When people think they know more than they actually do, the potential for massive mistakes multiplies. Or, as outlined in The Big Short by Michael Lewis, there is a potential for absolutely astronomical errors. Following the mantra that “Greed is Good,” Wall Street banks create securities out of thin air and sell them to others who can neither calculate risk correctly nor price it appropriately. Some firms take positions against what they are selling to their customers as conflicts of interest abound. The oversight of ratings agencies and the United States Treasury is entirely absent. Incompetence and ignorance are mixed liberally with arrogance.
After years of deregulation and I.P.O.s, financial institutions had grown so big that few dared question conventional wisdom and those who did were discredited. The idea of Wall Street was like the Death Star in Star Wars Episode IV – scores of procedures and protocols that are inefficient and ultimate ineffective – or Doctor No – an international terrorist who has a fire alarm in his base – and had become a complete contradiction. To maximize value, Goldman Sachs. A.I.G., and others packaged triple-B subprime mortgages into triple-A securities that were rated as high asa bond issues by the Fed. Moody’s and Standard and Poor’s seemed to be as astute as the Home Inspector on Holmes on Homes.
Lewis follows the Malcolm Gladwell model of tackling a wider issue by focusing on smaller case studies and creating human interest by profiling those involved. He writes about investors like Steve Eisman, Charlie Ledley, Greg Lippman, and Michael Burry as they investigate the asset-backed securities market and individually decided to short synthetic collateralized debt obligations. Many mortgages have a two year teaser period before interest rates increase and default rates skyrocket so the book tells the stories of how the investors must balance trust in their gut feelings with pressure from the clients, employers, and peers.
One common description for those who were shorting massive amounts of synthetic C.D.O.s might be “outsider.” Creativity (and eccentricity) allowed them to find opportunities in the financial system. It was almost absurd to see how others reacted to those profiled by Lewis. Some were supremely confident in the system and wanted to sell Eisman more credit swaps, not even considering the possibility of failure. Although Burry’s Scion Capital hedge fund had multiplied investors’ money several times, he could not receive the benefit of the doubt from clients. After the market crashed and he returned 150% to clients, Burry was criticized again by clients for making value-based investments in the stock market. Everyone thought that they knew better.
The book is an entertaining and easy read. After reading the first chapter, one is alarmed at how one can build an enormous house without any foundation. It seems as if many of the bond traders on Wall Street had taken the time it takes to read this book to look into the C.D.O. market carefully, this catastrophe would not have occurred.