Otis Chandler's Reviews > The Big Short: Inside the Doomsday Machine

The Big Short by Michael Lewis
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Mar 22, 11

bookshelves: business, nonfiction, finance
Read from September 06 to October 14, 2010

An extremely well-written account of the 2008 financial collapse. It explained complex ideas like subprime mortgage bonds and CDO's in a clear way, and almost read like a fast paced thriller.

Essentially it seems that a bad ratings system and human greed created an economy that fostered the creation of a lot of bad debts, that eventually went bad, and caused a lot of big companies to go under (Lehman brothers, Bear Sterns), or require a bailout (Goldman Sachs, AIG). This is the real crime. These big companies were so focused on short term profits that they failed to see that long term what they were doing wasn't going to work. They should be appropriately punished for this, and instead many of them were saved by Uncle Sam. Would we have had a worse recession if Obama hadn't done that? Maybe. Maybe not. Lewis should write another book about that :)

Let me see if I can get this right. The book explains that mortgages are sold by the banks that issue them, passing off the risk. Mortgages are aggregated into groups in mortgage bonds, which are then packaged into tranches, which are rated by agencies such as Moody's and S&P's. The math was complex, but apparently somehow tranches that consisted almost entirely of "subprime" (aka risky) mortgages were being given high A ratings. I guess the theory was that by spreading out the risk across lots of mortgage bonds it lowered the risk. Too bad this didn't work.

Many of these mortgages were the variety that started 2 year fixed then went floating. They were largely taken out in 2005 - 2006, and as they hit 2 years the interest rates jumped as they went floating, and hoards of people defaulted. This explains why we teetered in 2007 and crashed in 2008. One of my favorite quotes to illustrate the madness:

"In Bakersfield, California, a Mexican strawberry picker with an income of $14,000 and no English was lent every penny he needed to buy a house for $724,000."

And it wasn't just in Bakersfield. All over the country people were taking out loans that were too big for their britches, because the banks were encouraging it:

"The simple measure of sanity in housing prices, Zelman argued, was the ratio of median home price to income. Historically, in the United States, it ran around 3:1; by late 2004, it had risen nationally, to 4:1. “All these people were saying it was nearly as high in some other countries,” says Zelman. “But the problem wasn’t just that it was four to one. In Los Angeles it was ten to one and in Miami, eight-point-five to one."

Economics is about incentives, and this book explained how they went very awry. But it was also a story about greed, and how even unintelligent people made a lot of money by riding the subprime mortgage train. The book followed several investors who noticed what was happening, but when they tried to tell people and test their "crazy" hypothesis that the financial world was going to collapse, they were mocked or ignored. So they just ended up shorting (betting against) the whole thing to make some money, which is what a good investor does.

"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?"

I think the lesson in the end is that if it looks to good to be true, it is. That, and we need smarter people working at the ratings agencies.
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Quotes Otis Liked

Michael Lewis
“The simple measure of sanity in housing prices, Zelman argued, was the ratio of median home price to income. Historically, in the United States, it ran around 3:1; by late 2004, it had risen nationally, to 4:1. “All these people were saying it was nearly as high in some other countries,” says Zelman. “But the problem wasn’t just that it was four to one. In Los Angeles it was ten to one and in Miami, eight-point-five to one.”
Michael Lewis, The Big Short: Inside the Doomsday Machine

Michael Lewis
“the lesson of Buffett was: To succeed in a spectacular fashion you had to be spectacularly unusual.”
Michael Lewis, The Big Short: Inside the Doomsday Machine

Michael Lewis
“The CDO was, in effect, a credit laundering service for the residents of Lower Middle Class America. For Wall Street it was a machine that turned lead into gold.”
Michael Lewis, The Big Short: Inside the Doomsday Machine

Michael Lewis
“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?”
Michael Lewis, The Big Short: Inside the Doomsday Machine

Michael Lewis
“In Bakersfield, California, a Mexican strawberry picker with an income of $14,000 and no English was lent every penny he needed to buy a house for $724,000.”
Michael Lewis, The Big Short: Inside the Doomsday Machine


Reading Progress

09/13/2010
15.0%
09/17/2010
41.0% "The historical us average ratio of income to house loan is 1/3. In 2006 it was hitting 1/10 in some states."
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Comments (showing 1-7 of 7) (7 new)

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message 1: by Lisa (new)

Lisa Vegan I wish this book had been written prior to the "crash" and that more people in power had read it. It sounds interesting, but I'm afraid I'd just get more distraught if I read it. That example you quoted about the worker earning $14,000 and getting a loan to buy such an expensive house is truly unbelievable.


Kate In fairness to the people at the ratings agencies, the problem is more to do with incentives than smarts.


Otis Chandler You are probably right. Smart people are incentivized to work in places where they can make more money. But not always - working for something you believe in can often matter more - as long as you have enough money to live decently on (eg Non-profits, teachers, etc). Not sure if people who work at the ratings agencies believe in their mission?


message 4: by rivka (new)

rivka Lisa wrote: "I wish this book had been written prior to the "crash" and that more people in power had read it."

Plenty of people were warning of problems with the increasing numbers of high-risk mortgages for quite some time before the crash. No one ever wants to listen to Cassandra -- especially when she's right.


message 5: by Lisa (new)

Lisa Vegan rivka wrote: "No one ever wants to listen to Cassandra -- especially when she's right. "

So true. At the risk of sounding psychotic, I (and I'm sure many others) often feel like a Cassandra.


message 6: by Lawrence (new)

Lawrence I saw the film inside job; check it out, same topic. What happened in Iceland etc and ratings agency/govenment deregs was shocking. When I got back to London there were the icelandic volcanoes and a work agent joked it wasn't the volcanic ash causing air disruption but the banks cash, after watching this I understand what he meant !


Brian Would be hard to write this before the crisis as it's largely about the unconventional characters who bet against the mortgage madness and profited greatly. And there's more! I think I remember hearing him in an interview on the radio saying he met more characters who didn't fit into The Big Short, but will be in an upcoming book....Can't wait! :)


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