A Different View of the Financial Crisis

Some unsung traders saw through the sub-prime bubble to make a fortune. Michael Lewis uses the stories to show dubious practices by many banks and brokers.

Rarely does a book on economics and finance entertain in the way that Michael Lewis achieves with The Big Short. Not only is it a great read but The Big Short also explains how financial products and practices worked and effectively brought the financial world to brink of total collapse. Michael Lewis has pulled off a tour de force; he has created a financial thriller with a great story of greed, possible fraud and incompetence whilst clearly explaining complex financial ideas. In the end, a few small funds succeed in beating the frighteningly incompetent big financial institutions and for once, it is a true story.

Financial Crisis; Stories of Success and Failure

There are two parallel stories in The Big Short. There is the story of how small investment funds and individuals, in some cases in large organisations, were able to spot that the sub-prime loans would not be viable in the medium to long term. Their analysis also led them to see that the supposedly investment-rated credit default swaps and other synthetic derivatives were just repackaged low-grade debt and were doomed to fail.

At first, it was instinct that led most of these, mostly unsung, heroes to short, bet against, the packages of sub-prime mortgages. As the sub-prime market developed and derivative products such as credit default swaps came to be a major part of the market, these investors bet that these, too, would eventually fail. Their confidence grew as they understood better what was happening and that their lack of knowledge was only matched by the ignorance of the bankers and rating agencies who had no more, sometimes less, understanding of the products they were selling or ranking. It became inevitable that the house of cards would collapse. The small band of investors shorting this market had to worry whether the institutions would be able to pay out on their insurance policies, their short positions.

Was It Fraud?

That repackaging of low-grade debt and getting it marked as high quality, investment grade investment by the ratings agencies fed a monster. It was a gravy train, at least in the short term, that relied on constant repackaging of essentially poor quality investment vehicles as top grade. They could then bought by pension funds and other bodies whose constitutions only allow them to purchase top investment grade products.

Most readers will wonder, as does Lewis, why regulators and liquidators did not consider these practices as fraudulent. It may have been possible at the time when no one but a few obsessive, and subsequently successful investors, had read and understood the product documentation to overlook the problem. After the event when the nature of the abuse became clear then the case for considering the practice as fraud should have been overwhelming. Worryingly, many of the perpetrators are still making huge salaries and bonuses in the financial sector.

One suspects that most readers outside financial services will see these practices as fraudulent. At the very least; the misleading description of products could appear to be deliberate. In most other industries, such repackaging would be illegal.

The Clearest Description of the Financial Crisis Yet

With The Big Short Michael Lewis combines wit and serious analysis to bring clarity to the failure of financial services exposed by the sub-prime mortgage crisis. An easy read, it makes clear the dubious, to most ordinary people, practices of the financial services industry. It is probably the best starting point for anyone who wants to understand the financial crisis. The clarity comes because it does not attempt to explain it in terms of economic theory. It uses plain English to explain what happened. The reader may conclude it had little to do with economics and more to do with greed, incompetence and perhaps even worse by individuals and major institutions.

The Big Short, Inside the Doomsday Machine (2011, ISBN: 978-0-141-04353-1) by Michael Lewis is published in paperback by Penguin at £9.99

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