Sunday, April 18, 2010

#18: The Big Short

In describing the behavior of Wall Street bankers prior to the financial crisis, many adjectives have been bandied about. Greedy, say some; arrogant, claim others. What is only now beginning to gain ground on these populist declarations of discontent is a third, and far more horrifying, descriptor: stupid. This trait may at first seem less offensive to those of us who flaunt our self-prescribed moral superiority over these perceived miscreants. The reality, however, is anything but comforting. In The Big Short: Inside the Doomsday Machine, Michael Lewis, author of Moneyball and Liar's Poker, dabbles in the thriller genre, often to hilarious effect, as he details the inner workings of a financial world that was truly ill-prepared for its inevitable Waterloo.

I'll admit it: The Big Short is a very, very entertaining book. Mine is an admission whose sheepishness can only be understood once one has finished reading the book. It reads like a John Grisham novel, yet John Maynard Keynes is a far likelier neighbor on a library shelf. Lewis is profligate in his use of such terms as "big Wall Street firms" (32 occurrences, according to Google Books) and he is wont to transcribe entire conversations whose accuracy is often questionable but whose content leaves the reader in stitches.

Ultimately, it is funny, isn't it? Here were our best and brightest, as David Halberstam might say, assuring us that our money was safe, that real estate prices would continue to rise, that subprime loans were the healthy product of a heightened ability to reduce risk, not a house of cards upon which much of the global economy now rested precariously. And they were wrong, not because they intentionally lied (though some did), but because they failed to recognize the bright red flags everywhere on (and sometimes off) their own balance sheets.

The Securities and Exchange Commission's civil lawsuit against Goldman Sachs this week has resulted in even more vitriolic rhetoric against investment bankers and their ilk, a demographic Lewis takes no pains to please in The Big Short. He opens his book with this: "The willingness of a Wall Street investment bank to pay me hundreds of thousands of dollars to dispense investment advice to grown-ups remains a mystery to me to this day." And he ends it on an account of his lunch with an investment banker, his old boss at Salomon Brothers, recounted with equal parts nostalgia and regret. In between, he rips apart much of the industry, railing against "the madness of the machine" and buttressing his anecdotes with footnotes that occasionally take up half the page.

It's hard to say whom Lewis ridicules more, the bankers or the ratings agencies: while The Big Short is premised on the fact that high-powered bankers failed to research or even understand their own investments, Lewis makes it painfully clear that the foundation upon which all risk analysis rested was the highly coveted -- and, it turns out, highly manipulable -- ratings from industry leaders such as Moody's and Standard and Poor's. According to Lewis, employees of these firms, instead of conducting far-reaching investigations into the nature of subprime collateralized debt obligations (CDOs), simply took at face value much of what the banks told them. And since there were large fees to be had for each rating bestowed on these shadowy financial instruments, Moody's and S&P had significant incentive to perpetuate the subprime industry.

In one particularly enlightening passage, Steve Eisman, one of the book's central characters whose disgust for Wall Street types figured prominently into his investing strategy, explained the lack of incentives for analysts at ratings agencies, a misalignment that helped to create and foster the crisis. "'They're underpaid,' said Eisman. '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...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.'"

The Big Short is filled with quotes such as this. And although not all of them are as penetrating or as keenly observant of the recession's underlying fault lines, each is helpful in piecing together a panorama of the landscape that existed in and around these "big Wall Street firms." Michael Lewis has not compiled a tell-all here; if he has revealed any industry secret, it is simply the astonishing truth that, in the subprime lending business, there were none. When the dust had settled around our financial ground zero, it soon became apparent that even Wall Street had failed to understand Wall Street. In this, if nothing else, it shares the same fate as Main Street.

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