The Big Short
-What is it?-
The Big Short is a non-fiction book written by Michael Lewis and published in 2010. The book focuses on several narratives that follow various outsiders in the finance industry—from hedge fund managers, to Deutsche Bank traders, private investors, and others—and traces their separate realizations that the U.S. Housing Market is doomed to collapse because of its over-reliance on fraudulent housing loans.
-Who should read it?-
Many people have already been introduced to the general themes and plot of the book thanks to Adam McKay’s 2015 comedy/drama film of the same name. If you’ve seen the movie, there’s a chance you may very well enjoy the book—be warned, however, there are extensive descriptions of financial and investment banking terminology. This language isn’t so dense that it renders the book incomprehensible, but if you’re looking for a real smooth read, this is not it.
However, if you’re interested in a breakdown of the key elements of the Housing collapse—and an incisive look into those who run our markets today, as well as those who work within them to try and prevent the same catastrophe from occurring again—you may find this book rewarding.
-Some Key Ideas-
“Financial markets are a collection of arguments.” (pg. 67)
This quote relates to a major theme in the book, which is that a lot of finance is often packaged in hyper-complex language in order to obscure a simple message—most financial relationships boil down to one person who believes something has value, and another person wants to know if that statement is accurate.
Both people want to make money. There’s an outcome where the person with the argument of value will make more money, and there’s an outcome where the person questioning the value of the argument will make more money. There’s a third outcome where both parties stand to make so much money that neither cares whether the argument is valid—only that it’s valuable.
This is debatably the zone that the housing bond market quickly entered. The industry was generating so much revenue—so much so that $700 billion wasn’t even close to enough to cover the losses all the banks suffered in the collapse—that no argument from either party was challenged. Whatever someone said, as long as it kept the wheels turning, was approved and minted.
“ ‘There should be no greater thing you can do as an analyst than to be the Moody’s analyst. It should be, ‘I can’t go higher as an analyst.’ Instead it’s the bottom! No one gives a fuck if Goldman likes General Electric paper. If Moody’s downgrades GE paper, it is a big deal. So why does the guy at Moody’s want to work at Goldman Sachs? The guy who is the bank analyst at Goldman Sachs should want to go to Moody’s. It should be that elite.’” (pg. 122)
Moody’s and Standard & Poor’s—which is where the S&P 500 comes from—are the credit ratings agencies tasked with evaluating the stocks, bonds, and commodities that major Wall Street investment banks bring to them. These positions are vital to the health of the market, as whole industries depend on accurate, honest ratings of their financial assets in order to take their financial temperature and track their health. In the time leading up the housing collapse, these agencies were effectively pitted against each other by the investment banks.
For example, if Goldman Sachs came to Moody’s and asked for a bond rating, and Moody’s gave them a lower score than they preferred, the investment bank would simply go down to Standard & Poor’s and ask them for a rating. This kind of relationship is cited in the book as one of the key components of the housing market collapse—because the ratings agencies were incentivized into giving good ratings to whoever came through their door, the credit ratings that the entire industry depended on were severely out of proportion with the reality of the situation. This distorted view is what allowed the crisis to balloon out of control without anyone needing to deny or question what was going on. If the ratings were good, the markets were good too.
“What are the odds that people will make smart decisions about money if they don’t need to make smart decisions—if they can get rich making dumb decisions?” (pg. 191)
The traders and banks who played instrumental, or at least symbolic, roles in the collapse of the housing market were often let go with hefty payouts. Howie Hubler, the architect of the single largest trading deal loss in the history of Wall Street, was still paid millions after he left Morgan Stanley. And the Citigroup Investment Bank, after it received $25 billion in taxpayer investments—bailouts—also received another $20 billion from the Troubled Asset Relief Program—TARP—which was created to prevent major Wall Street Banks from failing. On top of this, Citigroup was granted $306 billion in government guarantees, meaning the federal government promised nearly half a trillion dollars in order to insure Citigroup from collapse. This is roughly two percent of the U.S. GDP and nearly all the combined budgets of the departments of Agriculture, Education, Energy, Homeland Security, Housing and Urban Development, and Transportation.
Ultimately, the point stands—if the top financial analysts and managers in the world aren’t expected to make intelligent and honest decisions with the capital at their disposal, and are in fact paid for their wildly costly mistakes, why would they do anything different? It’s not as though a system could be developed in order to vet only the best, brightest, and integrous of a population to handle with care the beating heart of a country’s economy. That would be ridiculous and there’s no precedent for institutions that would perform such a vetting, or any real-world industries that have such controls in place.
If you’re feeling up to the challenge, The Big Short is a rewarding, cathartic, and horrific book that puts on full display what happens when a financial system is allowed to generate ludicrous amounts of wealth without having to prove that any of it actually exists. While the movie certainly does a fantastic job of illustrating the characters and plots in cinematic language, finance and its truths lay in the numbers, and this book is full of them. You’ll walk away feeling like you could man a Goldman Sachs trading desk, realize what that means, and look to the East and wonder if anyone on that one street actually knows what they’re doing.
Lewis, Michael. The Big Short: Inside the Doomsday Machine . W. W. Norton & Company, 2010.
Link to The Big Short Podcast – Spotify
Link to The Big Short Podcast – Apple Podcasts
Link to The Big Short Podcast – Libsyn