Book Review: The Big Short

Posted on April 29, 2010. Filed under: Professional | Tags: , , , , |

photo of book coverThe ponzi scheme that became the financial meltdown of 2008 and almost led to a second Great Depression is thoroughly and lucidly described in The Big Short by Michael Lewis. The author carefully and systematically retells the story of how greed led to stupidity and the eventual bursting of the largest financial bubble in history.

Lewis sums up the storyline clearly in his description the difference between a gamble and an investment. “Investing” he says, “is like gambling when the odds are in your favor.”

We are all familiar with the adage about gambling in a casino, the games are designed to favor the house. Whether or not the gambler is conscious of these asymmetrical odds, he is more likely to lose than win every time he pulls a lever or rolls the dice. Even winning streaks  eventually turn; it is only a matter of time. Keep the gambler in the casino long enough and the odds turn back to favor the house.

In The Big Short, we already know how the ending before it starts… but Lewis retells the story with an insider-like perspective that kept my interest throughout. Along the way, I gained insight (notice, I didn’t say I understood) about some very esoteric bond industry terms like CDO (collateralized debt obligation, at the root of the collapse and were essentially the ticking timebomb), CDS (credit default swaps, the gamble on which the “short” players bet against the established financial industry), sub-prime bonds and mortgage backed securities (the building blocks of CDOs.)

Many of the players are familiar: Morgan Stanley, Goldman Sachs, JP Morgan, Citi Group, Bank of America, Washington Mutual and others. Those that were previously unfamiliar were the genius in the big short: Frontpoint Capital, a division of Morgan Stanley (Steve Esiman, Vinny Daniel, Danny Moses), Cornwall Capital (Charlie Ledley, Jamie May, Ben Hockett) and Scion Capital (Dr. Michael Burry). And other became familiar for their contribution to the underlying story: Howie Hubler who was responsible for Morgan Stanley’s biggest loss ever of $9B, Greg Lipman who put Deutsche Bank in the middle of the game and of course the government players Hank Paulson, Timothy Geithner and Ben Bernanke who seemed to be asleep when it mattered.

In a speech to Harvard Law School, Charlie Munger (Warren Buffet’s less famous business partner) spoke of the Lollapalooza Effect. In it, Munger suggests incentives are often at the root of much ignorance. In other words, if a system is setup to reward certain behavior — even if that behavior is not in the best interest of the system — that’s how people behave. Therein lies, according to Lewis’ The Big Short, the root of the Great Recession of 2008-2010.

Lewis walks us step-by-step through the recent past (it had all become a blur for me in 2008 and 2009.)

  1. Bear Sterns fails first and is bought by JP Morgan with government guarantees.
  2. Freddie Mac and Fannie Mae follow and are essentially nationalized.
  3. Lehman Brothers goes bankrupt.
  4. AIG fails and receives a total of $180B by the Federal Reserve.
  5. Washington Mutual is seized by the government and sold to Chase.
  6. Wachovia is purchased by Citi Group.
  7. Enter the Troubled Asset Relief Program (TARP) and a trillion dollar give away…

The closing pages of the book discuss where the key players are now and draws parallels to the savings and loan debacle of the 1980’s. Lewis actually claims the decision by John Goodfriend, then CEO of Solomon Brothers to go public (they sold shares of the company to the public where they had been a partnership previously), was the mustard see that grew into the recent crisis.

Overall, the book kept me hooked from the start — surely that is not because my career was just as disrupted as anyone else’s in this story?

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