Lewis comes up short The Big Short by Michael Lewis
Reviewed by Chan Akya
"Gyan is upset," said the Bear Stearns salesman.
"Tell him not to be," said Eisman. "We enjoyed it."
Having
complained in a previous review about picking up the wrong book by Michael
Lewis on the financial crisis when I selected his Home Game, imagining
it was about the flipping of
houses on the American West Coast, my feelings were perhaps more than a tad
positive when his actual book on the crisis landed on my table.
The Big Short is vintage Michael Lewis, returning the author of Liar's
Poker to his old hunting grounds of writing about the rich patina of
characters that inhabit (or more accurately, infest) the
financial markets. The story line is all about the kind of people who made
money by the billions on the financial crisis, despite being misfits in the
financial market. Correction - they made the billions because they were misfits
in the financial markets.
In starting the walk through identifying the various misfits and providing a
personal and altogether affectionate portrayal of how they pulled off the
biggest moneymaking deals in the history of financial markets, Lewis started
off by talking to celebrated bank analyst, Meredith Whitney, who was most
famous for her fantastic calls on the shaky state of US banks in 2007 and
afterwards. Whitney compiles for Lewis a list of people whom she felt had
cottoned onto the emerging disaster early; and had actually put money to work
against the disaster. That list, which was headed by Steve Eisman, forms the
basis of the book.
Ground zero of the clan of heroes is a doctor-turned-hedge fund manager,
Michael Burry, who started digging into the actual risk embedded into
mortgage-backed-securities (MBS) and even more so into the collateralized debt
obligations (CDOs) created by Wall Street and sold to hundreds of investors
globally - including the who's who of Asian central banks who were to later on
lose billions on these investments.
The approach followed by Mike Burry, who suffered from a form of Asperger
syndrome, which adversely affects people's social abilities, is vintage Graham
and Dodd, that is, good old-fashioned analysis of the details, creation of
robust financial models and intensive dedication to uncovering the truth about
the actual likelihood of defaults in these securities.
Then, using his hedge fund that had previously been focused on buying
ill-understood shares, that is, going long on the assets, Burry instead starts
selling assets related to MBS and CDOs that he doesn't have - going short on
the assets. One of the people he interacts with initially is a mortgage trader
at the giant Deutsche Bank, Greg Lippmann, who also understands his strategy
and begins replicating it on an epic scale inside the bank.
At the other end of the spectrum, Steve Eisman, who started off life as an
analyst who helped to bring public the first group of subprime mortgage
lenders, soon discovers the charm of the credit default swap (CDS) market, and
starts making deep bets against the multi-hundred billion industry, often using
Greg Lippmann to execute his trades. It is Eisman who comes across as irascible
and punchy, who has the best line in the book - the quote with which I started
this article.
The exchange between Gyan Sinha, who headed mortgage research for Bear Stearns
(and thus was perennially bullish on the assets that were being marketed by his
employer), and Eisman, who had done the actual homework on the underlying
assets, not only marked a shift of intellectual power from Wall Street to the
hedge fund world but also conveys the general irreverence of the funds for the
suppliers of financial products.
Lewis goes fairly easy on the people on the other side of the winning trades
put together by his team of heroes; calling them villains would be
counter-intuitive, but the lesser charge of negligent stupidity more than
stands in their cases. Ranging from the "brain dead" are rating agencies to
fund managers (the name Wing Chau is destined to become a symbol of notoriety
for years to come), and most of all a star Morgan Stanley trader by the name
Howie Hubler.
Where the book works ...
Lewis demonstrates style, flair and a very deep sense of humor in his book, all
of which are put to great use when we consider the drabness of the subject
matter. Every little anecdote and footnote drips with the acute irrelevance
that Lewis brought to the analysis of financial wizards in his first book (Liar's
Poker), even as the sympathetic etching of characters demonstrates his
evolution as a writer over the years.
The personalities that Lewis chooses as his heroes are oddballs, the same
underdogs that Americans have been taught over the years to love and respect.
That there are no conventional heroes in the book comes as a relief because the
sheer scale of the global financial crisis that followed was more than
sufficient to disrobe mainstream managers en masse.
A number of institutions and players who were celebrated by the financial media
in the aftermath of the financial crisis - ranging from Goldman Sachs to the
hedge fund manager, John Paulson - are portrayed in this book as mere copycats
who benefited from the path-breaking work that was done before them by the
likes of Burry and Eisman. Since I happen not to hold a candle for many of
these players, the portrayal came across as fairly accurate.
There isn't the chortling about the ease of making money that one would expect
from people who pulled off the trades (with the exception of Lippmann, who
comes across in the book as a typical, albeit talented, Wall Street prat);
rather, the focus is very much on their humanity and even humility in light of
the scale of profits made. This in turn makes the heroes that much more
accessible, if not acceptable to the reader.
... and where it doesn't
Unfortunately, I cannot consider this to be among the better works of Lewis
because the most important question - why? - is almost completely glossed over.
Why were the heroes the only ones to see the accident to happen? Why were they
the only ones to position vast shorts? Why couldn't others with similar
intuitions pull off the same trades?
One omission is the question of why Morgan Stanley, whose traders were short on
the lower-rated tranches of these dodgy assets, ended up losing billions?
To answer the question of "why?", Lewis needed to delve deeper into the arcane
architecture of quantitative risk modelling that was followed by Wall Street
banks. While both Howie Hubler and Greg Lippmann initially stumbled on the same
trade, ie to go short on the quality of borrowers in the American housing
market, their employers reacted differently to the ongoing cost of piling onto
these shorts - which was in the tens of millions every year.
While Morgan Stanley encouraged Hubler to cut the costs of these shorts, which
forced him to go long multiples on more of the higher-rated assets of the same
category, Deutsche Bank insisted that Lippmann simply find some company for his
misery, ie that he find other investors to also take short positions. In other
words, the risk department or management of Morgan Stanley wanted a "carry
neutral" position in the assets, while Deutsche merely insisted on ensuring
that it wasn't completely alone in thinking what it did. That difference ended
up nearly costing Morgan Stanley its independence, while almost completely
protecting Deutsche from the crisis.
Even those aren't the biggest omissions - compared with the key question of why
the biggest American mutual and pension funds didn't see a dollar of income
from the strategies followed by the heroes of this book?
The reason is that such funds are designed to be "long only"; they are only
allowed to purchase shares and bonds and not to sell them "short". The most
courageous thing that a fund manager could do in these institutions would be to
increase his cash holdings. The predilection for always being long has
psychographic consequences on a manager's (not to mention a market's) behavior.
That is the reason that some oddball hedge funds made money in a market in
which the giants of investing fared poorly.
All in all, I would think Big Short as an interesting book, but not
quite the instant classic I had expected from Lewis.
The Big Short by Michael Lewis. WW Norton & Co, 2010. ISBN-10:
0393072231. Price US$27.95, 266 pages.
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houses on the American West Coast, my feelings were perhaps more than a tad
positive when his actual book on the crisis landed on my table.
