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Book Review: The Big Short

In the last couple of months, I have started to receive mail from “Wealth Management” financial advisors like Merrill-Lynch.  This is funny for two reasons: 1. I have no wealth to manage and 2. after reading the book, The Big Short: Inside the Doomsday Machine, by Michael Lewis, the last people in the world I would give my money to is Merrill-Lynch.  They were one of the last companies to figure out how to make money during the subprime housing bubble.

The Big Short is about those esoteric “instruments” that Wall Street developed to suck money out of America, the rampant fraud that signified a bubble and some ragtag outsiders who accurately predicted the bursting of that bubble and made a lot of money in the process.  Our cast of characters, the good guys, if this tale has any heros at all, includes Michael Burry, a one-eyed neurologist with Aspberger’s syndrome who liked to read prospectuses for fun, Steve Eisman, an iconclastic hedge fund manager at Frontpoint, and a “garage band” hedge fund called Cornwall Capital consisting of Charlie Ledley, Jaimie May and Ben Hockett.  With the exception of Eisman and Hockett, the rest were amateurs, just dabbling in money markets and placing bets on unlikely events.

For each of these three groups of people, there was something unique about their approach to the financial market.  Michael Burry was discovered by investors who read some of his blog posts about where to put their money in the stock market.  He was persuaded to manage other people’s money and started Scion Capital.  But unlike other financial managers, Burry told his investors that they had to be in it for the long haul.  The Cornwall Capital guys started with $100,000 and the crazy idea that if you want to make money in the financial world, you have to bet against conventional wisdom.  Steve Eisman was raised on Wall Street.  He came from a family of analysts that seemed to think the Wall Street investment companies had a fiduciary responsibility towards their investors.

The Big Short follows our outliers throughout the last decade as they discover the subprime housing market and start to wrap their heads around the concept of collateralized debt obligations and credit default swaps.  As they wander their way through the complexity and deliberate opacity of the bond market, they start to realize that it is fueling a bubble.  Eisman quickly sees that the subrpime mortgage business is encouraging fraud when his Jamaican baby nurse tells him she is over her head in debt from the 5 townhouses she’s bought in Brooklyn.  Wall Street firms were writing teaser rate loans for people who didn’t have the income to pay when the balloon rate would kick in.  Then they bundled the loans, sliced them up and sold them to unwitting investors who didn’t read the prospectuses.  Michael Burry was one of the few who did read them.  With his sharp analytical mind, he calculated when the bubble would burst and was one of the first people to place a bet on the losses when he asked for custom credit default swaps from Morgan-Stanley and Goldman-Sachs.  Charlie Ledley and Jamie May thought the subprime market was too good to be true so they bet against it too.

The book takes us through the complicated maze of the financial world from Wall Street to Las Vegas and Berkeley and introduces us to a bunch of colorful characters.  There’s the almost allegorical investment fund manager who just passes his investors money through the CDO market, the salesman from Deutsche Bank who lays out how the whole Ponzi scheme works and the Morgan Stanley guy who loses more money for his accounts in the meltdown than anyone  in history.

Our good guys start to get more alarmed as the enormity of the coming armageddon starts to take shape.  Well before the crash, they challenge the ratings firms and bankers in public, write letters to their investors describing what’s happening and even have a social conscience when they make a trip to the SEC and try to explain it to a clueless government official.  When the proverbial $hit starts hitting the fan, they’re as anxious and distressed as everyone else even though they each made a ton of money.  In Burry’s and Cornwall’s case, the events were so unsettling that they gave up managing money.

There were a couple of take home messages for me.  For one thing, I absolutely do not trust Wall Street after reading this book.  There may be some honest brokers out there but not nearly enough to handle the trillions of retirement dollars that pass through their Bloomberg terminals every day.  Another disturbing thing is how disconnected Wall Street bankers and brokers seem to be with the lives of average Americans.  They don’t take care of the money they’ve been entrusted with.  It’s almost like it’s not real to them.  They might as well be manipulating poker chips or Monopoly scrip.  And it didn’t seem to occur to them that the vast number of Americans who got trapped into teaser rate loans were not going to be able to pay their mortgages when the loan readjusted.  Just where did these geniuses think the money was going to come from in a decade when wages were essentially flat and made more difficult to come by due the short term thinking of the institutional investors?  One curious thing is the timing of the bubble burst.  It started in March of 2007, well before the primaries of 2008.  The guys at Cornwall Capital started to get concerned that they were going to be exposed financially when the government came to the rescue of strapped mortgage holders.  But that never happened.  As we all know, Hillary was the one in favor of a homeowners bailout; Obama was not.  It makes Obama’s “win” even more suspect.

As you guys might know, I listen to books on my iPhone and rate my them by sponge count.  That is, the book has to be engrossing enough that I won’t even notice that I’m cleaning the kitchen.  I give this one 4.5 sponges.  It was easy to get engrossed in the book, so much so that I was laughing out loud while I was walking around Ikea.  But I was about 2/3’s of the way through the book before sentences like “And so it was that Ben Hockett found himself sitting in a pub called the Powder Monkey in the city of Exmouth in the county of Devon England, seeking a buyer of $205 million dollars of credit default swaps on the AA tranches of mezzanine sub-prime CDO’s” didn’t make me stop the audio and rewind.  So, if you’re new to mezzanine subprime tranches, expect some confusion at first.  Lewis does an excellent job of parsing it for the uninitiated but it’s still dense material.

I recommend the audible version in particular because it includes a 10 minute interview with the author at the end.  Lewis is pretty tough on the Obama administration.  He says it has made financial reform harder by hiring the guys who were most responsible for letting it the subprime bubble happen in the first place.  He has no respect for Geithner.  Lewis also thinks that Obama blew it when he took office.  He could have used the momentum and mandate he had in early 2009 to clean up the mess.  He’s now wasted his political capital on a lousy health care reform bill and has let the financial mess simmer, ready to boil over in another meltdown.  From what I can tell, it ain’t over yet, folks.

Highly recommended.

Note: I bought this book on my own and wasn’t asked to review it.

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9 Responses

  1. RD, do you have a page where you review books? I would lov eto check out your sponge ratings.
    Btw, I commend your courage in reading non-fic books about the mess we’re in. I am almost exclusively sticking to escapist fiction to stay sane these days.

  2. Michael Lewis was on 60 minutes a couple of weeks ago. The 30 minute interview is posted at their website linked below.

    The second interview that night was about a brilliant pianist who is blind from birth and is essentially an idiot savant. I cried and was inspired to see how he was able to develop his musical talent. You might have to look for that segment if you want something to lift your spirits after seeing the wall street debacle.

    http://www.cbsnews.com/stories/2010/03/12/60minutes/main6292458.shtml?tag=contentMain;contentBody

  3. If interested, here is link for Derek Paravicini, a masterful musician who is blind, with disabilities so severe he can’t tell his right hand from his left or hold anything but the simplest of conversations.

    http://www.cbsnews.com/stories/2010/03/12/60minutes/main6292474.shtml?tag=mncol;lst;5

  4. Thanks for an insightful review. Between your and DK’s comments, I’m definitely getting that book.

  5. WHY, oh why, are you dealing with a broker in the first place???????????

    Invest your money yourself in a no load mutual fund with a company you can trust.

    Vanguard, Fidelity, T Rowe Price or the like…..

  6. Thanks, RD, I know what book I’ll be downloading come April when I get my next audible.com book on my subscription.

    All of the money that goes into 401(K)s is a big, big windfall, and it props up the market. The fund managers don’t get returns that exceed the stock market average in about 97 percent of the cases.

    Still, there’s that percentage the fund gets, regardless, and it goes into marketing, high salaries for a few, recreation on the payees’ dimes to win over influential business at expensive resorts.

    When I got into a 401(K) two years ago as a new full-time employee, I noticed that everyone of the options disclosed investments in sub-prime mortgages (small print, and I’m sure that they had to). I stuck half in the money-market fund.

    Meanwhile, I’m working my way through Phil Town’s books so I can identify good, individual companies and buy when they are on sale. The stock market price/earnings ratios are way too high, and as soon as there are higher interest rates, big money can jump on to something else. The small investor who buys a handful of companies whose stock price is less than the value and that has a pattern of growth and a special advantage in terms of what it sells, however, has an advantage.

  7. Great review RD. Thanks so much. I won’t buy the book because I hate Michael Lewis. But it does sound like an enjoyable read. :-)

  8. Should have added that the the 401K amount deducted from taxable income makes the return larger than anything out there!

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