The Big Short: Inside the Doomsday Machine [Hardcover]

 

 

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Michael Lewis is one of the most gifted and entertaining writers today - anyone who has read his reputation-forming Liar's Poker will know this (if you haven't, and you aspire to a career in finance, you should), but his subsequent offerings, particularly the singularly brilliant Moneyball have also been outstanding. He distinguishes himself from his peers firstly by his thorough insider's understanding of how, when and why finance works (and by extension how, when and why it doesn't) but also a deft turn of phrase and devastating wit. When the subject is the logic-defying but leaden topic of tranched portfolio credit derivative armageddon, both attributes are in good demand. And both, in the shape of Lewis' airy but insightful writing, are in abundant supply.

The rosette for "best book about the financial meltdown" is hotly contested - luminaries such as George Soros, Mohamed El-Erian and Hank Paulson have entered more or less weighty tomes (some excellent, some portentous, some a bit wacky); as have well-respected and deeply learned journalists like the NY Times' Andrew Ross Sorkin and the FT's Gillian Tett.

I thought I had awarded my own best-in-show to Sorkin for his massive and all-encompassing political tome, which manages to encompass the total business perspective across an extraordinarily wide theatre of conflict, somehow holding the whole thing in focus the whole time. A criticism I had seen levelled at that book was that, while it admirably covered the outright red alert state of affairs that prevailed at boardroom level for a couple of years after the credit crunch, it failed - didn't really even try - to explain what, economically, caused all this mess in the first place.

Here, therefore, is the ideal companion volume. Instead of viewing the battle from Operations HQ by reference to the crisis meetings of Wall Street's and Washington's Masters of the Universe (the image that comes to mind is beetroot-faced generals strutting about impotently while the Andrews Sisters push military units around a big map with snooker cues), Lewis takes us right into the heat of the combat, like a journalist embedded with a crack squad of advanced position infantry men as they dodged sniper fire and the general fog of war armed only with a Rusty Humvee and some tarpaulin (think Generation Kill as opposed to Downfall).

This strategy enables Lewis to tell some interesting human stories - the rag-tag collection of fellow travellers he introduces us to are, as befits players in a tragic farce - idiosyncratic outsiders and loners - but through their experiences Lewis offers uncommon colour as to what it is like at ground level engaging with Wall Street.

Along the way you will learn, with great clarity and simplicity of image - exactly what mezzanine mortgages-backed CDOs were, why the went wrong, and how the self-fulfilling cycle of CDO creation ratcheted a well-intentioned risk-spreading device into something which was nothing more, really than a glorified ponzi-scheme. And, unlike Bernie Madoff's scheme, which took some time and expertise (if not much) to reverse engineer and figure out, this one - an order of magnitude larger - went on in full, transparent view of everyone.

That said, I do think Lewis over-simplifies, though not in ways that fatally undermine his case - but in ways that are calculated to make the whole market sound as preposterous as absolutely possible; an exertion which really was not needed. The role of AIG and the Monolines, for example, in converting the "towers of dross" into triple A securities, was under-explained. Lewis characterised the insurers as investors: in a sense they were, but actually they were insurers of the performance of these bonds for other investors - yes; exposed to the risk of their default so investors in that sense, but in return lending their own triple-A credit rating to the senior slices of what Lewis compellingly describes as a cow pat pie.

Lewis is especially, and incompatibly, unkind to some investment bankers in particular (a point well made by David Bahnsen in his excellent Amazon review), and having read this, it comes as no surprise that The Big Short should have fuelled the ire of the Senate financial services committee - whose chairman repeatedly referred to it - in its recent hearing on the Goldman Sachs Abacus situation, Goldman being repeatedly implicated within Lewis' pages.

With that in mind it will be interesting to see how The Big Short fares in this year's Goldman Sachs/Financial Times business book of the year (among the judges: L Blankfein)

But if Goldman is bagged, poor Howie Hubler from Morgan Stanley - who had the prescience to short the mezzanine tranches, but catered for the negative carry of his CDS premia by going long the (equally suspect) triple A tranches (ouch) but in ten times the size (ouch to the power of ten) thus losing nearly ten billion on a single trade is utterly excoriated.

Not poor Howie at all, actually, as he (like all Bank employees) got to keep previous (multi-million dollar) bonuses and was simply deprived of his own "forward carry" - a small and asymmetrical price to pay for putting 15bn of his employer's shareholders' money at risk.

Lewis handles the build-up to the final collapse masterfully - especially the lack of faith shown in his motley band of brothers by their own investors even as CDO indices plummeted yet, by some remarkable anomaly, the mark-to-market valuations of their short positions continued to decline - and the denouement when it finally arrives is as striking as you'd expect (Lewis, with a thriller-writer's flair, pegs it to a (positive) CDO forum being held at Bear Stearns, during which Bear's stock price, hour by hour, tanked.

As the dust clears Lewis returns to Liar's Poker, which he regrets has been read more as a how-to guide rather than the cautionary tale he intended. As an odd coda, in the epilogue, Lewis meets his old boss and nemesis (though from the exchange it transpires to be the other way round!) John Guttfreund. Clearly Guttfreund hasn't got over the damage Lewis did to his reputation (to be fair, Lewis was simply the first among many - and Guttfreund did preside over the most catastrophic hedge fund failure of all time well after Liar's Poker was published, so it's a bit glib of Guttfreund to sheet all his troubles back to Michael Lewis), and even now Lewis has not entirely forgiven the old Titan, for ushering in the era of the publicly owned investment bank, which Lewis contends was the sine qua non which made all of this disaster possible.

An interesting thought, whether that impulse, so many years ago, might have led to all this now.

Olly Buxton

Let me get one thing straight out of the way - this book is unlikely to have the impact of Liar's Poker (Hodder Great Reads) for two reasons. The former was one of the first on the subject and defined 1980s banking to an extent, it got many graduates excited about potentially becoming BSDs themselves. It was in a way the perfect pitch for the industry, working even better as a result of being a critique of the system. The second reason was that while Liar's Poker was timely, this book came out a bit late to the 2008 financial meltdown party. Books like The Black Swan: The Impact of the Highly Improbable or Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets were a lot more timely, and while not everyone will appreciate Taleb's writing style, they were in some ways more general and applicable to broader sets of situations.

Be that as it may, Lewis is still an accomplished writer and knows how to package the book well. Unlike in Liar's Poker, this book is not based on his own personal experiences (he retired from the industry prior to writing Liar's Poker) but follows several of the investors, who saw the unsustainability of the subprime mortgage market and decided to short it ahead of the curve. Through their stories Lewis shows how the market developed, the systemic problems plaguing the sector (a bit like in the second part of Liar's Poker) and how the downfall happened.

He does not go into the bailout to any great extent (only briefly passing over it in the last couple of pages), the sotry is largely over in the last part of 2007, when the book's protagonists have all succeeded beyond expectation in shorting what they (rightly) believed was a market doomed to fail.

The book is not as funny as some of the earlier ones by Lewis but will still produce the odd chuckle and is definitely easy to read. The language is not too complex and even someone not from the industry will be able to follow the logic, the arguments and the descriptions. Like Liar's Poker I foresee a generation of graduates getting excited over the content and the industry, and a generation of current bankers seething at what was written (Lewis does not exactly portray most of them in a gleaming light - although he does acknowledge that it was primarily the systemic failure, rather than individuals, who brought us to this).

Finally there is no solution proposed, only a warning - things changed drastically when the financial institutions playing the game turned from partnerships into publically traded companies and the incentive structures started getting badly misaligned with the long term interests of both the institutions and the stability of the market overall.

Michael Lewis tells the gripping story of how even the practitioners of high finance were themselves taken aback again and again by the absurdities of the system. After reading this book, I'm a little more familiar with the jargon of collateralized debt obligations and mortgage-backed securities and so on, but I still have only the faintest understanding of these instruments. Of rather more concern than my continued ignorance is that many of those running the global banks on huge salaries don't seem to understand them either.

One of the first characters we're introduced to, Steve Eisman, is a straight-talking analyst with a talent for asking awkward questions. He'll say "explain that to me" thirty different times or "could you explain that more, in English?" The conclusions he drew were no less comfortable. At one point he has an epiphany during a meeting with Ken Lewis, CEO of the Bank of America: "The guy running one of the biggest banks in the world is dumb!" Now, we might share that opinion, in hindsight, and from the comfort of our armchairs, but Eisman went back to his office and shorted Bank of America (along with several other big Wall Street institutions). He believed they were overpriced and money could be made betting that their shares would fall in value. Nevertheless, and against all expectations, Eisman "was on his way to becoming the financial market's first socialist" - by seeing just how much the banks had built their business on ripping off the poor.

Shorting a company can be a rational strategy. It is also a deeply un-American activity, in the sense that much of American culture is built on thinking positively about the world and your place in it (see Smile Or Die), and not talking down success. Planning for failure is not even a footnote in the American Dream, and the plague of self-help books by business gurus don't have much to say about all the companies that go bust using their methods (except the universal excuse, they didn't follow the programme). Eisman shared with the two traders closest to him, Danny and Vinny, "a general sense that bad things can and do happen, especially on Wall Street". They were later vindicated when they realized that what they were dealing with wasn't just credit, but "a fictitious Ponzi scheme". Vinny, always darker, summed up the bond market people: "There were more morons than crooks, but the crooks were higher up."

What was becoming apparent to these and the other analysts Lewis follows in the years leading up to the collapse of Lehman Brothers was that mistakes were being made on a huge scale. The mathematical models being used were wrong. For example, a fundamental assumption of the Black-Scholes option pricing model - that prices change smoothly - was flawed. Traders "were too certain about inherently uncertain things" and "had difficulty attaching the appropriate probabilities to highly improbable events". In contrast to the typical trader, two of the guys running the tiny Cornwall Capital investment firm both "had trouble generating conviction of their own but no trouble at all reacting to what they viewed as the false conviction of others". At one conference Ben and Charlie wandered the halls of a plush hotel - "We were trying to find people who could tell us why we were wrong" - but none of the market insiders could offer any persuasive counter-arguments. "The entire food chain of intermediaries in the subprime mortgage market was duping itself with the same trick, using the foreshortened, statistically meaningless past to predict the future."

Cognitive illusions (such as the illusion of confidence and the illusion of knowledge) and the techniques of self-justification are becoming more widely understood, at least within academic psychology. (A couple of excellent books are The Invisible Gorilla: And Other Ways Our Intuition Deceives Us and Mistakes Were Made (but Not by Me): Why We Justify Foolish Beliefs, Bad Decisions and Hurtful Acts.) Since many of the bankers in charge of billions don't even read the prospectuses for their own investments, it will be a while before they get around to reading about how their own brains work. It's not uncommon, of course, that those (such as advocates of alternative medicine) most in need of understanding the difference between, say, correlation and causation are often the last to acquire it.

Seeking understanding is easier said than done, especially in an environment like the bond market, where "it was still possible to make huge sums of money from the fear, and the ignorance, of customers" and where "terminology was designed less to convey meaning than to bewilder outsiders". Again and again while reading this book, as well as thinking how psychologists would have a field day on Wall Street, I was struck by the theological character of the world of finance. "Financial markets are a collection of arguments. The less transparent the market and the more complicated the securities, the more money the trading desks at big Wall Street firms can make from the argument." Theologians, like bond traders, depend upon a "meaningless flow of words" to keep their delusions alive; the Church, like Wall Street, employs smart people who are "basically wrong about everything" and a little too keen on self-regulation. And, strangely, church and finance both cater in their own ways to personal greed. After all, what is credit but the promise of having what you can't afford, and salvation the promise of what doesn't exist, eternal bliss?

The morality tale that emerges from this brilliant account has implications beyond the world of finance. A telling detail is that the game of choice of the bond trader was craps. It offered the player the illusion of control and "a surface complexity that masked its deeper idiocy". "For some reason," said Vinny, "when these people are playing it they actually believe they have the power to make the dice work."

It's this kind of thinking that has driven both secular and religious superstition for much of human evolutionary history, and which isn't going away any time soon. It's pretty harmless when confined to the horoscope pages of the newspapers, but, as Michael Lewis comments in the final chapter, when "the psychological foundations of Wall Street shifted, from trust to blind faith", all hell broke loose.

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5.0 out of 5 stars Amazing Story, Incredibly Believable
This book must rank as the finest piece of financial investigative journalism of all times. I couldn't put it down and finished it the same day I started it. Read more

Published 9 days ago by SmurfStar

5.0 out of 5 stars Greed, revisited
Michael Lewis returns to Wall Street 20 years after publishing his first book "Liar's Poker" of his time as a trader, to find that the system hasn't changed and has gotten worse -... Read more

Published 20 days ago by Sam Quixote

5.0 out of 5 stars Great read for anyone
Great 'bottom-up' account of the credit crisis, told from the ups and downs of not so much the key decision-makers, but of those working in the system day-to-day: principally... Read more

Published 1 month ago by Stephen Connolly

4.0 out of 5 stars delivered on time and very smoothly
delivered on time and very smoothly. the price is printed in an accompanying note, which is not ideal for a gift - but i had not asked for gift wrapping to be honest...

Published 1 month ago by et

5.0 out of 5 stars So that's what investment bankers do...
A first rate account of what really happened in the lead up to the sub-prime financial scandal. Amusingly and pacily told, seems well researched. Read more

Published 1 month ago by Ned

4.0 out of 5 stars A good read
An interesting and informative book, just a pity that I had to re-read section to grasp what the author was actually writing about!! Probably die to my age!!

Published 1 month ago by Me

5.0 out of 5 stars Utterly compelling and frightening
This is an exceedingly appropriate companion to "Too Big to Fail" by Andrew Ross Sorkin. Lewis' revelations about the realities of sub-prime and their impact on the bond markets... Read more

Published 2 months ago by PCB

5.0 out of 5 stars Well done Mr Lewis
A very readable narrative about the smaller people involved in betting against the sub prime market continuing. Funny in parts. Read more

Published 3 months ago by jimglynt

3.0 out of 5 stars Decent book on a subject which has probably been done to death
There's a huge amount of books out there about the financial crisis.. If this was the first book I read it may have got four stars but it was about the fourth. Read more

Published 3 months ago by A. G. Williams

4.0 out of 5 stars this book was a fascinating and frightening read
Michael Lewis does a really good job of bringing an extremely complex subject to the lay reader in a way which makes the overall gist of it understandable. Read more

Published 3 months ago by Sean Slippers

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