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the Big short: inside the doomsday machine
I haD My PLan To BeCoMe RICh anD FaMoUS. I had my big
idea. It was to write a work of speculative fiction, set in the not-too-
distant future, based on a band of oddball characters who would cre-
ate an exotic financial product that allowed them to run amok on Wall
Street, creating unimagined wealth for themselves while bringing the
entire financial system to the brink of destruction.
I was sure it would become a best-seller, allowing me to retire in style to a
tropical isle with nothing more to worry about than which expensive wine to
serve with that evening’s dinner.
Alas, Michael Lewis, with his book,
The Big Short: Inside the Doomsday Machine, beat me to the punch.
This is a book about the subprime
mortgage frenzy and its spectacular
collapse. Lewis (who also wrote Liar’s
Poker and Moneyball, among others)
chooses to tell his story not from the perspective of the big banks and investment
houses that created the storm and then
found themselves in the middle of it, but
through the eyes of a host of observant
misfits who foresaw the train wreck long
before it happened but couldn’t quite believe what they were seeing.
Our guides include a one-eyed mon-
ey manager with Asperger’s syndrome;
a trader who believed that markets un-
derestimated the probability of extreme
events and, as a consequence, acquired a
farm in a remote area with enough fruits
and vegetables to feed his family through
the coming cataclysm; and a graduate of
Harvard Law School who studied the
Talmud not for religious purposes but to
find inconsistencies in it, and of whom
his wife said, “He’s not tactically rude.
He’s sincerely rude.”
Despite their personal idiosyncra-
sies, these individuals who existed on
the fringe of the financial world shared
a common insight—subprime mortgage
loans were bound to default. And it’s
their incredulity over how badly Wall
Street insiders misperceived this risk
that propels Lewis’ narrative.
The subprime mortgage industry
was built on the premise that bor-
rowers would be able to pay off their
mortgages not from employment earn-
ings but by refinancing their loans
through newfound equity as their
homes increased in value. Within a rel-
atively short time, Lewis writes, “the
subprime mortgage industry became
the most powerful engine of profits and
employment on Wall Street.”
But two things went wrong.
First, loan quality deteriorated as
mortgage originators rushed to feed the
ever-increasing appetite of Wall Street
for packages of subprime loans. The
principle guiding these transactions
devolved from “Don’t make loans to
people who can’t afford them” to “Keep
on making those loans; just don’t keep
them on your books.”
In its frenzy to earn pass-through
commissions on these portfolios of
loans, the industry forgot (or chose to
overlook) one important fact: These
loans were highly correlated, and it
would only take a leveling off of housing
prices to set off a contagion of defaults.
74 continGencies JUL | AUG. 10
