The Big Short, by Michael Lewis, 2010
Michael Lewis wrote “Liar’s Poker” (reviewed below) about the financial crash of the late 1980s, based on junk bonds, insider trading and the S&L industry. Lewis is pro-capitalist, but an honest observer and reporter, and that is a valuable thing. “The Big Short” is the best look at what was going on inside Wall Street in the period leading up to the crash of 2008. Like Kevin Phillips book, “Bad Money” (also reviewed below) it focuses on the period before 2007, culminating in the implosion of the sub-prime derivatives market in 2007 with the forced sale of Bear Stearns. Lewis reminds us that this Wall Street circus has actually been going on since the 1980s, when many derivative products were first ‘invented.’ As Lewis puts it, “the bonus pool remained undisturbed” since then.
The key characters of this ‘mystery’ are those who saw that the mortgage industry and the investment banks had created a colossal Frankenstein, which nearly brought down capitalism, and has still deeply wounded it. They themselves went from a cynical view of what Wall Street represented to a social view. As Steve Eisman put it, lecturing Bill Miller, a hot-shot investor in Bear Stearns: “The upper classes of this country raped this country. You fucked people. You built a castle to rip people off. Not once in all these years have I come across a person inside a big Wall Street firm who was having a crisis of conscience. Nobody ever said, “This is wrong.” And no one ever gave a shit about what I had to say.”
To this day, nothing has changed. And we can thank not just the big media whores, who have created a myth about a mere ‘crisis of confidence,’ or the ostensible ‘protectors of the public’ like the SEC, but also the Democratic and Republican parties, who are for the most part the political arms of Wall Street. Lewis himself does not go into how deeply these forces reinforce Wall Street. That is for others to do. But as he puts it, “…pretty much all the important people on both sides of the gamble left the table rich.”
What Eisman, Michael Burry, Greg Lippman, John Paulson and a few other hedge fund managers did (including White Box, located her in Minneapolis) was actually understand what was factually going on. Lewis carefully explains the structure of Collateralized Debt Obligations (CDOs) and the specific errors of the ratings agencies. He shows how a “one-eyed money manager with Asperger’s syndrome” like Michael Burry (the first money-manager to understand the coming collapse of the mortgage market, and by extension, its ‘asset-backed cousin’ the CDO and the CMO in 2004) could, just by reading the prospectuses (which no one but the lawyers who write them ever do...) and studying a website of details on mortgage loans, figure out what CDO’s were going to fail first.
No one – not even the rating agencies – actually had the intimate facts on what mortgages had been bundled into what derivative. Nor did the rating agencies ever carefully vet the details of each ‘product’ – they skipped that part too. Instead, they accepted the assumptions of the Wall Street firms. There is even a statement that the models used by the ratings agencies did not include a possibility of a drop in housing prices. The rating agencies were more interested in just getting paid by Wall Street firms. Lewis calls them, “Nobodies … in blue JC Penny suits.”
Burry and analysts like Eisman looked at both specific and more general statistics on home loans, like what states the CDOs originated out of, or how many mortgage loans were ‘without paper’ or ‘second loans’ or balloons or for high amounts. They found the errors in the ‘FICO’ scores and the “Black-Scholes” option pricing models used by traditional Wall Street analysts. The funniest part of the book is Eisman insulting each and every financial and Wall Street CEO he ever met by telling them exactly what he thought – that their optimistic views and hazy understanding was bullshit. Hilarious, to the point, and absolutely unbelievable. In a way, the whole Street and industry had agreed that only 5% of house loans would go bad, and house prices would always rise. That was their faith, their 'party line.' As Eisman pointed out, all it took was a 7% failure rate for a CDO to default. The rates eventually reached 40% in some pools of loans.
Some of these guys started out as ‘value investors” like Warren Buffet. What these money managers did, once they understood the inflating capitalist mortgage and derivative bubbles, was to buy credit default swaps (CDS) on various CDO’s. CDS’s are like insurance on the failure of a certain investment, but cheaper than buying options. So in a way they were ‘shorting’ the whole U.S. mortgage machine, which had become the largest part of Wall Street’s ‘products.’ A 'short' means you wager money that the price of a product will decline. Hence the name of Lewis’ book. Once they did this, they took out traditional short options on the stock value of various financial institutions, mortgage companies and hedge funds backing mortgage-‘securities,’ just to rub it in. They knew their prices would decline when the bubbles popped.
At a certain point, as the CDO market began crashing in mid-2007, they sold the CDS’s to frantic Wall Street firms, because they knew that some of the CDS’s were guaranteed by AIG or Bear Stearns – both firms they realized could fail. And they did. Eisman, Burry, Lippman and others made millions while Wall Street/The City/The Bourse/Frankfurt capital markets firms lost billions of dollars, and ultimately, the U.S. government, and the U.S. taxpayer, had to step in with trillions to prop up what were now legally called ‘banks.’ Bernie Sanders now puts the number at $16T, not just $800B in TARP funds.
Some people will read this book in order to understand how to make money on Wall Street. Marxists and revolutionaries read it in order to understand financialization, which seems to be a terminal disease of world capitalism. Lewis considers the pebble that started this avalanche of financialization to be the moment that his original target in ‘Liar’s Poker’ – John Gutfreund – turned Salomon Brothers from a partnership to a corporation, thus transferring the risk from the partners to the shareholders. There is some truth in this contention, but it seems another small pebble in the overall pattern of financialization – which really got started when the derivatives market in currencies developed after Nixon ended Bretton-Woods in 1971.
As Christopher Ketcham recently put it: “The One Percenter seeks only exchange value, as opposed to real value. Thus foreign exchange currency gambling has skyrocketed to seventy-three times the actual goods and services of the planet, up from eleven times in 1980. Thus the “value” of oil futures has risen from 20 percent of actual physical production in 1980 to 1,000 percent today. Thus interest rate derivatives have gone from nil in 1980 to $390 trillion in 2009. The trading schemes float disembodied above the real economy, related to it only because without the real economy there would be nothing to exploit.”
Lewis is wrong because the risk has not just shifted from the partner to the shareholder – the risk has now been transferred to the public at large. And the ‘public at large’ is now the guarantor. Derivatives themselves are empty suits, they were not just invented by empty suits. You will hear the rhetorical homilies about how commodity futures are ‘farmers guaranteeing their product price in the future.” Since commodity speculators have taken over the trading pits, as Ketcham points out, these ‘honest farmers’ are less than 3% of the commodity futures market. The problem is far deeper than one single legal change.
Unfortunately, Ketcham is wrong too. The 'real' economy includes Wall Street. The real problem is ‘the system’ – one which cannot survive at this point without the debt casino of Wall Street. This constant narrative of left-liberals that the 'bad' financial capitalists are ruining everything - and we should just 'regulate' them more - is belied by financial capital's empirical support for the expansion of monopoly 'manufacturing' capital all over the globe. The present state of global monopoly corporations would not have been possible otherwise. Financialization is not a ‘growth’ upon capitalism, but its logical conclusion.
And I bought it at Jackson Street Books, Athens Georgia
Red Frog, October 20, 2011