's no small irony that this former medical intern developed his reputation for spotting true value in equities on the Internet.

Having built a small money management firm thanks to his prescient market musings in cyberspace, Burry achieved equity investment returns that crushed the S&P early this decade. Then, able to easily scan the fine print of loan documents thanks to his self-diagnosed Asperger's Syndrome, Burry noticed that the quality of home loans began to cascade downward in 2004. Of the view that "bubbles" could be identified, Burry convinced the various investment banks to sell him insurance (credit default swaps) that would skyrocket in value assuming the dodgy loans he'd sleuthed defaulted.

So with Eisman and Burry set to profit from the eventual collapse of a mortgage market created for higher-risk borrowers, Lewis introduces us to a "garage hedge fund", Cornwall Capital Management. Literally founded in a Berkeley garage, Charlie Ledley and Jamie Mai turned their $110,000 Charles Schwab account into a multi-million dollar hedge fund based on their belief that long-term stock options were mispriced when it came to extreme events, or disasters.

Having exponentially grown their fund through prescient option bets, Ledley and Mai paid a bond guru the princely sum of $50,000/month to explore the higher end mortgage debt that they assumed was similarly overpriced thanks to ratings agencies staffed with individuals (Daniel likened them to government employees) unable to secure Wall Street work, and who didn't understand the debt they were rating. Notably, insurance on this allegedly higher-quality debt was even cheaper to purchase, at which point Cornwall too was set to similarly score big if the mortgage market began to falter.

What's perhaps most interesting about the trades entered into by these deniers is how very weak was the mortgage foundation they were betting against. Indeed, arguably the most important point made by Lewis through the eyes of these financial "seers" is that for them to eventually profit, "Home prices didn't even need to fall. They merely needed to stop rising at the unprecedented rates they had the previous few years for vast numbers of Americans to default on their home loans." (my emphasis)

The above speaks to the broader truth about this decade's housing market, that it never collapsed as most in the media assumed it did. Instead, home prices merely stopped rising by 2006-07 such that the speculative play for home buyers ran aground; the rest history.

And with the stage set for the eventual storm, readers are introduced to Deutsche Bank's Greg Lippmann, Wall Street's Galileo as it were, who visited hedge funds anywhere and everywhere in order to present to them what at least in retrospect seems to have been the trade of a lifetime. Returning to the earlier point that profits would abound for investors willing to buy cheap insurance (Lewis chronicles AIG's role here masterfully) that would soar in value if the housing market merely flattened, Lippman staked his career and a great deal of Deutsche's capital on a bet against home prices.

In retrospect an easy trade to take on, particularly considering Lewis's stories of the $14,000/year strawberry picker able to secure a $724,000 mortgage, not to mention the two sisters in Queens who parlayed the rising value of a condominium there into ownership of six. Why then, were so many smart people fooled? There perhaps lies one weakness with The Big Short in that other than the fascinating account of the decline of super-trader Howie Hubler, the story of this horrific descent into financial chaos is largely, and entertainingly told from the perspective of the eventual victors.

Needless to say, the negative bets made by Eisman et al were certainly not seen as home runs by very many people as evidenced by how cheaply each could purchase credit default swaps. Of course even the purchase of the swaps was no small thing given the greater truth that to do so required "paying to be in a trade" as opposed to the positive carry that most investors were used to. In Burry's case, after having presumably established the credibility of his investing vision with past performance, he caught unending grief from his investors as he went far afield from stocks with a macro bet that no one quite understood. Entrepreneurs almost by definition see what others do not.

In that case, despite the conviction of Eisman, Burry, Mai, and eventually Lippmann, most (excepting the very certain Burry) continued to quiz those on the other side of their trade to perhaps find out what they were missing. The aforementioned quizzing leads to the book's most entertaining scene, when Lippmann sat Eisman next to a smug CDO bull at a dinner in Las Vegas; Vegas the setting of the annual "varsity" mortgage conference. Shocked by this man's hubris, Eisman cornered Lippmann afterward and told him he wanted to short every single mortgage security that his dinner companion purchased.

Lewis essentially brings his remarkable story of investment visionaries to a close after the above-mentioned dinner in Las Vegas. As one can imagine, the story's protagonists grew very rich off of the shocking mistakes made by some very smart people during a period that will be analyzed in detail for decades to come.

Regarding disagreements, there are a few. About Eisman and his socialist leanings which most notably drove him to be friendly with ACORN, Lewis noted that it must have been "the first time a guy from a Wall Street hedge fund exhibited such interest in an organization devoted to guarding the interests of the poor." This can perhaps be excused as license taken by an author driven to entertain, but it's also pure nonsense as evidenced by the Robin Hood Foundation, a charity created by hedge-fund types, and which "funds and supports innovative poverty-fighting organizations in New York City." Beyond that, one can't walk a college campus or a city street or search the sources of funding for most non-profits without seeing the names of leading lights of finance listed prominently.

Throughout the book Lewis made the point that the quality of loans packaged by Wall Street was irrelevant to its firms considering they'd largely shifted the risk to others. That's surely a nice thought, but what of the investors in possession of this dodgy debt? Implicit in Lewis's argument is that the symbol that is Wall Street knew what it was securitizing was worthless, at which point it decided to harm its best customers. Good work if you can get it, and arguably an oversimplification of that which wasn't simple.

In setting the stage for his lunch with former Salomon boss John Gutfreund, Lewis observed that "Gutfreund had done violence to the Wall Street social order - and got himself dubbed the King of Wall Street - when, in 1981, he'd turned Salomon Brothers from a private partnership into Wall Street's first public corporation." This popular assertion among the financial commentariat - one suggesting that Wall Street employees became careless once the money wasn't theirs - is baseless.

Indeed, as Lewis himself noted on the page before the one in which he blamed Gutfreund for activities that occurred well after his period of relevance, Greg Lippmann "was paid $47 million in 2007, although $24 million of it was in restricted stock that he could not collect unless he hung around Deutsche Bank for a few more years." The unspoken reality about Wall Street pay is that much of it comes in restricted stock, so when its employees are taking big risks, they're risking their own money. If this is doubted, readers might want to pay visits to the former employees of Bear Stearns and Lehman Brothers.

Lewis references the crisis just passed as "the most purely financial economic disaster in history", but that too seems an oversimplification.  Businesses, including banks commit major errors all the time, and in an ideal world would be forced into bankruptcy so that they couldn't make the same mistakes again.  If we ignore how various governmental initiatives (see below for the biggest) fed massive financial error, shouldn't it be said that the disaster in this story concerns a federal government that can't stomach failure such that it excused monumental error on the way to bailouts?  Indeed, if banks were acting in non-economic ways, and hindsight says they were, it seems the true economic fix was to let them fail in order cleanse the economy of practices that weren't working. 

It's rarely discussed, but over the last thirty years the world has experienced the happy rebirth of free markets to varying degrees, with global capital flowing to the countries that liberalized their economies, while exiting those where governments exerted greater control.  In that sense, is it possible that the crisis of 2008 was the rational response of investors positively horrified by the rebirth of governments controlling economic affairs from the Commanding Heights?  Financial disaster?  How about government disaster?

But the biggest quibble concerns what Lewis did not mention, as in the falling dollar this decade. He might respond that The Big Short is not an economics book, but as a book meant to tell us "how we got here", it would surely help readers to look beyond the mere symptoms in search of causes; one being weak-dollar policy.

Sure enough, housing booms the likes of the one we just experienced are hardly new, and have occurred throughout history anywhere and everywhere that currencies have been debased. Housing is commodity like, and has long served as an inflation hedge, even in countries like Canada (the Case-Shiller Index there doubled this decade) where a home purchase is very difficult. To put it very simply, the Bush Treasury sought and achieved a weak dollar this decade, and when we devalue stateside, it's always a worldwide event with housing the sure beneficiary.

The Big Short once again covers all the symptoms, from easy loans to rising home prices to clueless ratings agencies, but the collapsing dollar's perhaps central role in the housing spike that helped camouflage so many bad decisions, is not mentioned. In that sense, a very important book could have been made better. So much is explained in easy-to-read detail, the dollar not explained at all.

Despite the disagreements, The Big Short is an essential and enjoyable read; one that promises to delight readers inside and outside of finance. But does it spell the end of Wall Street?

Probably not, because as Lewis made plain early on, Wall Street's essential function concerns who gets and who doesn't get capital regardless of his flinty suggestion that those in finance offer no "social utility." There will always be a need for markets to separate the good stewards of capital from the bad, and as such, a need for finance that is symbolized by Wall Street.


John Tamny is editor of RealClearMarkets, Political Economy editor at Forbes, a Senior Fellow in Economics at Reason Foundation, and a senior economic adviser to Toreador Research and Trading ( He's the author of Who Needs the Fed?: What Taylor Swift, Uber and Robots Tell Us About Money, Credit, and Why We Should Abolish America's Central Bank (Encounter Books, 2016), along with Popular Economics: What the Rolling Stones, Downton Abbey, and LeBron James Can Teach You About Economics (Regnery, 2015). 

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