Michael Lewis’ ‘The Big Short’
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The financial crisis marked its dismal second anniversary in March. In the US, 3 million households are expected to be served with foreclosure notices in 2010, up from 2.8 million last year. Unemployment is edging toward 10%. States are hurtling toward bankruptcy. Economic pain is endemic. If you read one book about the crisis, make it Michael Lewis’ The Big Short: Inside the Doomsday Machine (Allen Lane, 266pp; $39.95). If I had my way, I’d make it compulsory reading, because the book is the perfect primer on Wall Street’s ways. And with the banking lobby intensifying its efforts to preserve the laissez-faire status quo, ignorance is no longer an option. The stability of the US is at stake but so too is Australia’s: the financial knee-bone is connected to the thigh-bone.
I know, I know: so much noise on the subject, so many books. A person could go cross-eyed at the word “banker”. However, Lewis writes with clarity and verve: The Big Short is a page-turner, a better read than Stieg Larsson’s Millennium trilogy. I confess to reading it grinning from ear to ear, for a number of reasons. First, I’m a huge admirer of Lewis’ peachy prose. Second, I’ve been watching economists and journalists elbowing each other aside to claim they saw the crisis coming and then endlessly jawboning about its causes and how to cure it, and most don’t know their arses from their elbows. The problem is that many commentators are at a remove from banking; they haven’t done hard yards on a trading floor or hit the road with a pitch book. Lewis famously worked at the now-defunct Salomon Brothers, a job that provided the material for his first bestseller, Liar’s Poker.
Lewis makes a convincing case that few saw the crisis coming and even fewer had the cajones to profit from it; that is, to take the other side of the subprime bets. Wall Street believed and put its money on housing prices going up. Or if they fell, they wouldn’t fall nationwide. A small posse of men – Davids to an exceptionally formidable Goliath – bothered to assess the quality of the crappy assets that were being bundled and rated AAA, and shorted them. How small? Lewis estimates that fewer than 20 people made these bets. Some were flat-out speculative bets on the world going to hell in a hand-basket; others were hedges against misfortune, or so investors were told. The payout was spectacular, the kind of money that makes you screw up your face in disbelief. John Paulson, thought by Wall Street to be a third-rate hedge-fund manager: $6 billion. If they lost sleep, it wasn’t because they might be wrong; rather they worried that no one would be able to pay up when the catastrophe they predicted became a reality. As it turns out, they were paid by us, the taxpayers. The sad part, Lewis notes as he winds up his tale, is that those responsible for creating “one trillion dollars in losses … out of whole cloth” also walked away with their pockets stuffed with enough dosh to play golf until the last trumpet sounds.
The men that Lewis scrutinises are the kind of Wall Streeters I appreciate: obsessed, quirky, blunt truth-tellers fizzing with energy and ideas. Oddballs, such as Steve Eisman and his colleagues Vinny Daniel, Porter Collins and Danny Moses. Eisman began his career as a subprime mortgage analyst: “You have to understand, I did subprime first. I lived with the worst first. These guys lied to infinity. What I learned from that experience was that Wall Street didn’t give a shit what it sold.’” Eisman hired men who shared his dark, doubting views. If a Wall Street firm got Danny Moses into a trade with no downside, he’d say, reports Lewis, “I appreciate this, but I just want to know one thing: How are you going to fuck me?” They had intellectual company in loner Michael Burry, a one-eyed neurologist with Asperger’s who glommed onto subprime mortgages with the single-minded focus of people with his condition because he wanted to understand why someone would lend money to a person with no income: “What you want to watch are the lenders, not the borrowers.” Another player with antennae for shadowy motives was Greg Lippman, a Deustche Bank bond trader who was nominally on the selling side but cheerfully told anyone who would listen to short his market. His bosses thought he was “a fucking whack job”. He eventually had the immense satisfaction, as housing prices began to slide, of beginning a phone call to a Morgan Stanley counterparty with, “Dude, you owe us $1.2 billion.” Add to this motley crew Charlie Ledley and his tiny team, who operated on the simple investing principle that the best way to make money is to discover what Wall Street believes least likely to happen and bet on it. Genius! After Ledley read a presentation authored by Greg Lippman on subprime mortgage bonds, he couldn’t believe his luck: “This is just too good to be true,” a thought rapidly followed by “How can this even be possible?”
All were outsiders afflicted with varying degrees of social illiteracy. “He’s not tactically rude. He’s sincerely rude,” says Steve Eisman’s wife. Eisman “dressed half-fastidiously, as if someone had gone to great trouble to buy him nice new clothes but not told him exactly how they should be worn,” writes Lewis. His thought processes were equally odd:
Eisman had a curious way of listening; he didn’t so much listen to what you were saying as subcontract to some remote region of his brain the task of deciding whether whatever you were saying was worth listening to, while his mind went off to play on its own. As a result, he never actually heard what you said to him the first time you said it. If his mental subcontractor detected a level of interest in what you had just said, it radioed a signal to the mother ship, which then wheeled around with the most intense focus. “Say that again,” he’d say. And you would!
Wall Street used to have a surfeit of eccentrics like Eisman: people who couldn’t find jobs anywhere else and were given safe harbour because they had a talent for making money. Along came the so-called “war for talent” in the 1990s. MBAs were recruited in large numbers, resulting in homogenisation and groupthink at the investment banks. For Lewis’ guys, these MBAs were sitting marks, the dumb money at the poker table.
I felt guilty that I enjoyed Lewis’ book. After all, it is a detailed catalogue of fraud and deception that led to unmitigated misery. The men placing the bets were also besieged by guilt. They might have lacked social graces, but they weren’t immoral buccaneers, placing bets against their own clients, as did the traders at Goldman Sachs when they woke up to how wretched the credit default swaps and collateralised debt obligations were. “But boy it gets morbid,” Michael Burry tells Lewis, “when you start making investments that work out extra great if a tragedy occurs.” Charlie Ledley informs his mother, “I think we might be facing something like the collapse of democratic capitalism,” and his mum suggests he take lithium. Later, he muses, “I think there is something fundamentally scary about our democracy. Because I think that people have a sense that the system is rigged, and it’s hard to argue that it isn’t.” On 18 September, 2008, three days after Lehman declared bankruptcy, Eisman and his crew sat on the steps of St Patrick’s Cathedral trying to grasp the enormity of what was happening and having similar thoughts to Ledley’s. The housing market was in free fall and their bets were paying off handsomely, but they watched the passing pedestrians and wondered if these folk knew they were “ruined or about to be ruined”.
By coincidence, as I was reading Lewis’ book, the Financial Crisis Inquiry Commission held hearings into the subprime mortgage smash-up, beginning with Alan Greenspan, former chairman of the Federal Reserve, Chuck Prince, ex-CEO of Citigroup, and Robert Rubin, former Treasury Secretary and Citigroup director. As a veteran watcher of such events, I expected idiocy from commission members, but questioning was not only sharp but informed and mostly non-partisan. After Greenspan appeared, the Financial Times ran the headline “Maestro Mauled”. This was before Prince and Rubin fronted; they weren’t so much mauled as boiled alive. Rubin, who lent his gravitas to Citigroup over a period of eight years for $101 million, couldn’t hide his discomfit. His mouth kept stretching like a little boy’s getting set for a bout of bawling. Commission Chairman Phil Angelides: “You can’t have it both ways. You either were pulling the levers or asleep at the switch.” Rubin: “Wahhhhh!”
I’ve been trying to single out my favorite moment in the hearings. Was it when Phil Angelides asked Alan Greenspan whether the Fed’s inexplicable refusal to conduct routine compliance examination of subprime lenders came “under the category of ‘oops’”? Greenspan palmed this “oops” off on his “very close friend” Ed Gramlich, a universally liked Fed governor who has since died, a breach of professional etiquette that did not go unnoticed, with Angelides, a Democrat, and the deputy chairman, Bill Thomas, a Republican, exaggeratedly referring to each other as “my dear friend” in subsequent exchanges.
Or was it when Greenspan faced off with Brooksley Born, who had tenaciously appealed to Congress to regulate derivatives when she was chairperson of the Commodity Futures Trading Commission, only to have Greenspan win the day. Born asked Greenspan whether his Ayn Rand libertarian philosophy of deregulation, which he claims in his book made him an outlier, had played a part in the financial crisis. Greenspan, once one of the most influential men in the world, replied that he had no power to sway anyone; he’d merely taken an oath of office and implemented rules that Congress made. Just a government servant, ma’am. He also told Born that structured finance still didn’t need regulating because, with the exception of credit derivatives, it had performed without a hitch under the stress of the past two years; he neglected to factor in the infusion of government money that allowed the banks, shadow and otherwise, to stand upright. The only true thing he said in the entire exchange was at the end: “I really fundamentally disagree with your point of view.” Greenspan’s irritation was palpable; Born, who had every reason to crow or drip scorn, seemed instead heavy with rue, if not sorrow – and scepticism.
Born has good cause for scepticism. Watching the committee’s acute questioning, one might hope for sensible reform, but the House has already voted on a weak-tea bill and the Senate is expected to do likewise in the American summer; the commission won’t be presenting its findings until 15 December. Also, with a paltry budget of $8 million, the commission is radically underfunded to perform the vast task of diagnosing the rot in the many branches of the financial industry tree. Compare that with $38 million spent by the federal trustee investigating the Lehman bankruptcy.
Still, some satisfaction was gained from watching these cavalier men being held to account, if only verbally, although their answers beggared belief. They are now on the record for students of financial disasters, and so we have a handy starting point for understanding the next collapse. Some of those appearing claimed to take full responsibility and then dumped blame on everyone but themselves: rating agencies, regulators, financial models, outside consultants, underlings, Fannie Mae and Freddie Mac’s mandates, capital requirements, extra-terrestrials. For his part, Greenspan didn’t even concede culpability: “Everyone missed it – academia, the Federal Reserve, all regulators.”
The word most often used was “unprecedented”. Even if the financial crisis was unprecedented, which it wasn’t – 29 October, 1929, anyone? – that didn’t mean it was impossible to predict, as Lewis’ book amply demonstrates. Common sense should also have made financial chieftains and their boards put the brakes on the gravy train: markets are always cyclical, risk never tamed. Every time the word “unprecedented” popped out of a mouth, I imagined a collective spluttering coming from Lewis’ guys. Here is Burry in a newsletter written in July 2003: “Alan Greenspan assures us that home prices are not prone to bubbles – or major deflations – on a national scale. This is ridiculous, of course … During the 1930s housing prices collapsed nationwide by roughly 80 percent.”
I had one belief overturned: I’ve long held that the banking nabobs knew what was going on but refused to pull the emergency cord because their compensation and bank profits were in the stratosphere. As it turns out, from the evidence of Lewis’ book and the hearings, these men and their boards were stone stupid. IQs of cabbages. And if they weren’t born dim, they were made foolish by certainty, thick by arrogance. Writes Lewis, “In retrospect, their ignorance seems incredible – but, then, an entire financial system was premised on their not knowing, and paying them for this talent.”
Are they delusional or do they know what they are doing? A question Eisman and the others asked all the time. And could ask now. Tomorrow, I could easily sit on the steps of St Pat’s and with good reason ponder who is ruined, who will be ruined. The banks are still stuffed with toxic paper; the hubristic, self-referential financial culture that got us into dire straits hasn’t altered one iota; trading desks are chugging along, taking the same risks; chairs have been moved around a bit and some have been exiled to sunny Florida, but essentially the same people are running the show, whether in Washington or on Wall Street; reform gets more diluted with each passing day by politicians angling for access to Wall Street’s coffers for their campaigns. If you want to make money, join the Charlie Ledley school of investing: bet on whatever Wall Street thinks won’t happen, and that would be another bubble sooner rather than later. In pondering his evolution, Eisman said, “I now realized there was an entire industry, called consumer finance, that basically existed to rip people off.” And so it is today.