I was recently able to read The Big Short by Michael Lewis. Even though there were quite a few details that went over my head, it's an interesting, compelling story about a few specific people who essentially shorted (in other words, bet against) the entire US financial system and ended up "winning" in the 2008 financial crisis. I knew the basic details of how mortgage-backed securities were packaged and repackaged to get high ratings from well-known agencies, even though the underlying instruments were high-risk mortgages given unscrupulously to poor people who were likely to default; that said, I found
incredible just how much fraud was being perpetrated, like laundering
credit scores based on essentially nothing, or ripping off low-income
people with false or misleading interest rates. Also, many financial models seemed to assume no underlying information and total
lack of correlation among various investments, assets, or liabilities, even this was obviously untrue: subprime mortgages bundled into financial instruments were
highly correlated by underlying economic indicators, and companies'
fortunes could often be predicted much more accurately even with
publicly-available information (like with Capital One's fortunes depending on regulatory
judgments against it), yet these models often still naïvely and nonsensically assumed Gaussian
distributions for such events.
Coupled with that ignorance of information in financial modeling seemed to be an intentional lack of transparency in the market for these complex securities and other financial instruments. Typically, enlarging a risk pool would seem to produce better outcomes throughout the market, but here, the mirror image of that was happening: more and more
people were being exposed to risk, and that risk was being multiplied
based off of essentially nothing tangible (often simply camouflaged
through clever names as comprising diversified assets), yet large Wall
Street firms were making money off of that for years before the whole system collapsed. On a related note, some people have claimed that short-sellers are beneficial to the market by
signaling that certain trading practices should stop as they are too risky, yet as far as I can tell, this
only works in an idealized world where information and people's decisions
are transparent to everyone, whereas the whole point is that the
short-sellers and those selling risky financial instruments were all
trying to one-up each other in a cloud of opacity and obfuscation so
that they could make their big money (which is what really happened).
Overall, the book is quite engaging and well-written. As I mentioned earlier, there are a lot of subtleties, nuances, and jargon that went over my head, but the narrative and salient points are clear enough to a layperson; if anything, the technicalities simply add to the authentic feel of what one of those short-sellers must have been thinking during those years leading up to the 2008 financial crisis. It is important to note that the focus of this book is the financial crisis and the years leading up to it, from the perspective of the finance industry/Wall Street; it does not really touch upon the broader economic trends in the US leading up to that point (except for specific trends that tie into the discussions of specific mortgage-backed financial instruments), and it does not discuss the recession per se. With that in mind, I'd recommend this to anyone who is interested in the subject.