The Big Short – Michael Lewis on Why We Looked the Other Way

I recently finished reading Michael Lewis’ excellent book The Big Short, and I’m left with two emotions: surprise at how long the party lasted for securities with no underlying value, and shock at the lack of questions we all had (all of us borrowers) for a market that seemed to have no end in sight. Clearly, hindsight is 20/20.

Lewis uses the story of a few traders who bet against the market for subprime mortgages as a broad brush to suggest that the financial industry is a machine for making and destroying bubbles, and that the contrarian point of view can often be a very lucrative one. The mechanics of the trading aside (in retrospect, the mechanics of taking a junk bond, slicing it into pieces, and then repackaging it as AAA-rated bond at the same time as the same bank might be selling a bet that the same bond would fall is somewhat staggering), the key insight I get from this book is that traders on Wall Street were selling snake oil.

No news, right? Traders have always peddled junk, and caveat emptor. The difference in this case is that the risk pool was so much wider, touched almost every facet of society, and used technology to hide the details. Unsuspecting (and suspecting) buyers went along for the ride, thinking they were in safe investments, and that those investments were backed by safe annuities, collateral that would pay off safely and smoothly over a 30 year period. Oops. We painfully know now that these assumptions worked in a world where loans were vetted carefully, where exotic loan products like “Pay Option ARM” and No Money Down didn’t exist, and where the value of homes rose gently over time.

We can’t stop the last bubble, but The Big Short addresses how we behave as investors (and more generally, how people make decisions). Lewis reminds that if it seems to good to be true, it probably is — and challenges us to ask questions when we need to know more. You might make a bundle, or you might end up holding the bag.


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