Wednesday, March 14, 2012

The Big Short

Today's interweb sensation over a New York Times op-ed by former Goldman Sachs executive Greg Smith (plus Matt Taibbi's comments on it) reminded me that I haven't written anything about Michael Lewis's The Big Short, which I finished a few days ago.

Cover of The Big Short by Michael LewisLike all of Lewis's books, it's very well done. The insanity that was (and generally still is) Wall Street is exposed -- how debts were combined into larger debts, then sliced up and rated from AAA to BBB, and then BBBs were repackaged into AAAs. How the guys who figured out that it was all a house of cards managed to make some money betting against it, but also how the guys who were in it up to their necks made out like bandits, too.

The metaphor of the emperor's new clothes fits it exactly. Almost everyone on Wall Street believed there couldn't be anything wrong with these "investments" because everyone else was doing it. The massive personal financial incentives to believe in the nonexistent royal clothes may have had something to do with it. Lewis describes one high-level manager who went from making $140,000 to $26 million a year, basically to look the other way instead of understand and manage his investments.

The few people who said the emperor was naked weren't believed. One of the skeptics profiled in the book, Michael Burry, ended up being sued by his investors even though the investments he made for them were returning over two hundred times what the S&P had over the life of his fund.

The ratings agencies come off incredibly badly in Lewis's book. They were putting grades on financial packages they couldn't begin to understand. According to Lewis, they employ all the people who aren't smart enough to work in the Wall Street banks. And we know how smart those guys are.

A few favorites lines:

  • The title of a report written by one of the skeptics: "A Home Without Equity Is Just a Rental with Debt."
  • "Any business where you can sell a product and make money without having to worry how the product performs is going to attract sleazy people." -- Sy Jacobs, investment banker
  • The turning point -- when Wall Street investment banks really started to go wrong -- was after 1981 when Salomon Brother CEO John Gutfreund took the company public. Once it was no longer a partnership, where the partners had personal risk, it "became a black box. The shareholders who financed the risk had no real understanding of what the risk takers were doing..." And: "No investment bank owned by its employees would have leveraged itself 35:1..."
It's hard for me to not analogize the scenario Lewis describes to our society's general attitude toward sustainability, whether economic or environmental. When all of the people who were making money from these garbage investments gathered in Vegas for a conference, one of the skeptics couldn't believe their self-deception:
He walked around the Las Vegas casino incredulous at the spectacle before him: seven thousand people, all of whom seemed delighted with the world as they found it. A society with deep, troubling economic problems had rigged itself to disguise those problems, and the chief beneficiaries of the deceit were the financial middlemen (page 154).
They were comfortable and happy with their lot in life; they thought they deserved everything they were getting. But it was all built on false assumptions, and it crashed. Doesn't that sound familiar?

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