The Big Short: Inside the Doomsday Machine

"Michael Lewis, to me, is the preeminent narrator of this crisis. He is the guy who constructs the story better than anybody else. He tells the narrative in just an utterly fascinating and delightful way. I have a review of The Big Short that I haven’t published yet, because it’s too profane. There’s a story in there of a fund manager who starts out as an archconservative, and ends up, at the end of the crisis, as this staunch liberal. That’s because he sees the entire subprime, securitisation thing as nothing more than Wall Street finally figuring how to extract profit from the poor. There’s a whole section of the book where he rails about it being an attempt to “fuck the poor”. So I had this fantasy of Michael Lewis going in with his manuscript to his publisher, and instead of calling it The Big Short , he called it Fuck the Poor . I had this whole debate between him, his publisher and his agent. “Michael! Be reasonable! You can’t call a book Fuck the Poor …” If you’ve ever seen Lewis speak, he’s a very low-key guy, he speaks in a very matter of fact way, and I just had this hilarious image of him saying, “Gentleman, this book is called Fuck the Poor . That’s what the story is, that’s what the main players say it’s about. If you want to subtitle it The Big Short, that’s fine. If you don’t like it, I will take my manuscript elsewhere.” In the book, he does what he does in all his books, which is he identifies these quirky, off-kilter guys that have some odd defect. One of them has Asperger’s, I think. They’re outsiders, not in the mainstream. Lewis just tells the same story over and over again, whether it’s technology or baseball or football or subprime mortgages . And the story is essentially a few people looking at the universe from outside, and seeing something everyone else misses. In this case, you have guys who not only capitalised on it, but also managed to raise a stink about how things are done, which of course we’ve promptly forgotten all about. I don’t know if the guy who said that was being a little flamboyant, but, ultimately, yes. Here’s the problem with banking. People have described a banker as someone who is willing to lend you an umbrella on a sunny day, i.e., if you really need the money, you can’t get it. As I said in Bailout Nation , the history of commercial credit has, for millions of years, been based on the borrower’s ability to service the debt. What took place from 2002 to 2007 is that the borrower’s ability to service the debt was replaced with a new standard for making loans. That standard wasn’t, “Hey, how do we fuck the poor?” but it was the ability of the lender to sell that debt to a Wall Street securitiser. All this goes back to the Fed taking the rates to such crazy low levels, that every bond manager had to scramble [for yield]. Most foundations and charities and pension funds and large trusts – especially the not-for-profit entities – as long as they give away 5% of their assets every year, they are completely tax free, and oversight is de minimis. Five per cent doesn’t sound like a big number. Typically, over long periods of time, the market returns are anywhere between 6-10% if you include dividends, and over a similar period of time bonds give you between 4-7%. What took place after the 2001 crash is that first you had markets down a ridiculous amount every year, and secondly Greenspan took rates so low that the 10-year [US Treasury bond] followed. If equity returns are negative, and bonds below 5%, how is a foundation or trust going to make 5%? If you were smart, you’d say, “We made so much money in 1998-2000, we don’t have to take any additional risk. We’ll just give away the 5% out of those profits and not worry about it.” But that’s not how human beings operate. Instead, they panicked. “We’re not going to make 5%! We’re going to have dip into the corpus of the trust or foundation!” And every bond manager got a phone call. “Hey dude, go and get me more than 5% and if you can’t do that, I’ll fire you and get someone else.” So along comes this product from Wall Street, securitised subprime mortgages. It’s triple-A rated, just like Uncle Sam, but yielding much more. You could get your 5-6%. So everybody piled into that product. They sold out. The more they sold out, the more Wall Street went to these non-bank lenders, mostly located in California, and said, “We need more subprime loans to securitise, and by the way if you do this many we’ll give you this much of a bonus.” That’s how you ended up with these mortgage companies giving loans to people who could barely fog a mirror. My favourite example was the two grape-pickers in California, who each made $14,000 a year and qualified for a $750,000 mortgage. If they took 100% of their salary and used it to pay the mortgage, they would still default. Also, by the way, these 30-year mortgages were sold with a 90-day warranty. You can buy a toaster that has a longer warranty than a 30-year mortgage! Your obligation, when finding a borrower, is “Just don’t default these first three months. Whatever you do after that is not my concern.”"

"This is probably the most popular book on my list, and many people will already have read it. It really is a masterful book. Lewis is an amazing storyteller, but what I loved about this book is that he really tries hard to understand how this system went wrong. Then he explains it, all the complexities, and he just makes it look so effortless. You feel really smart when you’re reading this book. It all becomes obvious. Of course it wasn’t obvious at the time, and it isn’t obvious until a master storyteller like Lewis gets his hands on it. This book should be required reading, and, because it’s a pleasure to read, that’s not a very onerous requirement. Yes. There are some other very good books on the crisis, but this would probably be the one. If I had any criticism of the book, it’s that he makes it seem too obvious. It becomes mysterious how anyone could have been confused. I think they probably are, for a couple of reasons. One is that reality is starting to produce really good data. Previously, data was something that would be collected by a government statistical department. You’d have data on unemployment, inflation, GDP growth and not much else. Now data is just thrown off in huge quantities by the likes of Google and all these computerised business processes. That means that if you want to do good empirical work, you need to start engaging with businesses. That is one thing that is changing. Another thing that is changing is if you look at the awards that are now being given to economists. A few weeks ago, Jonathan Levin was given the John Bates Clark medal, which is awarded to an American economist under the age of 40. It’s basically a forerunner for the Nobel: most Bates Clark medallists who stay in the profession have gone on to win the Nobel Prize – people like Paul Krugman, Gary Becker, Joe Stiglitz and much earlier, Paul Samuelson. Larry Summers probably isn’t going to win the Nobel Prize, but he was a Bates Clark medallist as well. So it’s a really serious award. Jonathan Levin is one of a new breed of economists who mixes very sophisticated economic theory with quite detailed empirical study. It used to be that economics was entirely theory driven. Yes, and then Steve Levitt came along. He won the Bates Clark medal in 2003. He’s the author of Freakonomics , he is a brilliant empiricist, a data guy, but not really much in the way of theory. He would say that himself – he’s just looking for patterns in the numbers. What’s happened more recently is there’s been this marriage of classical economic theory and careful empirical data collection. Levin won this year, last year it was Esther Duflo, who is also a brilliant empiricist. The year before it was Emmanuel Saez, who is famous for his very careful studies of inequality. The year before that it was Susan Athey, who is a co-author with Jonathan Levin. These are people who are really getting their hands dirty with the data. I think that is a change in economics. You can’t just produce theoretical models. There’s so much good data now that you can’t get away without doing some of it. It’s a book that’s made and broken reputations, so there is still some jockeying for position. I believe that somebody is suing Michael Lewis. He emphasised certain characters, and he could have looked at other stories. But I’m not aware of any consensus that Lewis made some awful, terrible mistakes in the book."

"This is a great book. There has been so much written about China over the years and this is a wonderful read. A lightly fictionalised tale of this guy Tim Clissold and his adventures as a businessman and investor back in the early 90s when China was just starting to open up and western businessmen were salivating at the prospect of selling into China and this is a very warts-and-all perspective on the problems that westerners run into. The British textile industry used to say that if each Chinaman would just lengthen his shirt by an inch the mills in Lancashire would be running indefinitely. There’s a billion of them, and people thought: ‘If I could just get every one in ten of them to buy my product, I’ll be rich!’ What people don’t anticipate is that trying to get that one in ten to buy your product is enormously difficult for a lot of the reasons that Clissold sets out – the local politicians have their hands in the till, trying to get paperwork signed, trying to make sure that if you’re buying this factory the person who sells it to you actually owns it in the first place. Trying to get anything done in the early 90s was enormously taxing. Yes. There’s some of that, because you had people who had not studied China sufficiently in depth to understand how things worked. It was just another market and riches would flow. Despite all the change in China the lessons of this book are still relevant today. If I were going to China as a businessman this is the book I’d read on the flight over."

"Michael Lewis is terrific both at picking topics and in his exposition. What I thought was most interesting about this book was that there is, to this day, a view about the whole pathology of collateralised debt obligations (CDOs) – these highly complex, packaged mortgage securities – as well as the credit default swaps – the insurance contracts written on those securities – that Wall Street created them and they simply got out of hand. They didn’t anticipate it would be hard to value them, how they would be misused, and so forth. “So what this book does quite brilliantly is show that there was actually a high degree of intentionality in creating the crisis. ” What Michael Lewis points out very forcefully is that they were deliberately created by Wall Street banks in order to produce non-transparent securities that could not be adequately evaluated by the rating agencies, which then could be sold to less sophisticated investors, who would buy the idea that this junk debt actually had triple A ratings. So what this book does quite brilliantly is show that there was actually a high degree of intentionality in creating the crisis. The worst of all these securities are the so-called synthetic CDOs. A CDO is a bond that represents maybe a couple of thousand mortgages; a synthetic CDO is a group of hundreds of CDOs, all packaged into a single security. When you get to that level of complexity, no one can evaluate what this thing is worth. You can come up with sophisticated rationales for why this might actually follow some kind of market logic, but I think Lewis shows that the reason this happened is that they didn’t want anyone to be able to rate it. Yes, but it raises this issue of intentional fraud, which has been at the root of a lot of the charges against banks like Goldman. The book is a story about these five or six weird individuals that realise what’s going on – that this housing bubble was expanding and then eventually would burst – and the other thing it makes very clear is that it undermines any kind of notion that the crisis was not foreseeable. In fact, you can see that a lot of the big banks began to understand that it was not going to be sustained, and did a lot to promote it, hoping that they would be able to get out before the whole thing collapsed. It depends what you mean by systematic. Lloyd Blankfein doesn’t get up in the morning and say, “OK. How are we going to defraud people today?” but I do think the relationship of these banks to social rules is fairly dodgy. Rules are viewed as potential obstacles that you try to get around if that maximises your profit. This is a deeper social issue that I think has to do with the economisation of a lot of thinking. Economists have this model of rational utility maximisation – that social benefit comes out of everybody pursuing their private rational self-interest. This has shaded over – imperceptibly over the past couple of generations – to a downplaying of social norms as constraints on behaviour. You see this in a number of places. In business schools, for example. “ When everyone was part of a partnership, there was more of a normative sense that you had a responsibility to customers and that your long-term reputation mattered a great deal.” Back in the 1960s and 70s, business schools regarded themselves as professional schools along the lines of law schools or architecture schools. They were meant to inculcate a certain sense of professional responsibility, that you have obligations to society at large. But as a result of the economisation of a lot of what was taught in these schools, individual profit maximisation began to displace this normative sense, and this spilled over into the behaviour of the people who went on from these programmes into the financial sector. In their minds, they weren’t deliberately trying to defraud people, but if they saw an opportunity to take advantage of less sophisticated buyers of subprime mortgages, they would go ahead and do it. A lot of people on Wall Street itself say that the norms were quite different 30 years ago. When everyone was part of a partnership, there was more of a normative sense that you had a responsibility to customers and that your long-term reputation mattered a great deal. This shorter-term trading mentality has really displaced that in many firms. Whether you can get that back or not is another big social challenge in the future. It’s a lot of things. As the industry has got bigger and more competitive, and involved more money, the kind of clubby, elite-run brokerages and investment banks that existed a generation or two ago have just disappeared. More competition, more participation and less elite control don’t always lead to the best outcomes."

"Lewis is a great writer and this is one of the best accounts of what happened in the run up to the crash. In fact, I just recommended it to someone I was with last night who was talking about the efficient market hypothesis – which is the basic paradigm of financial economics – and I told him that if he wanted to understand why it didn’t apply in the run up to the financial crisis, he needed to go away and read this book. In it, Lewis talks about the bankers who knew early on that what was happening was nonsense and was all going to end in tears and how they translated that insight into money making strategies. It tells us the difficulty markets have in correcting group think. You really have to be quite Aspergerish to take a stand against the crowd. In fact one of Lewis’s heroes, as it were, is hedge fund manager Michael Burry, who clearly had serious socialisation problems. Yes it does. The hedge fund manager John Paulson, who made serious money out of the financial crisis, has lost quite a lot of money in subsequent bets since then which raises questions as to what extent he was just lucky to get that particular call right or whether hubris has made him over confident as a result of having got that one right. It’s really readable. What Lewis does so well is give the reader a lot of fun while actually making a number of serious points. You can pretty well read this book on the beach for amusement, but there is a point there. That makes sense as Brad Pitt starred in the film version of Lewis’s book Moneyball . He must have connected with Lewis in some way."