So Two Guys Walk Into a Subprime Conference in Vegas…

Book Review: Michael Lewis' latest -- and superb -- effort, "The Big Short." Review by Joe Flood.

Book CoverMichael Lewis, it seems, has an uncanny knack for being in the right place at the right time. At a dinner for the Queen Mum in 1984, he was seated next to the wife of John Gutfreund, the CEO of Salomon Brothers, the most profitable investment bank on Wall Street. He parlayed the chance encounter into a short career as a bond salesman, which he recounted with equal parts Tom Wolfe and Joseph Heller in his first book, Liar’s Poker. Fifteen years later, Lewis was living in the next town over from the most head-scratchingly successful team in professional sports, the underpaid and overperforming Oakland Athletics, perfectly positioning him to chronicle—and to a surprising extent, promote—a statistical revolution that has reshaped America’s pastime. While Moneyball has gone on to become one of the most overimitated books in popular nonfiction, it was Lewis himself who once again stumbled onto similar revolutions in basketball, thanks to a chance encounter with Houston Rockets GM Daryl Morey, and football, after a conversation with an old high school classmate who’d recently adopted a mind-bogglingly large and ferociously talented young black man who played left tackle, aka, The Blind Side position on the offensive line.








Lewis’ luck seems at no risk of ebbing, thanks once again to Salomon Brothers. The causes and culprits of the recent financial crisis are myriad, but a disturbingly high percentage of them were born at Salomon. Lewie Ranieri, the blubberous, bellowing anti-hero of Liar’s Poker, all but invented the mortgage bond market there. A friend of Lewis’ from Salomon’s training program created the first mortgage derivative for Ranieri. Another of Ranieri’s underlings later created the first mortgage-backed collateralized debt obligation (CDO) bond. Salomon’s John Meriwether and his bond traders revolutionized the field of statistical arbitrage, eventually joining up with Nobel Prize-winning financial academics Myron Scholes and Robert Merton to form Long-Term Capital Management, which went belly-up in 1998 in one of the most infamous unheeded warnings about where the financial world was heading.








Perhaps most importantly, a few years before Lewis joined Salomon, the CEO whose wife was responsible for getting him a job, John Gutfreund, made history by taking the firm public, helping transform investment banks from partnerships with an eye to the future, into “black box[es],” as Lewis writes, where quick killings, big paydays, outsized leverage, and inscrutably acronymized investment vehicles turned banks into places in which the “shareholders who financed the risk-taking had no real understanding of what the risk-takers were doing.” Lewis left Salomon after a few years because he considered finance an absurd and unsustainable industry on the verge of collapsing in on itself like a dying dwarf star. How, he writes in his latest offering, The Big Short: Inside the Doomsday Machine, a 24-year-old “with no experience of, or particular interest in, guessing which stocks and bonds would rise and which fall,” could be paid “hundreds of thousands of dollars to dispense investment advice to grown-ups remains a mystery to me to this day.”








Lewis was right about the unsustainability, but wrong about the timeline, completely unprepared for the fact that “the financial 1980s would last for two full decades longer, or that the difference in degree between Wall Street and ordinary economic life would swell to a difference in kind.” The Big Short does its part to catalog Wall Street’s last two decades as it has lurched, zombie-like, from crisis to crisis, but those macro-developments are mere background for the most recent and spectacular of those crises. Unlike most accounts—centered on the endless streams of clueless Wall Street CEOs and government regulators getting in and out of limos on Liberty Street and Capitol Hill amidst the financial industry’s very public collapse in 2008—The Big Short focuses on the real collapse that preceded it. In typical Lewis fashion, it’s a story told from the bottom up, through a cast of oddball outsiders who saw the credit bubble, mortgage market, and exotic new financial instruments for what they were, and made billions betting on their demise.








Moneyball is perhaps the most influential account of the statistical revolution that has taken hold of American political, economic, and intellectual life in recent years—the magnum opus of a trend for quantification that spans from wonkish poli-sci policymaking, like the NYPD’s CompStat system, to businesses built around algorithms like Google, to tongue-in-cheek pop culture fare, like the TV detective drama NUMB3RS, where a team of mathemagicians use the laws of probability to solve crimes. When Nobel Prize-winning economist Paul Krugman explained the failure of economists to foresee the financial crisis by saying they “mistook beauty, clad in impressive-looking mathematics, for truth,” University of Chicago economist John Cochrane called Krugman a Luddite, and cited Moneyball as proof of the ineluctable “tide of quantification in all fields of human endeavor.”








Lewis, however, sees history—or at least, the history of the battle between intuitive and analytic approaches to problem solving that so often underlies his books—to be less the forward march of progress than a circular argument, with The Big Short serving as counterpoint to Moneyball. The members of Lewis’ newest ensemble of counterintuitive heroes use quite a bit of quantitative analysis to see the holes in the risk models and bond ratings systems that aided and abetted the crash, but their suspicions stemmed from a sense for narrative, not numbers.








In Moneyball, computer models turned undervalued minor league prospects into big league stars. In The Big Short, they turned piles of negative-amortizing loans into AAA-rated securities. Where A’s general manager Billy Beane avoided watching actual games for fear the unfolding drama would taint his analytic objectivity, hedge fund manager Steve Eisman says he can barely add. “I think in stories,” he tells Lewis, and it’s his nose for a flawed narrative—like learning that his children’s former baby nurse and her sister owned five separate investment properties in Queens, on none of which could they afford the mortgage payments—that leads him to uncover the fiction of perpetually rising housing prices and risk-free mortgage securities. There’s also AIG trader Gene Park, who sours on the housing market, and his company’s massive bets on it, after reading a Wall Street Journal story about a subprime lender whose balance sheet turns out to be a little too good to be true, and a pair of semi-amateur investors convinced to go all in on shorting the housing market after attending a subprime mortgage conference in Las Vegas. “Usually, when you do a trade, you can find some smart people on the other side of it,” one of them tells Lewis. “In this instance, we couldn’t.”








As he looks at the crash through those who saw it coming, Lewis digs into the nitty-gritties of the mind-numbingly complex array of derivatives, shadow markets, and side bets that laid the financial system low with his customary verbal dexterity and ability to turn esoteric detail and dry machinations into compelling narratives. In Lewis’ hands, credit default swaps are transformed from a confusing financial instrument into the fascinating financial creation story: a one-eyed former neurologist-turned-hedge fund manager with Asperberger’s obsessive quest to find a way to bet against a broken financial; investment bank hucksters eager to pass on catastrophic risk to dumb-money clients and pocket hefty fees in return for their services. The mystery of how poorly rated mortgage bonds could be chopped up, turned into highly rated CDOs (like “lead into gold,”) and sold off to unsuspecting investors becomes a hilarious tale of cafeteria politics and pop-psychologizing: underpaid ratings agency analysts who are mostly wannabe bankers, afraid to challenge their betters and hoping to “leave for Wall Street firms so they can help manipulate the companies they used to work for”; supposed CDO experts who are, in fact, “Two guys and a Bloomberg terminal in New Jersey,” with speculative-grade MBAs and AAA-conflicts of interest, turned “newly, obviously rich,” by pawning risky investments off onto the institutional investors they’re supposed to be protecting.








Like all of his books, Lewis is more interested in stories and characters than didacticism, but his tale of what went wrong and who saw it coming provides something much more important than regulatory advice: It’s the most insightful and enjoyable account yet of what went wrong on Wall Street, a must-read for any would-be reformers, regulators, or investment bankers hoping to learn from the mistakes of the past. As William Blake once said of Milton’s Paradise Lost, with Liar’s Poker, Lewis was, perhaps, “of the Devil’s party without knowing it,” the book’s portrayal of uproarious Wall Street excess proving more beguilement to future bankers than forewarning. With any luck, Lewis’ boisterous send-up of the morning-after hangover will prove as influential as his earlier dispatches from the party.