Big-short-inside-the-doomsday-machineI couldn’t have picked a better book to start the 52 week challenge – ‘The Big Short’ by Michael Lewis turned out to be a brilliant and very informative read. Michael Lewis has great flair for making nerdy and seemingly dull topics such as complex financial instruments very sexy.  I know this book is now 4 years old but expect the book to be in the news in a few months when the movie version comes out.  And the movie is going to star (And I swear I am not making this up) Brad Pitt, Christian Bale, Marissa Tomei, Ryan Gosling, Selena Gomez and Steve Carrell.

The book provided a very comprehensive and readable summary of what happened in the U.S. sub-prime mortgage bond market in the years leading to the 2007 meltdown. It does so in a very unconventional way – by telling the story of three guys – Michael Burry, Steve Eisman and Greg Lippman who end up shorting the market (essentially betting against the sub-prime mortgage bonds).

Some of the characters are fascinating, for instance Michael Burry (a doctor who later starts his own hedge fund), who has a glass eye and is diagnosed with Asperger’s syndrome and locks himself in his room for days together to read 10K documents. Eisman on the other hand who is described by his wife to have a talent for offending people rants to anyone who would listen that sub-prime mortgages is an elaborate ponzi scheme that is doomed to collapse.

It’s probably the only book where I ended up reading many paragraphs at least three times – the second time to understand what was going on and the third just to remind myself that this was not fiction. For instance, there is a fascinating section where the then CEO of JP Morgan is absolutely clueless when questioned on how his firm could lose $9 Billion because of the strategies of one trader. (His exact words are “We had been sprinting. Now we will be jogging. But we are in a risk business, and we will be in the market taking risk.”)

In Bakersfield, California, a Mexican strawberry picker with an income of $14,000 and no English was lent every penny he needed to buy a house for $724,000

As you read the book, you begin to understand why millions of really smart people completely missed the crash – there was (is?) a complete and utter lack of transparency on Wall Street, many financial instruments were (are?) so complex that even the ones selling them do not understand them and the rating agencies (Moodys and Standard & Poor’s) rated many of the mortgage bonds AAA without understanding the risk they actually carried. Worse, rating agencies had incentives to rate bonds to carry less risk than they actually did.

The book also describes in great detail the complete lack of accountability on Wall Street and especially in the Bond market. You have investment banks such as Deutsche Bank, and of course Goldman Sachs, who sell debt instruments to investors on the one hand and end up shorting the same instruments on the other hand. The banks For instance, Goldman’s 2007 Q3 report talks about how ‘Significant losses on non-prime loans and securities were more than offset by gains on short mortgage positions’

The book winds down essentially with all the “heroes” making obscene amounts of money that is hard to even fathom ($500 million+). A few of the banks made a lot of money (Goldman for instance) and many went bust (Bear Sterns & Lehman). Finally, of course it turns out that much of the risk in the market was actually being carried by the insurer of these securities – AIG, which would ultimately have to be bailed out by the American taxpayer.