Wednesday, March 03, 2010

The Big Short - Great article/book excerpt by Michael Lewis on the mortgage mess

Noted financial author Michael Lewis has a new book coming out about the recent mortgage mess entitled The Big Short: Inside the Doomsday Machine. A long excerpt from the book is in the latest issue of Vanity Fair in an article entitled Betting on the Blind Side. It essentially gives a very detailed view of one of the financial niches that actually came out ahead in the crisis.

The intro to the article tells us that:

Michael Burry always saw the world differently--due, he believed, to the childhood loss of one eye. So when the 32-year-old investor spotted the huge bubble in the subprime-mortgage bond market, in 2004, then created a way to bet against it, he wasn't surprised that no one understood what he was doing. In an excerpt from his new book, The Big Short, the author charts Burry's oddball maneuvers, his almost comical dealings with Goldman Sachs and other banks as the market collapsed, and the true reason for his visionary obsession.

A passage that gives you the flavor of Lewis' narrative:

In 2004 he began to buy insurance on companies he thought might suffer in a real-estate downturn: mortgage lenders, mortgage insurers, and so on. This wasn't entirely satisfying. A real-estate-market meltdown might cause these companies to lose money; there was no guarantee that they would actually go bankrupt. He wanted a more direct tool for betting against subprime-mortgage lending. On March 19, 2005, alone in his office with the door closed and the shades pulled down, reading an abstruse textbook on credit derivatives, Michael Burry got an idea: credit-default swaps on subprime-mortgage bonds.

The idea hit him as he read a book about the evolution of the U.S. bond market and the creation, in the mid-1990s, at J. P. Morgan, of the first corporate credit-default swaps. He came to a passage explaining why banks felt they needed credit-default swaps at all. It wasn't immediately obvious--after all, the best way to avoid the risk of General Electric's defaulting on its debt was not to lend to General Electric in the first place. In the beginning, credit-default swaps had been a tool for hedging: some bank had loaned more than they wanted to to General Electric because G.E. had asked for it, and they feared alienating a long-standing client; another bank changed its mind about the wisdom of lending to G.E. at all. Very quickly, however, the new derivatives became tools for speculation: a lot of people wanted to make bets on the likelihood of G.E.'s defaulting. It struck Burry: Wall Street is bound to do the same thing with subprime-mortgage bonds, too. Given what was happening in the real-estate market—and given what subprime-mortgage lenders were doing--a lot of smart people eventually were going to want to make side bets on subprime-mortgage bonds. And the only way to do it would be to buy a credit-default swap.

 

Neither Lewis or Burry was technically a Wall Street insider, but the book/excerpt gives an upfront, detailed view of what was happening before and during the mortgage crisis.

(I do get a very modest commission if you buy the book from Amazon by clicking on my link:)

-- Jack Krupansky

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