Book Review – The Big Short

The Big Short is another of the Michael Lewis books I got to pick up this summer (being a teacher is great for summer reading) and I thought it was even better than Liar’s Poker, which was the first book of his that I read.  Lewis has the unique perspective of someone who seen his career begin in the heart of the financial madness we see today.  He got his start at a big investment firm called Salomon Brothers, and seen the creation of such things as Mortgage Bonds, the derivatives of those same Mortgage Bonds, and other crazy financial products that have served to make Wall Street rich and leave the rest of the Western World sucking fumes.  Despite his career path, Lewis was clearly not cut from the same cloth as those around him (as evidenced by his writing a book about his experiences).  This allows readers to look at a criticism of the industry by someone who is intimately aware of its flaws and humorously inept dealings.

Put Your Money Where Your Mouth Is

This book specifically is about the few people on Wall Street who were confident in their prediction that the USA sub-prime housing market was going to collapse, and consequently cause a completely disproportionate financial disaster because of the mountain of financial products that had been manufactured out of it.  They were so confident that they placed bets against the market that eventually paid off big time.  Lewis is able to take a fairly complex concept (housing derivatives) and simplify it to the point that an English teacher was able to understand it, so maybe that is the greatest testament to his writing abilities!  If you want to be absolutely baffled by the greed and absurdity that took place on Wall Street, and the subsequent fact that tax payers bailed that same stupidity out, go ahead and read this book.  I am by nature oftentimes a pessimist, and I still couldn’t believe just how crazy some of the facts are concerning this financial mess we are in.

What Is a “Short” Anyway?

Lewis focuses the book on the dozen or so people that actually had the gumption to see the derivative market for what it was and bet huge against it.  When you bet against something happening, it is called a “short” in the investing community.  At this point investors can “short” pretty much any commodity or stock out there.  The mechanics involved are a little more complicated (maybe we’ll get into them another day), but the basic principle is that if you think a business or sector is going to go down, you can place a bet on that.  These dozen or so people couldn’t believe their luck when they realized how ridiculous building financial instruments made up of high-risk, sub-prime loans was.  They used common sense to deduce that the sort of people that were taking out interest-only loans, or loans with “teaser rates” (lower rates for the first two years, and then suddenly jacked up) would be the type of people fairly likely to default on their mortgages.  Once you figure this out, it doesn’t take a genius to come to the conclusion that people that bought bonds made up of these types of mortgages were screwed.

The Big Short – Why Do We Have Derivatives Anyway?

I won’t give away any more of the book, but if you want a brilliant insight into how derivatives work (I am absolutely convinced they have no real purpose other than to make a lot of money for the investment industry, and expose everyone else to huge risks), how corrupt Wall Street culture is, and how a few courageous/smart/simple people made millions of dollars, then this book is worth a read.  For me, the most interesting thing I may have learned is just how small the stock market is in the investing world.  Since it tends to grab all the headlines most people just assume it’s kind of the epicentre of the investing universe.  Apparently bond and derivative trading are much larger in terms of total market capitalization.  When you consider how ridiculous the concept of a derivative market is (the core ideal of the stock market is to allocate capital to the best and most efficient companies, derivatives don’t do this at all, they’re basically just placing bets), it is pretty scary to contemplate.  At the very least you will learn who to blame for this ridiculous financial predicament we are now in – pretty much the entire financial system.

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10 years ago

I’ve heard great things about this book and have been dying to read it. How important would it be to read Liar’s Poker before diving into The Big Short?

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