After I had reviewed Gregory Zuckerman’s book The Greatest Trade Ever and rated it as the best book on the financial crisis by far, one of my readers was kind enough to bring another book to my attention, namely The Big Short by Michael Lewis. And sure enough, this book in no way takes the backseat to Zuckerman’s book. Many readers may actually remember Lewis as the author of the classic Liar’s Poker.
In this latest book, Lewis discusses the same subject as Zuckerman, and even some of the same protagonists.
The author explains in detail how the securitisation system worked, how CDOs were structured, and how a CDS functions. In addition, though, he provides detailed profiles of the players involved in the subprime securitisation industry and of those other players watching them with deep suspicion while seeking a way to cash in on their conviction that the home price bubble would eventually, inevitably pop.
He shows very little sympathy for the representatives of rating agencies. “The ratings agency people,” he writes, quoting one of the protagonists, “were all like government employees” (p. 156). “Collectively they had more power than anyone in the bond markets, but individually they were nobodies.” Eisman, one of the book’s heroes and a sharp critic of the rating agencies said about the latter’s analysts: “The smartest ones leave for Wall Street firms so they can help manipulate the companies they used to work for. There should be no greater thing you can do as an analyst than to be the Moody’s analyst. It should be, ‘I can’t go higher as an analyst.’ Instead it’s the bottom! No one gives a fuck if Goldman likes General Electric paper. If Moody’s downgrades GE paper, it is a big deal. So why does the guy at Moody’s want to work at Goldman Sachs? The guy who is the bank analyst at Goldman Sachs should want to go to Moody’s. It should be that elite” (p. 156).
One of the finest passages in the book discusses the language of the securitisation industry, whose purpose seems to have been to blur the facts rather than clarify them. “Bond market terminology was designed less to convey meaning than to bewilder outsiders. Overpriced bonds were not ‘expensive,’ overpriced bonds were ‘rich,’ which almost made them sound like something you should buy. The floors of subprime mortgage bonds were not called floors—or anything else that might lead the bond buyer to form any sort of concrete image in his mind—but tranches. The bottom tranche—the risky ground floor—was not called the ground floor but the mezzanine, or the mezz, which made it sound less like a dangerous investment and more like a highly prized seat in a domed stadium. A CDO composed of nothing but the riskiest, mezzanine layer of subprime mortgages was not called a subprime-backed CDO but a ‘structured finance CDO’.” A bond that consisted exclusively of subprime loans was not referred to as subprime mortgage bonds, but as ABS (asset-backed security). “When Charlie asked Deutsche Bank exactly what assets secured an asset-backed security, he was handed lists of abbreviations and more acronyms—RMBS, HELs, HELOCs, Alt-A—along with categories of credit he did not know existed (‘midprime’)” (pp. 126-27). For instance, “A” was the designation for the most creditworthy borrowers, “Alt-A” for “alternative A paper,” that is, an “alternative” to the most creditworthy. This kind of rhetoric instantly calls to mind the “newspeak” in George Orwell’s novel 1984, a jargon of similarly deceptive nature.
A small group of people (“more than ten, fewer than twenty”) saw through the system and attempted to turn their knowledge into cash. These persons are profiled at great length. Some of them are idiosyncratic, or even strange, characters. Yet the fact that their personality structure is “very much different” than the broad mass of people is probably a precondition, qualifying you to go against an overwhelming trend. If everybody else – the big banks, the rating agencies, etc. – played along and assumed that home prices would keep going up and up, it did take a lot of imagination and mental strength to stem the tide. For the protagonists of the gigantic subprime securitisation market seemed to have the numbers on their side.
After all, the historic default risks had been calculated by mathematicians – who overlooked the fact that historic figures represented a poor basis for forward-looking predictions. After all, there was simply no precedent to the phenomenon that loans were granted by the hundreds of thousands to people who would quite obviously never be able to repay them. Neither had there ever been a stagnation of home prices, let alone drops. That is why the complicated models for calculating the probability of default for subprime loans or of the CDOs they backed were simply wrong. Few people recognised the fact – but those who did figure prominently in this book.
Logic dictates that whoever betted on the bursting of the home price bubble and the collapse of the sub-prime securitisation market by buying the corresponding CDOs needed a counterpart. Who, the pessimists wondered, were the betting partners in this game? Above all, it was the AIG insurance company or, more precisely, its special department AIG FP – and the book’s fourth chapter, which recounts its business with the insuring of subprime risks, is one of the best in the book (p. 85+).
Among the smartest people to recognise the risks early on counts Greg Lippmann of Deutsche Bank, and he is characterised in detail in Chapter Three (p. 61+). Yet Germans are also among the dumbest buyers of CDOs, as is well known, and as the following exchange suggests: “Who’s on the other side? Who’s the idiot?” Answer: “Düsseldorf. Stupid Germans. They take rating agencies seriously. They believe in the rules” (p. 93).
I highly recommend the two books by Zuckerman and Lewis, respectively. They make for more suspenseful reading than a potboiler – while you learn more about the contexts of the financial crisis than from most other books written on the subject. R.Z.