

Debunking Michael Lewis’ The Big Short - mofeeta
http://www.nakedcapitalism.com/2010/03/debunking-michael-lewis-subprime-short-hagiography.html

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yanowitz
(disclosure: I've read the book, enjoyed it, learned a bunch, but also thought
it had some weaknesses... Also, the author of this review has a competing
book, which should just be noted.)

Although I agree that there are weaknesses that flow from Lewis using the
forms of fiction story telling (plot arc, conflict, protagonists, etc.) to
tell a non-fiction story, I think a weakness of this review is that it ducks
the main scandal: the lack of regulation.

[Note, this may be covered in the author's book, EConned, I don't know, I
haven't read it, though I did just order it.]

Obviously, the people participating in the market who made money were "part of
the problem" -- but the bigger problem was the lack of regulation for an area
of the economy that is so significant the rest of us _have_ to bail it out
(privatized profit, socialized risk). This allowed, among other things:

1\. rating agencies to lie -- they had an economic incentive to do so (fees
from investment banks) and no one to stop them (so much of the market is
legally bound to use/rely on them). It's incredible in the wake of this that
S&P, Moody's, etc. still exist. They participated in the largest fraud in
capitalism's history.

2\. an opaque market in instruments that grew so large the rest of us were on
the hook for it. This is the largest transfer of wealth in history and it's
still not clear what the hell happened.

The BP oil spill looks transparent compared to what went on here.

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anamax
> but the bigger problem was the lack of regulation

Except that the problem was actually the regulation. Let's look at your
examples.

> 1\. rating agencies to lie -- they had an economic incentive to do so

The rating agencies had a govt mandated monopoly - that's a creation of
regulation. That pretty much guarantees that their failures will cause system
failures. Note that the regulation in this case pushed that failure into the
core of the banking system. The ratings determined whether something counted
as an asset, so when they got it wrong, banks tanked.

Note that regulation also said that "insurance" on mortgage-backed securities
made them safe. The regulators did this because they wanted banks to hold more
MBS, which makes them cheaper, which causes more of them to be created, and so
on.

> 2\. an opaque market in instruments that grew so large the rest of us were
> on the hook for it. This is the largest transfer of wealth in history and
> it's still not clear what the hell happened.

Sure it is. Politically connected institutions were made whole. (Example - We
gave money to AIG to pay its debts to Goldman Sachs.) We're still pissing
money into Fannie and Freddie.

Regulation is systemic risk.

Note that regulators don't have any skin in the game and politicians have even
less. (I'm looking at you Barney Frank and Chris Dodd.)

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PaddyCorry
Liar's Poker was great, and I'm enjoying reading 'The Big Short' at the
moment.

Although I'm not sure that the guys making money from Credit Default Swap
agreements on CDOs are on morally safe ground, I disagree with Yves that Steve
Eisman, Mike Burry et al were "the moving force behind otherwise inexplicable,
superheated demand for the very worst sort of mortgages." Ultimately,
irresponsible mortgage lending was the root cause of the crisis: it was a
superheated supply scenario.

It was only when the rate of defaults on home loans dramatically increased
that the CDOs dropped in value, and the Credit Default Swaps could be
redeemed.

For example, in addition to the high number of defaults that occurred after an
initial two year, fixed-interest period, (when the interest rate jumped in
some cases from 6% to 12%) some of the loans even defaulted on their very
first payment. Lewis makes the point in the book that the question is not "who
defaults on their first loan repayment?", but rather "who lends to someone who
can't even make a single repayment?"

As for Magnetar being undocumented, Chicago Public Radio did a great podcast
about it a couple weeks ago, which was where I got the recommendation for 'The
Big Short'. It's well worth a listen:
[http://www.propublica.org/ion/podcast/item/bernstein-and-
eis...](http://www.propublica.org/ion/podcast/item/bernstein-and-eisinger-on-
the-magnetar-trade)

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T_S_
Hagiography, maybe. But the notion that shorts kept the market going is just
crazy. Short sellers get a bad rap, but if you think about it, shorts are the
pins we need to pop the bubbles before they get too big.

The only problem with shorts, but this is equally true of the longs, is that
investment activity is secret and information fails to be spread around; big
risks creep into the markets without enough discussion taking place. If
markets run on information, our markets are running on fumes. No wonder they
sputter a lot.

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billjings
How is it crazy? A trader takes a short position on CDOs. They find a way to
go further with that short position by driving up the amount of toxic debt in
the market and betting on that. There's nothing to limit the amount to which
they can short the market because they've figured out how to hedge their risk
and make a small profit as long as the bubble stays up. That's essentially
what many of these hedge funds managed to do.

And of course, that's what they're paid to do - they're just good at their
jobs. Which is why there's a larger issue at stake here about what constitutes
ethical trading behavior in modern markets, and I think this is part of that
discussion. It's completely inaccurate to say that short bets are wrong,
because as you say, they are so crucial to keeping liquidity in the
marketplace. At the same time, to take a position that you know for a fact
will drive the bubble up to be larger, to fall harder, well - are you
completely irresponsible for the consequences of those trades?

When you get right down to it, this is why regulation is necessary. This is
why we have referees in sports - nasty behavior is encouraged and necessary in
competition, so there needs to be some sort of line to say what is in and
outside of the realm of acceptable behavior. And the boundaries of what is and
is not acceptable are always changing. Rules aren't static in baseball and
football - they change as people figure out how to play within and around them
and change strategies.

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yummyfajitas
_At the same time, to take a position that you know for a fact will drive the
bubble up to be larger, to fall harder..._

A long position drives prices up and inflates the bubble. A short position
lowers prices and lets a little bit of air out of the bubble.

~~~
billjings
That's not necessarily true in the land of derivatives. A derivative is a bet
on the change in value of something. Essentially hedge funds would build a
market for a crap asset and then use derivatives to bet that the value would
go down. So while the position was short, assembling it drove the bubble up
higher.

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foomarks
I started reading this too, and did some tangential reading along the way.

I'd hate to be in the same room as 2010 Lewis and 2007 Lewis:

"But the most striking thing about the growing derivatives markets is the
stability that has come with them. More than eight years ago, after Long-Term
Capital Management blew up and lost a few billion dollars, the Federal Reserve
had to be wheeled in to save capitalism as we know it." <http://bit.ly/cg9H6w>

Also this fun one from Janet Tavakoli:

"I was in the Salomon Brothers' 1985 training class that Michael Lewis
lampooned in his amusing book, Liar's Poker. Imagine my surprise to see him
billed as a trader on 60 Minutes, since he was actually a junior salesman.
Well-heeled male peacocks strutted the trading floor, and junior salesmen were
girlie-men, mere eunuchs serving their pashas." <http://huff.to/9pclUR>

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joe_bleau
I've seen both Lewis and Tavakoli on C-SPAN's Q&A recently. Lewis seemed to be
trying to be funny, but I found Tavakoli more interesting. And I think Brian
Lamb did try to wind up Lewis by mentioning that remark from JT, but I can't
recall now how he responded.

JT: <http://www.youtube.com/watch?v=WA20Am0pwtA> ML:
<http://www.youtube.com/watch?v=x387_k963yY>

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onewland
I really liked that font for the main article, if anybody else does and
doesn't feel like digging into the HTML/CSS, it's Optima.

