Wednesday 11 February 2015

BETTING AGAINST THE HERD – REVIEW OF MICHAEL LEWIS’S “THE BIG SHORT”

Books on the 2008 financial crisis engross me. I believe, as many Austrian economists do, that the 2008 financial crisis was wrought not by excessive deregulation but by the American government’s eagerness to make every American a home-owner and also by moral hazard: if the US had not arranged for the bail-out of Long Term Capital Management in 1998 and further, if not for the “Greenspan put”, Wall Street players would not have taken such huge risks as they did.



Michael Lewis’s book The Big Short (2010) is hilarious, if that one could apply that word to what is essentially a tragedy. While most traders and investors were having a blast during the housing bubble, a handful of them such as Steve Eisman and Michael Burry saw it for what it was, and bet heavily against the housing market. Lewis tells their story – how they grew rich while the world crashed around them.

While Lewis portrays Steve Eisman as an outspoken and eccentric character, his portrayal of Michael Burry takes the cake. Burry was trained as a doctor and was working as a resident in neurology at Stanford Hospital. He had learnt about value investing on his own by reading books by Ben Graham and others. Burry was more or less a loner, largely because he was suffering from, Asperger’s syndrome. This disability proved an asset to him since he could spend several hours in intense concentration in reading annual reports and analyzing market trends. He became a blogger when the term wasn’t even popular and acquired a discerning following. Later he quit his residency and launched his own investment firm. He was backed by firms like Gotham Capital (headed by the legendary Joel Greenblatt) and White Mountains.

Michael Burry analyzed housing trends and concluded that a large percentage of loans being issued were risky. He diverted his attention from value investing and bought credit default swaps (a kind of insurance) on subprime mortgage bonds. When the bonds became trash in 2008, he stood to gain hundreds of millions of dollars.

Lewis ends his book with the onset of the 2008 crisis and does not dwell further. Some other very good books like Roger Lowenstein’s The End of Wall Street (2010) and Andrew Ross Sorkin’s Too Big To Fail (2009) go further beyond and describe how the US government stepped in to stem the collapse.

I read a recent article on Bloomberg that narrated how some US firms like Angel Oak Capital are back with subprime bonds, only this time they call it “nonprime bonds”. These firms claim that they are careful not to repeat the mistakes of the past. All I know is that economic laws are as unassailable as the law of gravity and there is no time that is “different” than earlier ones.

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