The Big Short – Michael Lewis

Michael Lewis worked briefly, incompetently (in his view), yet successfully, trading stocks and bonds for a Wall Street broker in the early 1980’s. He left and wrote an exposure of the folly he found there in his book “Liar’s Poker”, fully expecting the unsustainable industry he had been a part of to crash sooner rather than later.

Unfortunately for us all it took a full two decades of even more ballooning business in “financial derivatives” before the bubble burst. In The Big Short he describes that crash of 2008 from the viewpoint of those few traders who not only foresaw the collapse but decided that money, big money, could be made from it.

The how is complicated, but Lewis builds up the reader’s knowledge logically, explaining the nature of “sub-prime” home loans (those not 100% backed by the property value but predicated on the lender’s ability to pay at least the interest or to repay the loan from the later sale of the house on an assumed rising market). The industry then went on to package those dubious base products into mortgage bonds and sold them on to largely unsuspecting investors who relied on “triple A” ratings awarded by agencies such as Standard & Poor’s or Moody’s who either did not know or did not care about the inherent fragility of the underlying loans. In another spiral of self-deception those mortgage bonds were subsequently lumped together into vast “collateralised debt obligations” (CDOs) and sold on yet again.

That this became a sort of pyramid selling (or in US terminology - a Ponzi scheme) became apparent to a few perceptive but maverick dealers who decided they could profit from “shorting” the market. Shorting involves finding a way to profit from the fall in value of a stock or any financial product (the reverse of the normal investment process of picking stocks whose value will rise). In the case of financial derivatives such as the CDOs, the method was a “credit default swap”, effectively insuring against the fall in value of the product. For a relatively small annual premium there was the potential for huge gains, particularly as the US economy stalled, home owners lost jobs and property prices fell.

And a key element of this was that you could insure products you didn’t even own - it was betting pure and simple.

Lewis, in his attractive breezy style, concentrates as much on the personalities of those maverick dealers involved in this “Big Short” as the technicalities, which makes it an entertaining as well as informative read. Their stories, as outsiders betting against the received wisdom (or foolishness) of a seemingly rich and all-powerful business, has a David and Goliath quality. They emerge not as villains who caused the crash, but clear-sighted individuals whose initial warnings were ignored and who decided if the financial world was going to hell in a handcart they would at least make a bob or two out of the wreckage.