The Big Short Summary

Michael L. Lewis

The Big Short

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The Big Short Summary

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The Big Short: Inside the Doomsday Machine,a 2010 nonfiction book written by Michael Lewis, follows the events leading up to the housing bubble crash in 2008 as told from the perspective of several individuals who foresaw the crash. The book spent twenty-eight consecutive weeks on the New York Times bestseller list at the time of its publication and has been adapted into a 2015 motion picture directed by Adam McKay and starring Ryan Gosling.

In the prologue,financial analyst Meredith Whitney accurately predicts the collapse of Citigroup. She forecasts a similar fate for the subprime mortgage market, in which many major Wall Street firms haveheavily invested. After this prediction also proves to be accurate, the author, Michael Lewis, pays Whitney a visit and asks her who else knew about the impending housing market crash. She gives him a list of individuals, including her former boss, Steve Eisman.

The book then shifts to Eisman’s story a few years earlier. He is an analyst at a financial firm called Oppenheimer and Company, and was one of the first people to become involved in the mortgage bond industry. Mortgage bonds are mortgage debt owed by ordinary Americans that are packaged by financial firms and sold to investors. When the homeowners make payments on their mortgage, the holder of the bond receives a yield on the bond. The longer-term and riskier the mortgage, the higher the return on investment. Some of these bonds are based on subprime mortgages, or mortgages with lower interest rates that are offered to entice working-class people into buying homes, but whose rates increase dramatically after just a few years.

Eisman is initially optimistic about the potential of this industry, and helps many subprime mortgage companies enter the market. However, he soon becomes alarmed by the generally poor quality of the bonds and the fact that many of the homeowners, particularly owners of mobile homes, default on their mortgages. He also finds that many financial firms selling mortgage bonds are being dishonest about the risk that the investment carries. Eisman publishes reports denouncing the subprime mortgage industry, but at the same time starts a hedge fund called FrontPoint Partners to try to make some money from his knowledge.

Next, Lewis introduces the reader to Michael Burry, who is also trying to profit from the situation. A former medical student, Burry is a fervent Wall Street investor and owner of a successful investment fund, Scion Capital. Burry gets into the practice of buyingcredit default swaps, financial instruments where the seller must pay big dividends to the buyer if a mortgage bond defaults. Credit default swaps become particularly lucrative when Goldman Sachs and other financial institutions start packaging the riskiest subprime mortgage bonds as collateral debt obligations, or CDOs, while clueless ratings agencies continue to give these bonds high ratings despite their risk.

The practice of betting against a bond is also known as “shorting.” Burry earns millions in this endeavor, but soon others catch on to his ideas. In particular, Greg Lippmann, a shady Deutsche Bankbond salesman, after doing his own research on subprime mortgage bonds and realizing how risky they are, buys a lot of credit default swaps for himself and to sell to others. Since most people still believe that the housing market is in good shape, however, Lippmann initially has a tough time selling the swaps. He then meets Eisman, whoeagerlypurchases the credit default swaps knowing that they are highly likely to pay out.

Meanwhile, two other traders,Charles Ledley and Jamie Mai,start a capital management company together called Cornwall Management and makemillions buying Capital One options. They become acquainted with Lippmann through their friend, Ben Hockett, a Deutsche Bank employee, and decide to buy credit default swaps from him. Ledley buys more from Bear Stearns at a subprime mortgage bond conference in Las Vegas.

Lippmann and Eisman go out to dinner with Wing Chau, a CDO manager, who sells credit default swaps and is unaware of the imminent collapse of the housing market. They learn from their conversation with Chau that companies are betting against the credit default swaps they sell by creating and selling “synthetic CDOs,” bonds that must be paid out when a credit default swap pays out. Because ofthe combination of credit default swaps and synthetic CDOs, the default of a single mortgage bond could cause billions in debt. At the end of dinner, Eisman takes advantage of Chau’s cluelessness by buying credit default swaps from him.

It becomes more and more clear to Wall Street that a housing crash is imminent. Although companies artificially inflate the prices of their mortgage bonds to try to sell them off before the crash hits, eventually the bonds bottom out and bond holders find themselves in mountains of debt. Many Wall Street firms are also in deep debt because of the credit default swaps they sold, and because many invested in CDOs themselves. Morgan Stanley owes billions to Deutsche Bank from their sale of swaps to Lippmann, and Bear Stearns collapses and is sold to JP Morgan as a result of massive debt. Although Lippmann, Eisman, Ledley, and Mai all come out of the subprime crisis very rich, they feel a little uneasy about having profited off others’ misfortune. In the book’s epilogue, we learn that the indebted banks were bailed out by the federal government.

The Big Short illustrates the events on Wall Street leading up to the housing crash and ensuing economic recession of 2008, and explains the underlying causes of the crash. In dissecting the origins of a recent crisis in American history, the book shows that even powerful institutions can be undone by greed, willful ignorance, and the allure of risk-taking, leading to terrible consequences for many. It also condemns Wall Street’s exploitation of innocent investors and homeowners for financial gain.