Friday, June 04, 2010

Book-A-Day 2010 # 121 (6/4) -- The Big Short by Michael Lewis

Writers of narrative non-fiction fall into two camps: reporters and historians. Reporters like to get out at ground level, talk to people, fill up notebooks with observations, and then write the specific story that they’ve seen. The big picture may get blurry – or may be distorted by the beliefs of the people they interviewed – but the specifics are as correct as possible.

Historians care more about that big picture, and want it to be as sharp and accurate as possible. So they may skimp on the GOYAKOD part of the job – getting off their asses and knocking on doors – but they read more widely, and are fully aware of all of the competing theories. A historian will be more dependable over all, but a reporter always has better stories to tell -- and so reporters are almost always more popular.

Michael Lewis is a reporter, and has been since Liar’s Poker – a book in which he reported what happened to him in his own days in the financial-services machine. The Big Short is his book about the financial crisis of 2008, but, in the typical fashion of Lewis (and of reporters in general), he doesn’t want to explain what happened in aggregate, but to get out and talk to a few specific people. In the prologue to this book, he describes Big Short as something of a sequel to Liar’s PokerPoker explained how he got into the financial world himself, as a young and na├»ve man, and soon got out of it after he realized that the people around him didn’t have much more of a clue about finance than he did, and that, though the money was excellent, it wasn't what he wanted to spend his life doing. Since then -- he explains -- he’s come to believe that most of the financial world really doesn’t know what’s it's doing:
Somehow that message [that the financial world is "phony"] was mainly lost. Six months after Liar's Poker was published, I was knee-deep in letters from students at Ohio State University who wanted to know if I had any other secrets to share about Wall Street. They'd read my book as a how-to manual.

In the two decades after I left, I waited for the end of Wall Street as I had known it. The outrageous bonuses, the endless parade of rogue traders, the scandal that sank Drexel Burnham, the scandal that destroyed John Gutfreund and finished off Salomon Brothers, the crisis following the collapse of my old boss John Meriwether's Long-Term Capital Management. the Internet bubble: Over and over again, the financial system was, in some narrow way, discredited. Yet the big Wall Street banks at the center of it just kept on growing, along with the sums of money that they doled out to twenty-six-year-olds to perform tasks of no obvious social utility. The rebellion by American youth against the money culture never happened. Why bother to overturn your parents' world when you can buy it and sell off the pieces?

At some point, I gave up waiting. There was no scandal or reversal, I assumed, sufficiently great to sink the system. (pp.xv-xvi)
But then, of course, there was a reversal "sufficiently great to sink the system" -- or so it looked for much of 2008. Lewis's timeline in the prologue has him starting to work on this book early in 2008 -- before Bear Sterns's collapse was the first pebble of the avalanche, at least for those of us not paying close attention to the structured-finance world -- and wondering if, finally, the financial world would go back to what it was before the early '80s, before Salomon Brothers (and then the other investment banks) went public and started playing with everyone else's money instead of their own. That was the story he was thinking about: that the last twenty-five years of so of Wall Street hubris was the exception, and that things would crash back to the way they used to be, finally.

So, for Big Short, Lewis wanted to find a few people who he figured did know what was going on – those who saw the crash coming, bet against it, and made lots of money as the markets imploded. Some of those people begin to wonder, towards the end of Big Short, whether their willingness to make those huge bets might have done something to worsen or hasten the crash – but, like financial people everywhere, they quickly brush off those concerns. There’s always a market, and markets are, by definition, right. So making lots of money is the proof that you did the right thing, and the guy losing his shirt has equally proven to have done the wrong thing. In fact, Lewis' conception of Big Short implicitly buys into that central truth of Wall Street -- the guy who makes the biggest pile of money is right. He was just waiting, not all that patiently, for the system he is sure in untenable to finally smash so badly that the people betting against it can make the monster profits (like John Paulson's hedge fund, which made $20 billion as the market shot downward) that prove, once and for all, that he and they were right.

Those people are a small band of short-sellers, some of whom knew each other, and all of whom were loosely linked through a few vectors. (Paulson himself, though, is mostly absent here; presumably, he isn't one of the people Lewis talked to, for whatever reasons.) As Lewis tells it, those short-sellers are at the core of the story -- from Steve Eisman, an ex-Oppenheimer analyst turned New York hedge fund manager, to Michael Burry, an ex-doctor turned California hedge fund manager, to Greg Lippman of Deutsche Bank, who "infected" a dozen others with the same idea.

That idea was, to vastly simplify it, that the US residential mortgage market was becoming vastly over-inflated, as less and less qualified buyers were being placed into houses under shakier and shakier loans (balloon ARMs and even more exotic forms, such as the one that required no payments at all, and just rolled interest into the principal until...well, that was the question), driven primarily by investment bankers that had found a vast new line of business turning those mortgages into investment-grade securities and peddling them to various institutional investors. That may still be too complicated, I suppose. So let's say that there was a huge tower of paper wealth, spread worldwide, built entirely on the ability of American homeowners -- a large percentage of whom had refused to state their income -- to pay the mortgages that pretty much everyone knew they couldn't afford.

After the fact, of course, everyone saw the crash coming. (Those of us who owned houses through the boom often found ourselves wondering how anyone could afford those ever-escalating house prices, without realizing the truth: they couldn't.) But most of Wall Street lost vast amounts of money -- with several firms disappearing entirely, being eaten by the competition, or fleeing the golden fields of investment bank-hood for something a bit safer -- and the institutional investors that they sold to had it even worse. Lewis's bracing account focuses entirely on the people who made money. So this isn't yet another book about the crisis that talks about Jamie Dimon, or Dick Fuld, or Ben Bernanke, or the poor saps at Bear and Lehman. Those people stay offstage; they're busy, doing their own things, busily building the towers that will collapse. Lewis tells the story of the few men (and, aside from the Oppenheimer analyst Meredith Whitney in the prologue, they're all men) who found ways to bet against that teetering tower of mortgage debt and eventually win big.

Reading The Big Short in 2010, we know what will happen. We know that Burry and Eisman and the rest will eventually be vindicated, so the tension that Lewis tries to create by describing their angry investors and unease as the bull market continued powering upward falls somewhat flat. But Lewis is a great reporter, so he can create a compelling story about an inevitability.

Still, Big Short doesn't explain, or try to explain, why and how these complex financial instruments were created -- all of the credit-default swaps and collateralized debt obligations that were sold off to enrich the issuing banks. He does explain what they are, and how they work -- clearly enough that I once again almost understood them entirely, for a few days, while I was reading his book. And maybe it doesn't really matter who, precisely, created some particular tranches, or figured out how to manipulate Moody's into rating nearly everything as AAA. Lewis isn't looking for a culprit -- he assumes nearly all of Wall Street is guilty of extreme greed and aggravated stupidity and third-degree short-sightedness, so it's pointless to find any small group of people and declare that they "did it" -- so those kind of details are irrelevant to his story. As Lewis sees it, Wall Street has been off-kilter and detrimental to the health of the rest of the country for more than a generation, so the particulars of this crash -- no matter that it's the biggest one yet; the latest crash is always the biggest one yet -- are beside the point.

Along the way, Lewis is tremendously entertaining, as usual, here's one great description, near the end, as even the dimmest, most conventional money managers were beginning to suspect that things couldn't go up forever:
In the murky and curious period from early February to June 2007, the subprime mortgage market resembled a giant helium balloon, bound to earth by a dozen or so big Wall Street firms., Each firm held its rope; one by one, they realized that no matter how strongly they pulled, the balloon would eventually lift them off their feet. In June, one by one, they silent released their grip.
The Big Short won't be the definitive book on the 2008 crash, since it avoids writing about the actual crash almost entirely. (I still like John Lanchester's I.O.U. as an overview.) But it's excellent for Lewis's perspective on why this crash was inevitable, and how further crashes -- each one worse than the one before it -- will also inevitably follow as long as Wall Street is allowed to continue on the path its made for itself since the early '80s. It's a frankly chilling book -- not so much for what it says, but for what it implies.
Book-A-Day 2010: The Epic Index
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Listening to: A.A. Bondy - When The Devil's Loose
via FoxyTunes

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