Review of “The Big Short” by Michael Lewis

You’ve got be really weird to think that everyone else is wrong and be willing to bet heavily on your thoughts. Lewis’s book follows several people who bet against the subprime mortgage bubble. Lots of people said they saw the apocalypse that was coming, but these people actually bet on it.

The people are Michael Burry, Steve Eisman and the three guys that ran Cornwall Capital.

One of the guys that ran Cornwall, "had bought a small farm in the country, north of San Francisco, in a remote place without road access, planted with fruit and vegetables sufficient to feed his family, on the off chance of the end of the world as we know it." Here’s another talking to his before the crisis:

"I said to my mother, ‘I think we might be facing something like the end of democratic capitalism,’" said Charlie. "She just said, ‘Oh, Charlie,’ and seriously suggested I go on lithium."

Here’s some on Eisman:

He’d go to meetings with Wall Street CEOs and ask them the most basic questions about their balance sheets. "They didn’t know," he said. "They didn’t know their own balance sheets." Once, he got himself invited to a meeting with the CEO of Bank of America, Ken Lewis. "I was sitting there listening to him. I had an epiphany. I said to myself, ‘Oh my God, he’s dumb!’ A lightbulb went off. The guy running one of the biggest banks in the world is dumb!" They shorted Bank of America, along with UBS, Citigroup, Lehman Brothers, and a few others. They weren’t allowed to short Morgan Stanley because they were owned by Morgan Stanley, but if they could have, they would have.

Burry is "a one-eyed money manager with Asperger’s syndrome."

In addition to chronicling the stories of these very interesting people, the book is probably the best complete explanation of what went wrong that I’ve read. It includes a (very short) bit on making loans to poor people, blaming the rating agencies, and all the other explanations you can think of. However, most of the blame is put on the fact that investment banking is conducted in a certain way, and once the investment banks turned into public companies, there was basically no restraint on their willingness to take risk. Here’s how Lewis sees the crisis:

The subprime mortgage market had experienced at least two distinct phases. The first, in which AIG had taken most of the risk of a market collapse, lasted until the end of 2005. When AIG abruptly changed its mind . . . The people who ran the CDO machine at the various firms had acquired too much authority. From the end of 2005 until the middle of 2007, Wall Street firms created somewhere between $200 and $400 billion in subprime-backed CDOs [and AIG was not on one side at this point]: No one was exactly sure how many there were. Call it $300 billion, of which roughly $240 billion would have been triple-A-rated and thus treated, for accounting purposes, as riskless, and therefore unnecessary to disclose. Much, if not all, of it was held off balance sheets.

This sort of thing would not have happened if the investment banks were betting their own money, but they weren’t and they still aren’t. As Lewis says, "[w]hat’s strange and complicated about it, however, is that pretty much all the important people on both sides of the gamble left the table rich. . . . What are the odds that people will make smart decisions about money if they don’t need to make smart decisions–if they can get rich making dumb decisions? The incentives on Wall Street were all wrong; they’re still all wrong."

Nevertheless, the personalities were more interesting to me than the story. Burry found that, "he had been right, the world had been wrong, and the world hated him for it."

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6 Responses to Review of “The Big Short” by Michael Lewis

  1. bjarne says:

    I’ll buy it! Thanks

  2. bjarne says:

    wrong post

  3. dearieme says:

    Keynes somewhere made a remark along the lines of … for bankers it’s better to be wrong in company than right in isolation. Whether or not his macroeconomics has much merit, Keynes really was a very clever chap.

  4. Handle says:

    This is why it’s not safe, in this era, to save or invest in anything but production of scarce primary commodities, especially fossil energy, for which there are no cheap substitutes.

    By the way, if you’d like a nice guest post on “what the future probably looks likes” analysis based on BP’s latest report (the energy geeks wait all year for its release), then I’d be happy to oblige this fine site.

    Example: In 2010, China built the equivalent of over 100 500 Megawatt electric power plants, about two per week, mostly coal-burning. India built only 10% as many. China now uses fully half the world’s coal output, and more than the entire world used thirty years ago.

    Meanwhile, the entire developed world finished only a single one, in Portugal, and only because it was begun at a time when people were optimistic about Portugal’s prospects for economic growth, which was a mistake, because they are clearly bankrupt.

    China also exceeds US CO2 emissions by 50% now, having added as much to their annual rate since just 2002 as all of Europe (minus Russia) combined. If you wanted to stabilize global emissions at 1990 levels by asking the OECD to take most of the hit, they’d have to immediately drop consumption by 75% this year, and turn out the lights altogether forever in 3 more, and after reaching that limit emissions would still go up.

    My non-alarmist view of global warming (like my understanding of Economics) is more generous to the basic mainstream theories than many in the Reactionary blogosphere would be comfortable with, however, my perspective is that whatever the consequences of CO2 will turn out to be, that’s it provably absurd to try and control emissions rates, and especially to try and do so on our own, because China and India are going to burn every gram remaining in East and South Asia by mid-century.

  5. Matt Landry says:

    It’s not especially hard to spot a bubble in the middle of one. Lots of people knew the housing market was going to collapse, and quite a significant fraction of them were at least approximately right about what the secondary and tertiary consequences of that would be.

    Making money on that, on the other hand, requires guessing with an unrealistic degree of accuracy about when the bubble is going to burst.

    The market can stay irrational longer than you can stay liquid.

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