2010.19. Michael Lewis and The Big Short

Michael Lewis has great timing and a strong nose for Wall Street scandals. The Big Short: Inside the Doomsday Machine (Amazon.com Michael Lewis The Big Short) describes the investors, including the now-famous John Paulson, who shorted CDOs and made a fortune when the market crashed.

I finished it a week before the Goldman/SEC complaint – SEC Goldman complaint 2010 – was announced. The book is a perfect introduction to the ensuing, very public media flurry about Goldman, Paulson and the SEC.

And no one has emerged unscathed (one piece of smut literally being smut: how much porn was watched on SEC computers as the financial system was tottering on the verge of collapse).

I’ll skip the Goldman story; writing about that is journalism and not my calling. What about Lewis’ book? First, he does an excellent job portraying the financial story as a series of personal narratives. He’s able to entwine his pages with complex securities dealings in an understandable, entertaining and even humorous way. Like a novelist he describes people’s quirks and thoughts. He still mocks the innocent – with both humor and abandon (I’d hate to be on the receiving end). As always, his caricatures of dinner party attendees are unparalleled.

Overall, I loved the book and learned a lot about the CDO mess and how it unrolled. An interesting subsequent Wall Street Journal editorial (The Misguided Attack on Derivatives by L. Gordon Crovitz explains the irony of John Paulson getting such bad press now. Many have asked why no one saw this collapse coming yet someone who did and bet right is now being demonized. When did making a right bet on a trade become a bad thing? Personally, the right bets are what keep me solvent.

Essentially, the book covers a few individuals (investors, sales people, analysts) who noted how risky CDOs had become and looked for a way to profit from the coming crash.

As the mortgage pools started to be made up of ever lower quality loans, the risk of those CDOs increased more (in retrospect) than valuation models indicated (due to how entwined institutions were, the lack of black swan events being properly accounted for in the models and numerous other factors). The Big Short is an interesting primer to this tottering market, increasingly out of synch with reality. Lewis is brutally critical of many participants. I not only enjoyed the book but got a timely overview of what is now front page news. In sum, I’ll put a “strong buy” rating on the book.

Liar’s Poker (Amazon.com Michael Lewis Liar\'s Poker), Lewis’ first book, is a Wall Street classic. It described the Salomon Brothers of old, before a scandal brought down Lewis’ ultimate boss, John Gutfreund (at Salomon and in the period covered in the book) and the firm. The book gets its designation as a classic because it, in an engaging and entertaining manner, identified and captured a point in time that was about to disappear. Indeed, Lewis has often been credited with accelerating Salomon’s downfall through his scathing disclosure. The macho, extreme culture Lewis described softened over the ensuing years industry-wide but Salomon itself disappeared completely (sold to Citibank) after a trader was caught submitting false bids to the US Treasury.

Now Lewis has written a new classic; has he chronicled another world that is about to end, but perhaps on a larger scale? To answer that question we’d need to be looking back at history but the signs indicate that he may have spotted another “market top” for one part of Wall Street. The Obama administration is aggressively pursuing a larger and more involved governmental role in our financial services industry – which would change the sector immensely. Certainly, the common view of derivatives, with their complexity and entwining nature (causing the systematic risk we just experienced), are viewed differently now than they were a mere few years ago. Warren Buffett’s much quoted characterization of derivatives as “financial weapons of mass destruction” from years past, thought then to be alarmist, seems ever more prophetic (though he himself engages in large derivative plays now). Indeed, Buffett has morphed into the new JP Morgan: he stepped in after the Salomon scandal because he had a large share holding; in the current crisis he took large positions in Goldman Sachs and GE; and now he’s actively involved in the derivatives legislation debate. Warren Buffett\'s annual shareholder letter 2010

One thing is certain; the complexity level of securitization will decline, at least in the short run. Long held economic theory is even under attack (The Black Swan being only the most obvious example – definitely, the reliability of the ubiquitous “quant” models used to value the most esoteric securities has been discredited).

If I could ask Michael Lewis one question it would be “what is the next Wall Street topic you’re planning to write about?” And then I’d figure out the appropriate short.

A few questions to those who have read the book: what did you think of it? Do you agree with my comments? Buy or not?

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