If you read only one book about the causes of the recent financial crisis, let it be Michael Lewis’s, “The Big Short.”
That’s not because Lewis has put together the most comprehensive or authoritative analysis of all the misdeeds and misjudgments and missed signals that led to the biggest credit bubble the world has known. What makes his account so accessible is that he tells it through the eyes of the managers of three small hedge funds and a Deutsche Bank bond salesman, none of whom you’ve ever heard of. All, however, were among the first to see the folly and fraud behind the subprime fiasco, and to find ways to bet against it when everyone else thought them crazy.
Nor would anyone — including Lewis, I’m sure — claim this is an even-handed history that reflects the differing views of investment bankers, rating-agency analysts and industry analysts, all of whom he holds up to ridicule for their arrogance, their cynicism and their relentless incompetence.
In many ways, this is the same smart-alecky Michael Lewis who brilliantly exposed and skewered the ways of Wall Street 20 years ago in “Liar’s Poker,” written when he was fresh out of the training program at the once-mighty but now forgotten Salomon Brothers. But as he says in his introduction, those days of $3 million salaries and $250 million trading losses look almost quaint compared with the sums made and lost by the most recent generation of Wall Street fraudsters and buffoons.
What’s so delightful about Lewis’s writing is how deftly he explains and demystifies how things really work on Wall Street, even while creating a compelling narrative and introducing us to a cast of fascinating, all-too-human characters.
In “The Big Short,” which publishes Monday, we meet Steve Eisman, a second-generation Wall Streeter whose foul mouth and total lack of social graces made it easy for others to dismiss his relentless criticisms of the subprime mortgage industry as far back as the 1990s, when he first characterized it as nothing more than a Ponzi scheme.
There’s Michael Burry, a physician turned stock picker with an antisocial personality (later diagnosed as Asperger’s) who becomes the first money manager to buy a credit default swap on subprime mortgage bonds.
There’s Greg Lippmann, a prototypical bonus-grubbing Wall Street bond salesman who early on sees the potential of the subprime swaps market and becomes the leading evangelist for betting on the housing market’s collapse.
And there’s Charlie Ledley, Jamie Mai and Ben Hockett, three young financial hustlers from Berkeley, Calif., who set up a hedge fund in a Greenwich Village art studio, go looking for a long shot and find it in supposedly AAA-rated securities cobbled together from BBB subprime junk.
From their tales, we learn that Wall Street banks think nothing of stealing the trading strategies of their clients and peddling them to other customers. We learn that the investment bankers knew as early as 2006 about the rising default rate on subprime mortgages but engaged in elaborate ruses to hide that reality from ratings agencies and investors. We learn that when investor demand for subprime mortgages outstripped the supply, Wall Street filled the gap by creating “synthetic” mortgage-backed securities whose performance would mirror that of the real thing.
We learn that Goldman Sachs and other banks conspired to inflate the price of mortgage-backed securities well into 2007, even when they knew the true value was falling, only marking them down in value after their own hedging strategies were in place. And we learn that top executives were largely clueless about the risks their organizations were taking.
For me, the most memorable chapter in Lewis’s tale involves Burry’s struggle to keep his fund alive in 2007 and early 2008 as longtime investors lost faith in his strategy to “short” the housing market and began demanding their money back. Although home prices had begun to fall and mortgage defaults were rising quickly, Wall Street’s securitization machine had managed to prop up the price of mortgage securities while forcing down the value of the bets Burry had placed against them. And even after the market crashed and Burry’s strategy was vindicated with a $720 million profit, not a single investor called to say thanks.
“What had happened was that he had been right, the world had been wrong and the world hated him for it,” Lewis writes. “And so Michael Burry ended where he began — alone, comforted by his solitude.”
There is nothing subtle about the dark portrait Lewis creates of the financial community. Through his lens, all bond salesmen are out to cheat their customers, all top executives are clueless and all ratings analysts are second-raters who could not get jobs in investment banks.
Even footnotes drip with sarcasm, such as this one regarding a less-than-forthright statement by Morgan Stanley chief executive John Mack to his investors on how his firm managed to lose $9 billion on subprime securities: “It’s too much to expect the people who run big Wall Street firms to speak in plain English, since so much of their livelihood depends on people believing that what they do cannot be translated into plain English.”
Even discounting for its generalizations and exaggeration and limited frame of reference, however, “The Big Short” manages to give us the truest picture yet of what went wrong on Wall Street — and why. At times, it reads like a morality play, at other times like a modern-day farce. But as with any good play, its value lies in the way it reveals character and motive and explores the cultural context in which the plot unfolds.
What Lewis writes of two of his characters, young Ledley and Mai, might just as well apply to Lewis himself, or to us:
They “had always sort of assumed that there was some grown-up in charge of the financial system whom they had never met; now they saw there was not.”
Steven Pearlstein writes a business and economics column for The Washington Post.