I enjoyed and benefitted from Michael Lewis’ "Liar’s Poker" about 25 years ago, but I’m not enough of a sports fan to have read his subsequent nonfiction bestsellers, "Moneyball" and "The Blind Side." (Confession: I haven’t even seen the movie that was adapted from part of "The Blind Side.") My father-in-law encouraged me to read Lewis’ latest effort, "The Big Short," and I’m glad I took his advice.
"The Big Short," published in March by W.W. Norton & Co., gave me a better understanding of collateralized debt obligations and credit default swaps than I’d been able to glean from 18 months of meltdown postmortems. It’s still a challenging read – some subjects are simply too complex to ever be made simple – but Lewis has a talent for analogy and for giving the reader enough information to understand the action but not so much as to bog down the story. I closed the book feeling a little less embarrassed at how baffling the mortgage-backed securities industry had been since, as it turns out, people who were intimately involved with these complex financial instruments didn’t understand them either. And even people who understood them didn’t understand them well enough.
Now, Lewis’ book is neither an academic work nor a forensic investigation. He is a storyteller at heart, and in "The Big Short" he tells the stories of a handful of money managers who recognized relatively early that the housing bubble was being created not by honest consumer demand but by Wall Street greed and figured out a way to bet against it. Their bets weren’t short-selling in the traditional equities-market sense – which is a shame, because transparent shorting of stock plays an important role in tempering irrational exuberance. These guys had to jury-rig one esoteric corporate bond insurance product to make it applicable to a very different type of credit risk – and then convince someone to sell them the policies.
The characters involved were very different, but they all had the kind of contrarian personalities that seemed to make them immune to irrational exuberance. I’m often struck by the unshakable optimism that seems to be required in business, and "The Big Short" is a reminder that there’s also a crying need for skepticism and even pessimism.
Even though I should be over it by now, I’m still stunned by the anecdotal tales of nonexistent underwriting standards for subprime mortgages. In a chapter titled "How to Harvest a Migrant Worker," Lewis tells of a Mexican strawberry picker with annual income of $14,000 a year who was able to borrow "every penny he needed" to buy a $724,000 house in Bakersfield, Calif. A Jamaican housekeeper borrowed enough to buy five townhouses in the New York borough of Queens, even though she couldn’t possibly make the payments.
Of course, we’ve all read horror stories like this, and we’ve all understood that mortgage originators were eager to make these loans because they were able to sell them on the secondary market, where they were packaged into bonds and sold to unsuspecting investors. But only "The Big Short" explained to me why the bond houses were willing to accept loans like these, which Lewis regularly described as "crappy."
It seems the credit ratings agencies were only interested in the average credit scores of the borrowers – and "[i]mmigrants who had never failed to repay a debt, because they had never been given a loan, often had surprisingly high [credit] scores," according to Lewis. These clearly unqualified borrowers were sought out in order to raise the average credit score on a pool of mortgages.
The steaming pile was even crappier than I realized.
(Gwen Moritz is editor of Arkansas Business. E-mail her at firstname.lastname@example.org.)