Wall Street is probably best known for the movie quote “Greed is good.”
But after reading The Big Short, Michael Lewis’ excellent book about the lead up to the 2008 global financial crisis and the small group of people who saw the collapse coming and bet against it, I think Wall Street needs a new saying: “Y’all are a bunch of greedy assholes.”
Lewis has a talent for making his readers feel smart. Taking in his best works, you’re granted kinship with the elite. Like a trader at Salomon Brothers, you might laugh at the chumps in the bond market; or like the money-constrained boss of the Oakland A’s, you might cobble together a winning line-up by way of statistics; or like a genius of modern day football, you would recognize the importance of a great left tackle in protecting your quarterback’s blind side. Now, with The Big Short, you will have no doubt foreseen the folly of investing in subprime mortgages with their impending defaults. He does this in a very readable way, too. The characters are all interesting – often genuinely quirky. And his vantage point as a quasi-insider signifies the straight scoop. Whatever the topic, he explains its subtleties well enough that you can paraphrase it to impress friends over cocktails.
Our man Lewis was clever to focus on the winners of the bet. As he explained in an interview, those were the ones who were willing to talk to him. They saw what became obvious in hindsight: that many of the loans backing mortgage securities were originated with very low standards applied (by firms who didn’t have to eat their own cooking), were issued with teaser rates that would soon adjust up, and were likely to default as soon as the air started coming out of the big housing balloon. For reasons Lewis explains well, the bet against the bubble was not so apparent to many. These securities were hidden in tranches of complicated mortgage-backed securities with obscure features that made it harder to do proper due diligence. They were also rated too high by Moody’s and S&P for the default potential they contained (partly because the agencies were easily duped by the Goldmans of the world who were paying their fees and wanted AAA assets to vend). Plus, there was little to go on from past default data because such high levels of credit unworthiness had never before been experienced. Modeling assumptions were poor, too. For instance, it was thought that diversification across regions would reduce risks. The widespread downturn in housing showed otherwise, of course. Default correlations were high. It hurt the cause, too, when some of the strongest personalities in the business, like Cassano at AIG and Hubler at Morgan Stanley, were also some of the wrongest.
The misdeeds on Wall Street were spotlighted well. I couldn’t help feeling, though, especially at the end, that Lewis had overstated his case. There were times when he claimed the investment banks were stupid for not knowing the true value of these assets and at the same time duplicitous in passing them off to customers. You can’t have it both ways, at least not in that case. I was also hoping that he would weigh in on some of the other factors that contributed to the crash, such as the role of government with its CRA program and the poor oversight of its sponsored enterprises, toxic waste-makers Fannie Mae and Freddie Mac. Other points Lewis made against the investment banks were more deserving, I thought, among them, the fact that they are no longer partnerships (where any losses would truly hit home), but rather corporations with limited liability. Agency theory in economics points to the problem of employees receiving a much bigger share of the upside (with bonus structures as they are), and a lot less of any downside. Riskier strategies result. That doesn’t explain everything, though. Several of the notable blow-ups included principal architects who were also major shareholders. For instance, Richard Fuld lost over half a billion in share value when Lehman went under.
The other thing I thought was noteworthy about Lewis’s critique was something he alluded to in the introduction. He said when he wrote Liar’s Poker that he intended for it to be a finger-wagging at the industry’s bad behavior. Many read it instead as a how-to manual. This disconcerted him, and it was apparent that he went to greater lengths this time to dwell on the negatives. That said, might we still get the sense that he wants it both ways? His descriptions are alluring, the language of the cognoscenti is enticing, the personalities are bigger than life, and the market savvy that decides who wins the pot is celebrated. Wittingly or not, there’s an extent to which he glamorizes. I’ll take him at his word that he doesn’t want to see bright young people flocking to Wall Street anymore, but it seems there’s a small, slightly disingenuous part of him that still finds it all pretty fascinating.
In summary: strongly recommended as a guidebook on the crisis, very entertaining, but maybe not the one-stop shopping it might have been for assigning all warranted blame.
P.S: The movie is quite decent as well.