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Michael Lewis – The Big Short

Michael Lewis writes entertaining novels, and “The Big Short” follows suit.  The book focuses less on the mechanisms of the financial collapse and more on a few characters who were able to see that something was massively amiss and able to capitalize on it.  Lewis tells the story of an ever pessimistic and self-righteous Steve Eisman, a fund-manager/ex doctor with Aspergers Syndrome named Michael Burry, and a few lesser known individuals with seemingly endless luck.  The book is a quick read and has many anecdotes that will leave you scratching your head with their insanity.  At times the story can be educational, but seems to gloss over the major causes and mechanisms of the crisis while trying to villainize certain, less humanized players.

Lewis makes it seem that very few investors and financial “specialists” were able to foresee the financial crisis in the making, but in reality the truth is a bit less straightforward.  Having had a front row seat during the run-up and subsequent unraveling, I can say that argument is far from factual.  The truth is that most money resides with institutional money managers which include pension funds, insurance companies, mutual funds, foundations and endowments.  These are what the street refers to as “real money players” because they buy investments with cash, not on margin like hedge funds.  These real money players are “investors” because their intention is to take investable cash and lend it to borrowers so that the real money player feels like he is earning an adequate return for the risks being taken.  When the federal reserve keeps short-term interest rates low, these real money buyers have a very high cost of sitting on cash even if they believe that the investments do not provide adequate risk-adjusted returns.  As yields and returns compress, some of the naive institutional buyers are lured into riskier and riskier investments as they try to appease their constituents (shareholders, customers, policyholders, pension boards, donors, beneficiaries).  Unfortunately, the many educated and astute institutional investors who never bought any of the “toxic assets” and even saved their constituents billions of dollars by raising cash in euphoric market conditions against the wills of their bosses, never made the front page of Bloomberg.  Many saw the crisis coming, but did not have the tools or ability to execute a “short” to directly benefit from their knowledge.  When reading “The Big Short“, keep that fact in mind because the personalities and social defects of the characters in the book had more to do with their windfall than did their prescient knowledge.

The second big hole in the book is the portrayal of the banks as big dumb brokers that never knew the extent of the garbage they were holding.  I do believe the banks were caught off guard by the toxic waste they were holding, but mostly by the speed with which things deteriorated and their inability to toss the garbage overboard before the water overcame them.  The truth is that they were fully aware of what they were doing, but they just did not care.  With the repeal of the Glass-Steagall Act in 1999, banks were given a golden ticket.  The Glass-Steagall Act had been around since the Great Depression as a way to separate commercial banks from investment banks.  By repealing this act, congress provided banks with the perfect platform to make billions of dollars and, in so doing, set the world up for a financial crisis.  Mortgage brokers originated loans without abandon because they earned a commission and sold the risk to banks.  Banks packaged up the crappy loans and paid rating agencies to put a “highly rated” stamp on them so that they could then sell the risk to naive investors.  The mortgage brokers made money, the banks made money, and the rating agencies made money.  The only problem was that the banks were left holding a bundle of mortgages because the market blew up before the banks could blow the rest the rough pipeline.

Despite a few shortfalls, “The Big Short”  is highly entertaining and suggested for a weekend read.

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5 Responses

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  1. cg says

    ‘Any business where you can sell a product and make money without having to worry about how the product performs is going to attract sleazy people’ pg 9.

    If the banks that were engaged in this mess knew what they were doing — then where were they getting the specific information on the mortgage pools. Not even Moodys had this information. Somehow, Wells Fargo, with massive presence in California and Arizona and Nevada — among the very worst regions in this downturn — knew enough to stay out of trouble. Those other banks were just chasing bad business — and it was unethical and it led to their own downfall.

  2. SurlyTrader says

    “If the banks that were engaged in this mess knew what they were doing — then where were they getting the specific information on the mortgage pools. Not even Moodys had this information. ”

    The banks had the information about the underlying loans (or the lack of information about the underlying loans that told them volumes), but their job was only to hoodwink the rating agencies into stamping the group of loans with adequate ratings for naive investors to buy them. Do not get me wrong, there were plenty of small trading groups within banks that bought into what they were selling their customers, but for the most part the banks knew that this was merely a way for them to make exorbitant commissions. Repackage garbage with a smiley face and a pretty bow.

    In the commercial real estate market they did not call it “liar loans” as they did in the residential real estate market, instead they called it “pro forma” which means that they had vastly optimistic numbers about the prospective growth in lease demands as well as lease payments.

    Bottom line: fool someone else into believing optimistic growth assessments and you not only sell the current deal but increase the demand for future deals.

  3. cg says

    “but their job was only to hoodwink the rating agencies into stamping the group of loans with adequate ratings for naive investors to buy them.”

    This is what a company built with ethics has managers for — it takes adults to run a company correctly. their ‘job’ was not to hoodwink anyone — their job was to act ethically.

    I worked in the money management arm of a major bank and when we pitched a company on the east coast to manage a piece of their pension fund — they said they would give us the business IF we could persuade the loan officers to extend them needed credit. We asked and our managers said no — this was bad business. I was under the impression that this is what management is for — to instill ethical behavior rather than chase bad business because of short-term incentives. Guess what, the bank I worked for had no trouble this last crisis.

  4. SurlyTrader says

    I agree with you, the problem is that the unethical behavior was never really punished. Those who made bad loans, those who packaged bad loans, those who sold bad packaged loans…never felt the full pain of their actions and decisions. In fact, the majority of them were able to keep their bonuses and walk away unscathed. The bigger issue is that the incentives have not been changed at all. The banks have been saved from their own disastrous positions at the cost of tax-payer funding while the next crisis is all but certain.

  5. cg says

    This talk by Wells Fargo ex-CEO on how they managed to miss the debacle. These are adults actually being leaders and turning down bad business:

    Go to 21:18 of this video:

    http://www.youtube.com/watch?v=hnSY-3Qwc5k



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