Sunday, July 04, 2010

Michael Lewis' The Big Short

I read Michael Lewis' The Big Short: Inside the Doomsday Machine (by the way, what kind of terrible subtitle is that?) and highly recommend it as a perversely entertaining and straightforward narrative of how subprime mortgages were bundled into bonds few people understood, given too-high ratings, and then traded for enormous sums of money on the assumption that the booming housing market would go on forever.  The book focuses on the handful of people who realized it was all bogus and absolutely could not last.  As I read it, I kept thinking about Kurt Eichenwald's Conspiracy of Fools, another good book that tells the story of the bizarre and complex pyramid schemes dreamed up by Enron executives.  Everyone thinks they can make money by creating nothing, and indeed even having companies sell their own bad investments to themselves.

And the bonds that had been most ineptly rated were the bonds that Wall Street firms had tricked the ratings agencies into rating most ineptly.  "I cannot fucking believe this is allowed," said Eisman.  "I must have said that one thousand times" (p. 101).

Indeed, it was the bundling that helps accounts for the disaster.  Good mortgages were bundled with bad, and then sold as if they were all good.  Further, even different types of bad mortgages could be made to look good.

By assuming that one pile of subprime mortgage loans wasn't exposed to the same forces as another--that a subprime mortgage bond with loans heavily concentrated in Florida wasn't very much like a subprime mortgage bond more concentrated in California--the engineers created the illusion of security (p. 74).

We all know the outcome, and the story of greed and stupidity is not exactly uplifting.

With its personality-driven style, the book only touches on the broader structural issue of how regulation and deregulation created the environment in the first place, though it does not claim to do so.  What it also does not delve into is the fact that the "heroes" of the story, that is, the Steve Eismans of Wall Street who spoke out about how it was all a lie, made money only because of massive collapse.  Yes, Lewis does bring it up, but there is a broader point to be made about how in many ways these guys aren't heroes at all.  They were very smart, but they got rich only because many Americans got screwed.  At least Lewis does make the point that nothing has really changed.  Once the economy picks up again, something like this will definitely reoccur.


pc 1:22 AM  

Couldn't agree more with the last paragraph, I had the same reaction. They were all pretty likable, and they didn't create the problem, but they capitalized on it as much as anyone. They didn't deceive their clients the way the banks did, which of course constitutes a huge difference morally, but I kept feeling like they were on the opposite side of the same coin. And especially the guy in California (can't remember his name) who basically invented the credit default swaps on mortgages and talked banks into creating them and selling them to him, if he doesn't do that (and no one else does either), isn't the crisis significantly less severe?

Steven Taylor 7:58 AM  

I dunno, "The Doomsday Machine" was one of my favorite episodes of the original Star Trek, so more power to the subtitle.

Greg Weeks 7:12 PM  

Basically, if they didn't create the credit default swaps, then fewer bad loans would be made because everyone would know how bad they were. So yes, I think the crisis would have been smaller. The credit default swaps encouraged making bad loans.

leftside 12:55 PM  

I thought Lewis' book was rather superficial. Stiglitz's book is much better - though still problematic.

Lewis' focus on the bundling on loans and credit default swaps misses the forest for the trees. Stiglitz goes a bit deeper into the overall ideaology of "market fundamentalism" that explains a lot of this. But, of course, the root of the problem is embedded within the contradictions of capitalism itself.

You have to start with capitalism's war on labor in the 1970s and 80s and the resulting fact that median wages barely budged in 30 years, failing to keep up with inflation. With a lack of money and therefore consumer demand, capitalism had to create cheap credit for all. Combined with the overarching ideological impetus for homeownership, Government colluded with industry to ratchet down barriers to buying houses people could not afford. Fannie and Freddie, CDOs and CDSs, deregulation of investment banks, HDMA, etc. were the policy responses. The financial sector boomed as a result of the need to create cheap money, creating further structural impediments to sound policy. Now we think we've solved the private sector financial crisis, but crises don't end, they just move around to different places. Hence the sovereign debt crisis with the PIGS countries now...

So the only rational response is to fight capitalism and demand that we control our economy to serve the needs of people and our planet.

Apologists for capitalism prefer to blame a process, a personality, greed or something else. Anything to avoid solving the real issue.

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