The Big Short by Michael Lewis

Michael Lewis tells the story of Steve Eisman, a stock analyst who ran a hedge fund at Morgan Stanley, and Michael Burry, a neurologist turned value stock investor, each of whom perceived that Collateralized Debt Obligations constructed of subprime mortgage loans, the hottest derivative product on the market by the year 2005, were AAA-rated Ponzi schemes destined to blow up.

As they researched these CDOs, they discovered that nobody in the business really knew any more about these toxic financial instruments than they did; the players were blinded to the risk involved by the millions in commissions to be made. In 2006 for example, J.P. Morgan profited a billion dollars selling these CDOs, about twenty percent of their total that year, and were planning on doubling that in 2006.

Eisman and Burry, looking for a way to short this market, started buying credit default swaps on these bonds, paying a fraction of a percent in premiums every year for insurance in order to collect when mortgage defaults made these bonds worthless, which was only a matter of time, specifically, two years into the loan period when the low, “teaser rates” went up and the folks with these no-doc “liar loans” went into default.

This all happened right on schedule, bringing Eisman and Burry a return on their investments of over 800%, as investment banks on Wall Street and around the world lost hundreds of billions of dollars, crashing financial systems around the world.

This story does not support the often-heard meme that the housing crash happened because people bought houses that they couldn’t afford. This crash was predator-driven.

This book gives examples such as a Mexican strawberry picker in Bakersfield with an income of $14,000 per year who was lent $724,000. A Jamaican cleaning lady from Queens bought a townhouse. The value of the townhouse rose, and the lender came back suggesting that she refinance and take out $250,000. She used the money to buy another, and so on until she owned six townhouses when the market fell and she couldn’t make any of the payments.

When Eisman heard Wall Street people argue that the crash was caused by “the mendacity and financial irresponsibility of ordinary Americans” he said “What – the entire American population woke up one morning and said, ‘Yeah, I’m going to lie on my loan application’? Yeah, people lied. They lied because they were told to lie.”

And of course the players in this business all made money. Howie Hubler, a bond trader at Morgan Stanley, lost more money than any trader in Wall Street history, but still got to keep the tens of millions he made. Winners, losers, people who bankrupted their companies or were saved by federal bail outs, all got rich.

Me, I’m just happy to be back near where I was two years ago. And we’re not out of the woods yet. Remember that the crash of ’29 happened three years before FDR was first elected, and he wasn’t even New Dealing yet. At that time he was proposing the same sort of austerity fix that the GOP and the teabaggers are calling for now.

As Bette Davis said, “hold on to your seats, it’s going to be a bumpy ride.”