Inside the Doomsday Machine
When starting a book club, why not kick things off with a bang? In an effort to pierce the veil of financial crisis circa 2008, we decided to crack open Michael Lewis’ acclaimed new book The Big Short, which chronicles the years preceding the financial crisis through the eyes of a select few hedge fund managers who made millions predicting doomsday. While the book is often long-winded, redundant, and occasionally frustrating, it succeeds in exposing the systemic flaws of modern finance in a language that even the CEO of a major bank could understand.
The Big Short centers on the parallel adventures of three capital management firms: FrontPoint, Scion, and Cornwall. By 2005, these firms determined that the financial markets were burdened by systemic problems that would lead to financial collapse sometime in the near future. At the heart of the problem was the market for subprime mortgages. In short, banks began extending home loans and refinancing options at an unprecedented rate. To shield themselves from the risk of default, the banks utilized new financial instruments to package loans into tradable bonds called “mortgage-backed securities” that were then sold on the open market. In many cases, the repackaging of loans occurred multiple times over, until the contents of these “collateralized debt obligations” became exceedingly opaque. You would think that the securities with shadier contents (those repackaged more times) would be rated lower along with other riskier investment options. Unfortunately, the opposite happened. The more murky and repackaged the bonds became, the higher they were rated by Moody’s and S&P (thanks to a combination of negligence on the part of the rating agencies and bullying on the part of big banks). Of course, this fantasy came crashing down in 2007 when the housing bubble burst, causing the supposedly foolproof market for mortgage-backed securities to explode, dragging down most of the major banks in the process.
For some reason, 99.99 percent of Wall Street investors did not connect all the dots. The remaining 0.01 who predicted the impending crisis, including Scion, Cornwall, and FrontPoint, tried to find ways to profit from the crash. How the hell do you profit from failure, you might ask? You buy insurance, and lots of it. Each of these firms were able to purchase cheap insurance on the failure of mortgage-backed securities. The big banks were happy to sell the insurance. From their perspective, buying insurance on CDOs was like buying flood insurance on the house on the top of the mountain. In reality, the houses were all on the floodplain, and FrontPoint, Cornwall, and Scion were the only one’s selling life vests.
The aforementioned hedge funds were all considered crazy prior to the collapse. That’s why they won so big. Steve Eisman became a billionaire seemingly overnight. The 20-somethings at Cornwall Capital turned $100,000 into over $100 million, thanks to a combination of dumb luck and huge cojones. Michael Burry made his clients $750 million thanks the gamble. On the flip side, the losers lost even more, showcased by Howie Hubler, a hedge fund manager who lost $9 billion for Morgan Stanley, the single largest loss in Wall Street history. Obviously, the biggest loser would be the U.S. taxpayer, who will be fronting the bill for the banks’ incompetence for years to come.
The stories that Lewis imparts are truly incredible. Also, by viewing the crisis through the eyes of the few winners, the reader is able to better understand how and why the crisis came about. In meticulous detail, Lewis conveys the raw emotions of these few prophets of doom who, at every juncture, were belittled, chastised, and laughed at by the big banks who thought they were insane. It is truly amazing to see how out of touch most financiers on Wall Street really were.
Unfortunately, a 250-page book is probably not the best medium for Lewis’ narrative. It suffers from extreme redundancy at times, to the point where I was convinced that Lewis finished the book and realized he was about 50,000 words shy of the number in his contract. Most of this filler space is occupied by weak character development and/or meaningless “words of wisdom” from either Steve Eisman or Michael Burry. The problem is that the characters are one-dimensional, no matter how Lewis tries to sell them. Just because they happened to guess right (and lived in Cali) doesn’t mean they aren’t greedy intolerable bastards. Also, while profanity is a fact of life, it became distracting when seemingly every insight from an investment banker sounded like an argument from a middle-school playground. Somehow I doubt that the back-alleys of Wall Street sound like an audiotape of Catcher in the Rye.
In the end, this story would have been perfect as a long article in the Atlantic. Keep the concise historical analysis. Keep the characters. Keep the skeleton of the argument intact. Just cut off the fat.
