Analysis of The Big Short by Michael Lewis - Book Report/Review Example

? The Big Short – Michael Lewis In the book The Big Short: Inside the Doomsday Machine, Michael Lewis has narrated his assessment as a Wall Street insider for a time period spanning over 20 years. The author sheds light on fallacies of newer financial products (like subprime mortgages, collateralized bond obligations (CDOs), credit default swaps (CDS)) brought out by financial corporate houses starting from the 1980s and pursued vigorously during the 1990s and the first decade of this century that led to a terrible economic recession beginning 2008. More importantly, Lewis takes his readers through the Wall Street culture of refusing to handle or admit the problem. Lewis revisits his financial base to unearth the predicament of 2008 economic crisis, utilizing his skill of glancing through the private stories of a number of Wall Street outsiders who were putting money in order to study anecdote of overwhelming greed and fear that caught Wall Street before the crisis formally began with the fall of Lehman Bros in September 2008. The book ‘The Big Short: Inside the Doomsday Machine’ portrays some of the dark sides of capitalism through snippets of well-thought-out interviews and historical events that led to present day economic recession in US. The book throughout has flavors of humor and sarcasm as analysis and personal interviews are conducted. The author has been a skeptic of prevailing Wall Street culture since the 1980s. His book ‘Liar’s Poker,’ first published in the late 1980s, brought him into a group of few who were not convinced with the viability of practices at some of America’s biggest financial institutions, like Goldman Sachs, Bear Stearns, and Merrill Lynch. Lewis writes in the introduction, “In the two decades after I left, I waited for the end of Wall Street as I had known it.” (Lewis XIV, XV). The selling of something that seller does not own is called short selling in financial market. While short selling in stock market may bring equilibrium in day-to-day stock movements, imprudent use of this concept in the long-term debt and bond market perhaps added a deep problem to the system. According to author, such actions, if left open, can be used by financial operators to buy facts which are misrepresent overtime. As Lewis puts it, CDS was a sort of monster dragging us into the sea. Lewis mocks the claim that CDS solved the timing problem. It is evident that an event such as selling something that does not exist has no real economic utility. Interestingly, Lewis finds that if this is what the job in a Wall Street should be, there should be no reason why young Americans who really want to offer something valuable to the society should choose it. Author’s expectation after writing his first book was that ‘some bright kid at Ohio State University who really wanted to be an oceanographer would read my book, spurn the offer from Goldman Sachs, and set out to sea.’ (Lewis XV and 65) The book points out many inside stories of Wall Street such as creation of first mezzanine CDO at Drexel Burnham in 1987, first mortgage-backed CDO at Credie Suisse in 2000 by Andy Stone, and subsequent effects of such financial products on the US economy (Lewis 254). CDO (Collateralized Debt Obligation) can be defined as an undertaking to remunerate lenders in a time series built on method of cash flow the CDO gathers from the group of bonds or other assets it possesses. CDO securities are divided into different risk categories, or tranches, whereby ‘high ranking’ tranches are deemed more reliable securities. Interest rates are determined on the merit of seniority, such that junior tranches attract higher payments to make up for extra default risk. If cash pulled together by the CDO is inadequate to reimburse all of its financiers, those in the lower tranches bear losses to begin with. In the words of Lewis, “CDO created a tower of bonds, in which both risk and return diminished as you rose.” For CDOs, one remark in the book “They may not have known what a CDO was, but their minds were prepared for it” highlights once again culture of greed with ignorance that took over Wall Street during its long crazy years (Lewis 73, 129). A CDS (Credit Default Swap) is a type of insurance that defends the lender in the event of loan default. When a lender buys a CDS from an insurance company, the loan turns into an asset that may be swapped for cash in case the loan defaults. In contrast to a customary insurance policy, anyone can buy CDS, even someone who has no direct interest on the loan being reimbursed. According to Lewis, credit default swap was confusing mainly because it was not really a swap at all. The book reveals how ‘subprime CDSs’ became a ‘new place’ to ‘stuff’ the’ riskiest triple-B tranches’ of’ subprime mortgage bonds’-‘though who these people were was not entirely clear for.’ As Steve Eisman (a Wall Street investor) in an interview with the author states, “A bank with a market capitalization of one billion dollars might have one trillion dollars’ worth of credit default swaps outstanding.” (Lewis 29, 31, 90,263)  The author therefore points out the inclination of the banks to obtain high credit ratings. It was obvious for the blue chip firm with high credit rating to take part in transactions involving CDS and long-term investment options – “stand in the middle of swaps and long-term options and the other risk spawning innovations” (Lewis 69). Greed was one of the reasons why Wall Street was turned into a corporation instead of still running in partnership mode. As John Gutfreund (CEO of Salmon Brothers in 1986) acknowledges in the interview with Lewis that though there was a consensus among Wall Street firms that it was an impractical thing to do, yet when the ‘temptation’ arose, they all succumbed to it (Lewis 129, 263). The book reminds that for a long time Wall Street was everything about stock market. However, Wall Street gradually started encroaching bond market during the 1980s, designing newer products with the debts of the Americans and making even bigger money. Recollecting 1986, when then CEO of Salomon Brothers, John Gutfreund, was salaried $3.1 million as he ‘ran the business into the ground’ and few more such incidents, author highlights greediness or foolishness at the top gear. It is lamented that despite so many hiccups like the ‘Internet bubble,’ the system kept growing. The US government policy of bailing out banks on the plea of too big to fail, according to an interview conducted with Wall Street investor Steve Eisman, is, instead of a ‘solution,’ points to the ‘symptoms of still deeply dysfunctional financial system.’ (Lewis XIV, XV, 262) According to author, the US financial culture was so rigid to amend - all the more so after the sub prime mortgage fiasco (that showed symptoms of looming problems since mid-2006). The book observes, “There was an umbilical cord running from belly of the exploded beast back to the financial 1980s. The crisis of 2008 had its roots not just in the subprime loans made in 2005 but in ideas that had hatched in 1985.” Going forward, Lewis, therefore, gives a message to policy makers to take a long-term rational approach when approving financial products, something that adds value to the system instead of popularizing products like short selling leading to the 2008 economic crisis or in author’s sarcasm ‘The Big Short’ (Lewis 254).  Thus the novel brings highlights the crisis situation, which emerged owing to the credit rating system and eventually affected every individual and the entire economy, which underwent a cascading, impact owing to the crisis.     Reference: 1. Lewis, Michael. The Big Short: Inside the Doomsday Machine. W. W. Norton & Company; 2010, USA Read More