Time for a book review.

I’ve just finished Michael Lewis’s “The Big Short”. It’s an amazing book, not just because it informs us of the road to the subprime mess but he creates a story around the protagonists. He also manages to expose the whole wretched mess, the fictionalisation of risk and yield laid bare. He introduces us to the main players in the debacle through the eyes of a few weird and wonderful players who worked out that something was terribly wrong and bet against it. These colourful characters expose the whole damn scheme as nothing more than a paper pyramid.

As Lewis sums up the Collateralized Debt Obligation (CDO) on page 73:

“The CDO was, in effect, a credit laundering service for the residents of Lower Middle Class America. For Wall Street it was a machine that turned lead into gold”.

Simply put a CDO was a collection (a tower) of subprime loans that had miraculously transformed from junk status to triple A (AAA) credit and therefore it was investible by major funds (referred to in the book as dopey Germans).

So what was the short? Well on one hand you had investors who sold insurance on these debts defaulting. They believed (incorrectly) that it could never happen and therefore they were picking up free money. The shorters realised the were getting amazing odds on the loans defaulting and piled in.

At the bottom of this was an average person with no money and a big mortgage, usually 100% or more. Any fall in the price of their property would immediately put them in a default position. Yes it was a giant pyramid scheme. The real laugh is that even the guys going short didn’t really understand what it was they were shorting so opaque was the structure and process.

I recommend the book very highly. It’s a gripping read and manageable for the layperson.

You’re left wondering how the bankers got away with it. The answer given by the bankers (well laid out in Sorkin’s book) was that they were too big to fail.

This sets us up nicely for the next round.

P.S.

Today the SEC is launching a case against ICP Asset management for their role in handling CDO investments. Along with the case against Goldman Sachs we can expect more companies to be investigated for their role in this financial fraud. It will also be interesting to see when the rating agencies themselves will come under review. They were the ones who gave the AAA blessing to these products they really knew very little about. Makes you wonder about the whole darn shooting match!

Tags: andrew sorkin, banking, big short, cdo, debt, federal reserve, financial crisis, fraud, interest, michael lewis, money, subprime, too big to fail, wall street