|The Big Short|
by Michael Lewis
How do you account for Michael Lewis' great success? Beginning with "Liar's Poker," and continuing with books like "Moneyball" and "The Blind Side" and now with "The Big Short," Lewis defies easy categorization: He has mastered a sort of amiable, knowing tone that's makes the most tangled material palatable. He combines interests in reliably interesting ways, notably sports and business with a larger preoccupation with how individuals struggle against stifling orthodoxies. He is willing to generalize, often with some wit. And he gives you fully fleshed-out characters, certainly not common in financial journalism. In "Liar's Poker" he took Main Street into the Wild West of John Gutfreund's predatory world at Salomon Brothers, which he suggests in "The Big Short" represented the origin of the current Wall Street doomsday firm as principally a publicly traded, fixed-income trading vehicle (and one, as he points out, that traded complex mortgage instruments, not to say one he recognized was already being distorted by pay issues). He wants to inform and entertain, to, as he says, "tell tales." When his books fall short -- and they do occasionally -- you almost feel as if it's because his characters, which often include Lewis himself, let you down.
"The Big Short" displays all these strengths and a few of those weaknesses. The book examines a handful of figures who cottoned onto gathering problems in the market for subprime mortgages, and who then constructed bets using credit default swaps -- the so-called big short (Lewis never goes into the derivation of the expression, but we find Gary Cohn, Goldman, Sachs & Co.'s president, referring to the firm's "big short" of mortgages in one of the e-mails recently released by Congress, suggesting it was part of Wall Street patois in 2007). Lewis isn't the first writer onto this story. In "The Greatest Trade Ever," The Wall Street Journal's Gregory Zuckerman last year published an excellent portrait of the man who put on the biggest of the big shorts, hedge funder John Paulson. Zuckerman reported that Paulson helped Goldman select mortgages for synthetic CDOs he then shorted -- the heart of the current Securities and Exchange Commission civil suit against the firm, and a practice Lewis also illuminates. Lewis never mentions Zuckerman (and "The Big Short" lacks an index or footnotes, though he makes it pretty clear whom he talked to), and while Paulson makes an appearance, he's mostly offstage. Nevertheless, Paulson and his team easily fit into the profile Lewis develops of his cast of characters who also broke through the accepted wisdom: cranky, odd, brilliant, feisty, tactless outsiders, nearly all equity traders who brought fresh insights into the jungle of bond trading.
They are an odd lot. There's Dr. Michael Burry (who also appears in Zuckerman), a physician-turned-investment manager who is most comfortable locked away alone in his office analyzing investment data and trends and sending out regular missives to often-unhappy limited partners. Well into adulthood, Burry diagnoses himself as afflicted by Asperger syndrome, which explains his social aversions and his ability to intensely focus on a single subject. There's Steven Eisman and his crew Vinny Daniel and Danny Moses at FrontPoint Partners, a hedge fund owned by Morgan Stanley. Eisman was, to say the least, difficult, brilliant, if self-absorbed, a barely controlled truth teller. As his mother said, "Who else studies the Talmud so that they can find the mistakes?" And there's an odd group gathered at Cornwall Capital: Charlie Ledley, Ben Hockett and Jamie Mai. They are Lewis' "accidental capitalists," bright but unfocused wanderers who had drifted through Wall Street. As Lewis writes, they had a few big ideas they thought had money-making potential: First, those private markets like private equity might be more efficient than big public markets; and second, that too few investors looked at the big picture. They decided to try that and, with scant capital from a Schwab account, they discovered mortgages.
These are wonderful characters, and Lewis weaves them together with great skill and affection. But he ends up telling the same basic story Zuckerman has already told with Paulson. Lewis goes beyond Zuckerman, however, by offering glimpses into the Other Side, the longs, the banks and the folks who worked there. It's fascinating to follow Lewis' collection of outsiders thinking their way to a contrarian judgment on mortgages, but arguably more valuable is the sense Lewis offers of those playing in the midst of mounting evidence that mortgages would not rise forever. The real subject of any story about a bubble is how the conventional wisdom continues to justify facts swinging further and further from reality. Why did so many fail to recognize what the few saw?
Lewis includes one character who stands at the confluence of those two colliding forces, the long and the short: Greg Lippmann, a successful bond trader from Deutsche Bank AG (he recently left the bank for a hedge fund), who careens around Wall Street marketing a clever way to short mortgage-backed collateralized debt obligations using CDSs. Lippmann too was a difficult personality: self-absorbed, loud, opinionated. Lippmann wanted traders like Eisman to bet against vehicles created by his own bank. His proselytizing and research would eventually touch nearly everyone on the short side. He was the closest thing Lewis can find to the center of the subprime crisis on Wall Street, his "patient zero."
Lippmann takes readers into the controversy currently agitating Wall Street and Washington: What was the role of firms, like Goldman, Deutsche or AIG, in the implosion? The answer is complex, partly because the firms, and the broader markets, were increasingly complex. Firms were rarely all on one page; there were many ways of making money, complex incentives and dauntingly intricate instruments, all of which implicitly argue against the notion that a Wall Street firm could organize an effective conspiracy or a coordinated strategy. Deutsche had heard that Goldman had figured out a way to create synthetic CDOs, thus getting around the problem of a restricted supply of less-than-A-rated mortgages and creating a pure, open-ended (in terms of size) speculative side bet on residential real estate. The key: AIG's Financial Products Group in London was eager to insure vast quantities of those synthetic CDOs using CDSs at the same rock-bottom price as corporate debt. Writes Lewis: "Back in the 1980s, the original stated purpose of the mortgage-backed bond had been to redistribute the risk associated with home mortgage lending.... The goal of the innovation, in short, was to make financial markets more efficient. Now, somehow, the same innovative spirit was being put to the opposite purpose: to hide risk by complicating it. The market was paying Goldman Sachs bond traders to make the market less efficient."
It then gets even stranger. Deutsche wanted into this very profitable game, but there weren't enough investors willing to bet against mortgages; the bubble mentality persisted (it was very lonely on the short side, particularly as CDO indexes refused to reflect the underlying deterioration, and Lewis is scornful about the number of people who later claimed to have seen it coming). So Lippmann, a bond trader, not a salesman or a denizen of the CDO desk, "became a stand-in," writes Lewis, for those bearish investors: He was asked to short CDOs through CDSs and to sell investors on that big short, in order to take advantage of that insane inefficiency concocted by ratings agencies, AIG, Goldman Sachs and other banks. Goldman and Deutsche were thus setting up a trade pitting one customer base against another, taking fees while playing the short themselves. Indeed, to induce those scarce shorts into this trade, firms like Deutsche and Goldman allowed them to have a hand in selecting the mortgages. For the firms, the payoff was in keeping the game going, as well as whatever you'd make on the short.
Much of "The Big Short" follows Lippmann around as he preaches the possibilities of shorting synthetic CDOs to folks like Eisman. There's a lot of fodder here for reflection and blame. There's blindly self-destructive AIG, of course, feckless credit rating agencies and regulators who might well have not existed. But what about Goldman or Deutsche? They had interests in keeping the structuring business going and in making money by trading. Did the firms do wrong in exploiting inefficiencies, in creating product that turned an efficient redistribution of risk to inefficient ends? How wrong was it to allow the short side to pick the CDO mortgages? How high in those organizations did the decision to unleash the likes of Lippmann go? And what greater fool stood on the other side?
Lewis reports that Lippmann regularly derided dumb buyers "from Düsseldorf" who took the long side of the trade, clearly referring to IKB, the German bank that bought the controversial Goldman synthetic Abacus CDO and eventually failed. It's strange enough for Goldman to exploit the credulity and greed of a customer, but Deutsche is a German bank. One would have thought banks at home would have been at least warned of their possible folly. But then IKB clearly wanted to play. Is it wrong for an intermediary to allow the deluded to crash and burn, financially sophisticated or not? Of course, the trouble with that question starts with the term "sophisticated" and ends with the notion that any outcome appeared inevitable. The civil complaint against Goldman ushers in a debate over the handling of sophisticated investors. In fact, there was no clear consensus at either Goldman or Deutsche on the future of mortgages. Lippmann was, like Paulson, Eisman, Burry and the Cornwall gang, long an iconoclast who ended up being amazingly correct.
The image Lewis leaves with this book is of a Wall Street dominated by imperial (in size and ambition) institutions that are more like federations than unitary organizations. They resembled, as well, complex ecosystems made up of divergent interests, each firm, each desk, each individual reaching for its perceived advantage, occasionally long term but mostly short. There were obviously degrees of central control and attempts to align interests, but they seem to have been rare. Late in the book, Gutfreund tells Lewis that no Wall Street CEOs understood how these exotic instruments worked. Goldman stands out here, not just because even Lewis admits its executives were viewed as the smartest around, but because Goldman seemed to be one firm that recognized the danger and devised a strategy to continue structuring and selling CDOs while engaging in the big short. But for all the skill that required, Goldman still made the ultimate mistake: It failed to see that under the weight of the inefficiencies it was helping to spawn, the entire system might collapse, pulling it down as it crashed. It downplayed its responsibility to the community, to the larger ecosystem. And Goldman was blind to how its involvement might play in the world beyond Wall Street.
Lewis touches on many of these larger matters almost by indirection. Like Zuckerman, he glorifies the CDS shorts (not unlike John Meriwether in "Liar's Poker"), if only by lavishing so much attention on them, but neither author really wrestles with the morality (or immorality, or ambiguity) of shorting and, by extension, the responsibility of those within the market for those outside it. Lewis, for all his nuance and for all his silky style and narrative skills, still leaves us asking what is to be done. His answer arrives at the end of "The Big Short" when he asks Gutfreund out to lunch and completes an arc of to his own career, which began with "Liar's Poker." Lewis decides the original sin occurred when Gutfreund forcibly transformed Solly from a partnership to a public company. It is a classic Lewis moment: dramatic, funny, nicely observed, with a relatively simple idea attached, more an exploration of character than a deeply reasoned argument.
Lewis remains, to the very end, an intelligent and ever-curious observer of the human carnival. Despite the successes of his ragtag (now wealthy) crew, he remains skeptical of large claims and orthodoxies. He set out to write a book about a handful of traders who bucked the conventional wisdom and won; he's not trying to be Richard Posner, unpacking arguments and proposing remedies. He wants to entertain and inform. And that's ultimately his greatest strength and limitation: He won't risk boring us with really hard, abstract stuff, with theory, speculation and policy. He's not a historian or a prognosticator, though he's fascinated by those who claim prescience. Still, he leaves us with more questions than when we started, which is better than most other books published on these matters. His modesty seems oddly appropriate to the subject.
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