The Big Short is Michael Lewis’ engaging tale of a handful of investors who saw the madness in lenders offering toxic mortgages (such as, and I’m not making this up, the interest-only negative amortizing adjustable-rate subprime mortgage) and rating agencies handing out triple-A rating on these mortgages like candy on Halloween Eve. The subprime mortgages were then sold to investors around the globe who, perhaps blinded by the pristine credit rating, were glad to bear the risk in these securities for little more than a few basis points premium over Treasury bonds.
Some savvy investors found a way to make explicit bets against subprime mortgages through credit default swaps that investment banks, often the same ones that had assembled the subprime mortgages into bonds and sold it to other investors, were only too happy to put together. As a rule, these individuals were Wall Street outsiders — one was Michael Burry, a one-eyed doctor with Asperger’s syndrome who had launched a hedge fund with initial capital raised primarily on his postings on Internet message boards. Michael Burry invested mainly in stocks and managed to handily beat the S&P in his initial years but in 2004, he started noticing the decline in lending standards and started hounding investment banks to sell him credit default swaps on the crappiest subprime mortgages eventually building a $1 billion short position, which was costing him just 2 percent annually (i.e. for a premium of $2 per year, Michael Burry could collect $100, if the underlying bonds defaulted). When the bonds eventually defaulted, as Michael Burry was sure they would, he realized profits of about $720 million.
It must have helped that the author has a background in bond trading because he does a good job in explaining the mind-numbingly complex derivatives brewed up by Wall Street’s finest that almost brought down the global financial system. I read this book on the recommendation of a reader (Thanks Gaby) and I’m glad I did. Though this book is not really about what caused the credit crisis, it is best one I’ve read so far on the events that led to the financial meltdown of 2008. The book retails for about $17.50 on Amazon.
Vanity Fair magazine ran a lengthy excerpt from the chapter In the Land of the Blind. Hat tip to Guinness 416.