Mark’s #33 – The Big Short by Michael Lewis

The Big Short: Inside the Doomsday Machine

As with his other works of nonfiction, Michael Lewis retells a story with all the drama and plot twists of a novel.  In this book, Lewis delves once again into the seediest side of Wall Street – the bond and real estate derivative markets.  Granted, that doesn’t sound like a compelling place for a story to take place, but in reality, that was where the foundation of the global financial crisis of 2008 began.  We often hear phrases like, “the predatory lending practices that led to the financial meltdown” – In this book the reader is given an inside look at exactly what phrases like that mean.

Greed begets more greed.  Imagine a the world’s biggest Ponzi scheme fueled by the world’s biggest investment firms.  In short, in a rush to create more and more mortgages, in the mid 2000s, banks began to significantly lower their lending standards, and in many cases remove any standards all together. These banks would receive various fees for the creation of these loans, and then would sell these sub-prime loans to other financial institutions – thereby passing off their investment risks.  All of this was well and good as long as the U.S. housing market continued to increase in value.

For example, in one instance an immigrant strawberry farmer in California with a $14,500 annual salary was given a loan in the amount of $749,000.  Obviously, this farmer could not pay the mortgage on such an amount.  Why would the banks do this? Well, the plan was tease people into very low 2 year rates that would later balloon into higher rates (by that time the bank would have sold the mortgage to someone else).  When the farmer was about to default on his loan, because of the increased value of the property, the bank would just refinance the loan for say, $800,000… Again, this only works with increased property values.

Eventually the housing market bubble burst – big time.  Only a select few investors saw this coming and invested accordingly – as they figured out ways to ‘short’ the real estate derivatives market.

What struck me about the story, as the author points out in the end, is that both the smart guys who bet against this insanity AND the greedy heads of various financial institutions came out multiple millions of dollars ahead of the game.  Almost no one went to jail.  Major financial institutions such as Bears and Stearns went bankrupt, but the U.S. government stepped in to ‘bail out’ the other big boys in the financial services industry… So in the end, the people that are hurt by all of this are the poor and middle-class who were suckered into these loans and the American taxpayers.

Read this book if you’re interested in the inside story of perhaps the worst financial crisis of the modern world.

The Big Short: Inside the Doomsday Machine

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