A book review: The Big Short, by Michael Lewis

by Dr. Les Sillars
May 12, 2010

Dr. Les Sillars directs the Journalism Program at Patrick Henry College. Besides his duties at PHC, Dr. Sillars is Mailbag Editor at WORLD magazine and a Contributing Editor at Salvo magazine.

A friend who owns a landscaping business in northern Virginia recently described for me how a few years ago some of his workers started showing up for work in Hummers and brand-new pick-ups. “I pay them pretty well for the landscaping industry,” he said, “but I don't pay them that well.”

He discovered that several had purchased half-million-dollar homes during the sub-prime mortgage boom. To induce blue-collar workers to take out these massive loans, the mortgage companies had offered extra cash at closing. That is, to finance a $500,000 house, the mortgage companies forked over $550,000 or so and the guys would buy new vehicles with the extra. Then they would cover the initial payments by renting the house to friends, and when the mortgage rates went up after two years they would walk—er, drive away, leaving the keys in the door.

Such loans created the “sub-prime mortgage crisis” of 2008, which nearly sparked a meltdown of the world's financial systems, froze credit markets, and cost American taxpayers billions of dollars in government bailouts. If you're wondering how such insanity could happen, a good place to start is Michael Lewis's bestselling new book, The Big Short: Inside the Doomsday Machine. Lewis is also the author of The Blind Side, Moneyball, and Liar's Poker, among others.

Lewis tells the stories of a handful of colorful investors—a doctor with Asperger's Syndrome, a “garage band hedge fund” that started in 2003 with $110,000 and cleared $80 million in 2008, and a sordid cast of others—who figured out that the incredibly complex securities based on sub-prime mortgages were likely to go down in flames and made large fortunes betting against the market.

It is a deeply disturbing, albeit fascinating story of an obscene strain of greed and self-enrichment beyond which most of us had ever imagined. It describes how a group of investors and Wall Street investment banks figured out how to con the securities rating agencies into giving top ratings to bonds and bond derivatives. These ratings were based on what would become toxic pools of sub-prime mortgages that, sooner or later, were going to go bust when enough home-owners defaulted on their loans. Disastrously, an enormous pool of money looking for safe yet profitable investments naively trusted the AAA ratings (as safe as Treasury Bonds!) and created a ravenous market for these bonds and something called “collateralized debt obligations” (CDOs). This wicked alchemy sparked a borrowing binge whereby mortgage companies lowered lending standards through the floor, creating an illusion of economic vitality but feeding a housing bubble that was, in fact, a house of cards waiting to topple.

One way people “shorted” the market (that is, bet against it) was to purchase “credit default swaps,” which are a kind of insurance for securities. As Lewis nicely explains, it's like buying fire insurance on a rickety old building you don't own in an accident-prone neighborhood. When all these heinous loans turned rancid as the bubble burst, the securities defaulted; the securities' owners (including the Wall Street banks) lost billions, and the “shorts” cleaned up.

In the end, as Lewis points out, the people who failed to foresee the catastrophe—the CEOs, the officials at Treasury and the Fed, the ratings agencies—not only emerged from this cataclysm as wealthy individuals, they became central figures in plotting the future of the financial industry; this despite the fact that, as Lewis put it, “they had proven far less capable of grasping basic truths in the heart of the U.S. financial system than a one-eyed money manager with Asperger's syndrome.”

Lewis’s book puts words and faces to a sense of dread many of us feel in the rickety economic aftermath of the Great Recession. It's unsettling to realize that the people running our economy may not know what they're doing—that they may, despite their impressive credentials and $3,000 suits, be driven simply by greed or, just as worrisome, are feeling their way through the dark just like everybody else.

Reading this book and its baffling revelations of insatiable greed and monumental foolhardiness, I was simply reminded that, especially in times like these, our hope lies thankfully elsewhere. As the Psalmist says, “Do not put your trust in princes, in mortal men, who cannot save. When their spirit departs, they return to the ground; on that very day their plans come to nothing. Blessed is he whose help is the God of Jacob, whose hope is in the LORD his God, the Maker of heaven and earth.”