THE BIG SHORT

By Michael Lewis
1.0 INTRODUCTION
The Big Short (2010) is a book by the famous American author Michael Lewis who is
renowned for his reporting of financial crises and behavioral finance. After completing his
graduation, he started his career on Wall Street (1980s) as a bond salesman at Salomon
Brothers. The experience incited him to write his first book Liar's Poker (1989). From that
onwards, his skepticism about the financial world drove him to write many such books. In
2007, he came across Meredith Whitney who had predicted the crash of Citigroup and other
major banks (resulting from the burst of the housing bubble). This inspired him to write ‘The
Big Short’ which once again affirmed his skepticism about the Wall Street anomalies. In this
book, Lewis portrays ‘The Great Recession’- the financial catastrophe of 2007-08 which
resulted from the burst of the United States housing bubble and took form of a global
pandemic. The financial crisis caused by sub-prime mortgages can be traced to the complex
dynamic between these key players- Bankers, brokers, investors and the insolvent
homeowners who took mortgage loans. To elaborate, when the housing market was booming
in the mid-2000s, every US citizen exhibited profound interest to invest in this market. Since
the property price showed an increment curve, banks were issuing adjustable-rate mortgages
even to high-risk candidates and charging high interest rate. The mortgage companies would
next pack the mortgages into bonds and sell them to investment bankers who further
compiled them into CDOs (Collaterized Debt Obligations) consisting of AAA, AA, BBB
rated tranches. Then the banks insured it for a CDS (Credit Default Swap) and these CDO
slices of various risk were sold off to various investors, bankers and hedge funds (short the
subprime mortgage bonds). But since 2006, the house prices started plunging and the
mortgage default rate went up by 8% in 2007. Thus the chain collapsed leaving millions of
US citizens homeless. What we also learn as we go through this book is that those who bet
against the subprime fiasco made hundreds of millions of dollars. The book takes us back to
the fall of the Wall Street owing to the self-interest of each of these personnel- banker,
investor, rating agency, hedge fund managers etc.

2.0 SUMMARY
The cast of the characters in this book commences with Steve Eisman who is blunt,
outspoken and aggressive in his pursuit of ensuring justice in the world of finance. He started

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his career as a lawyer but soon switched to being an equity analyst at Oppenheimer & Co. In
this firm, Eisman came across Vincent Daniel whom he chose to investigate the subprime
mortgage market as his personal assistant. While looking into the market data, Danny
discovered the delinquency rate of home loans. Thus during the 1990s, Steve’s inquisition of
the financial market finally led him to unveiling the fraudulent subprime mortgage bond
business and its defective CDOs, including that of the Housing Finance Corporation.
However, Goldman Sachs, Morgan Stanley, Deutsche Bank managed to keep their subprime
gamble up and running by providing a new incentive of floating-rate mortgages. In 2004,
Steve set up his own hedge fund FrontPoint Partners, an entity of Morgan Stanley. Having an
in-depth understanding of both the U.S. housing market and Wall Street, he and his team
decided to gain from the loopholes existing between the two and Eisman thus shifted to being
a bond trader from a stock trader.

Chapter 2 focuses on Michael Burry who gave prominence to his obsession with the stock
market/value investing rather than his profession as a doctor. In 2004, he started his own
hedge fund- Scion Capital in which big-shot investors put their money. Burry spent the years-
2014 & 2015 investigating the MBS (Mortgage Backed Securities) and next discovered
Credit Default Swaps (similar to an insurance policy). He approached the big banks to create
Credit Default Swaps on mortgages that will pay off if the underlying bond failed. He started
to buy several hundred million dollars in CDS from Deutsche Bank, Goldman Sachs etc. and
thereby was able to short $10 Million during the first quarter of 2015. Later in 2005, many
investors like Greg Lippman, the head trader of Deutsche Bank bought back CDS from Burry
and thereby placed his bet against the subprime mortgage market.

Chapter 3 begins with pointing out the differences between the stock market and the bond
market implying that the bond market is comparatively complex and less regulated. In
February 2006, Greg Lippman approached FrontPoint Partners to convince them in buying
credit default swaps on the crappiest triple-B CDS on mortgage bonds so that he could collect
hefty fees. Meanwhile, triple-A rated entity AIG FP was taking the long side of these bets
(sold CDS) believing that house prices will keep on rising indefinitely. Also, Goldman Sachs
came up with synthetic CDOs and sold them to AIG FP earning a profit of $400 million in
the process.

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In Chapter 4, it is seen that Gene Park- an employee of AIG FP alerted the company about
the risky line of work with the Wall Street firms. Consequently, AIG FP stopped making any
new CDS trade. Meanwhile, convinced by Lippmann, Eisman stepped into betting against the
subprime mortgage bonds since premiums on even the worst bonds were less than 2% of the
face value of the bond per year. This was a minor cost ($2 million) compared to what he
would earn ($100 million) once the subprime market crashed. Besides, in May 2006, the
announcement of falling property price and change in Standard & Poor’s model of rating
subprime bonds stirred Wall Street. The rating agencies placed exaggerated ratings on
worthless mortgage securities owing to their faulty model as well as self-absorption.

Chapter 5 showcases 30-year-old Jamie Mai & Charlie Ledley (Accidental Capitalists) who
formed the supposed garage hedge fund- Cornwall Capital. Their initial success was based on
purchase of options (LEAP) which delivered profit of around $526,000. Later on, Benn
Hockett who quit Deutsche Bank after 9 years of employment joined Cornwall Capital and
assisted them to obtain an ISDA agreement with Deutsche Bank. This allowed them to buy
$110 million worth CDS on AA tranches of CDOs which would take longer to flop.

Chapter 6 takes off with Annual Subprime Conference in Las Vegas on January 28, 2007
attended by every big player in the mortgage market. In this event, Greg Lippman
orchestrated a meeting where Steve Eisman met Wing Chao, a CDO manager whose job was
to select a Wall Street firm to supply him with subprime bonds that could serve as collateral
for CDO investors. However, negligent managers like Chao neither monitored the individual
subprime bonds inside each CDO nor replace the bad with better ones. Thus, Steve’s doubt
about the housing market collapse was confirmed and he bought Credit Default Swaps on
Wing Chau’s CDOs. Eisman also understood that Wall Street was dependent on these bets
against credit default swaps in order to create more duplications of bonds backed by home
loans and keep the cycle running. At the same time, Jamie & Charlie were trying to fathom if
their investment in AA-rated CDOs was wise and came to the conclusion that the entire
financial system was disastrous.

In Chapter 7, we come across publicly traded index of BBB subprime mortgage bonds which
started to fall on fall in price on Jan 31, 2007. That is, subprime loans started defaulting in
large numbers. Morgan Stanley stopped selling insurance on subprime mortgage bonds. On
June 14, 2007 Bear Stearns Asset Management suffered a huge loss of $3.8 billion. Right
when Cornwall bought CDOs on the collapse of Bear Stearns from HSBC, HSBC too

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announced a loss. The housing market hit rock bottom when the US Federal Reserve
announced $100 billion in losses.

Chapter 8 begins with the author sketching a direct line between Burry’s Asperger’s
syndrome and his obsession with numbers. If it wasn’t for Burry’s overwhelming knack for
reading lengthy subprime mortgage bond prospectus, he could’ve never predicted the
financial calamity of 2007-08. The author also sheds light on Eisman who regarded himself
as Spider-Man in reference to his constant pursuit of unveiling the “dark forces” of Wall
Street. When the mortgage market started showing some negative fluctuations, Morgan
Stanley, Goldman Sachs decided to purchase Credit Default Swaps again. Conversely,
Michael Burry was compelled to ‘side-pocket’ investments. The investors overlooked
Michael’s gains of 186% over 6 years and held him at gunpoint for the meagre losses in
January, 2017. Overall, the book reaches its climax in Chapter 8 and hints of an awakening of
lenders, traders and rating agencies.

In Chapter 9, it is seen that Cornwall Capital and Michael Burry earned a profit of around $80
million and $720 million respectively. On the contrary, Howie Hubbler, a bond trader at
Morgan Stanley who was selling CDS on AA-rated CDOs suffered a loss of $9 billion
(largest in the history of Wall St.). The largest subprime mortgage lender- New Century was
also flooded by defaults and filed for bankruptcy. And the same happened with Bear Stearns.
Thus, the giant helium balloon disguised as the subprime mortgage market was going bust
anytime soon.

In the last chapter, Eisman is found predicting disaster at a Bear Stearns Conference and at
that very moment, stock started to fall radically. On March 14, 2008 JP Morgan provides
emergency financing to Bear Stearns and bought it for $2 a share on March 16, 2008 when it
collapsed completely. Cornwall Capital, which bought insurance against its collapse, made
$105 million in the process from their original bet of $300,000. In spite of their worst
prediction coming true, Eisman, Michael, Charlie, Danny weren’t overjoyed by their win;
They soon realized how unemployment rate would go up for lower and middle class
Americans owing to this bubble burst.

Initiation of the credit smash is accredited to the length of the easy monetary policy
implemented by the Federal Reserve’s Chairman, Alan Greenspan after 9/11 which is
presented in the last section of the book. Also, it is cited that after the damage had been done,

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the U.S. Government stepped in and bailed out the same firms ($152 billion in TARP funds)
who were responsible for the breakdown. Goldman Sachs, Morgan Stanley, AIG, Citicorp
were bestowed billions in the form of loan guarantees, asset purchases and loans with barely
any collateral. Meanwhile, low and middle income Americans were provided with $600 tax
rebates. By the end of 2008, the Fed had reduced the target interest rate to zero percent for the
first time in history with a view to encouraging borrowing and investment.

3.0 CONCLUSION
My personal experience of reading the book was equally insightful and pleasant. I
particularly liked two metaphors- ‘The Giant Helium Balloon’ and ‘Two Men in a Boat.’ In
case of the first metaphor, the author compares the subprime mortgage market to a giant
helium balloon by quoting "bound to earth by a dozen or so big Wall Street firms." He
explains that each firm on Wall Street held a rope but the balloon would take off someday
lifting them up with it. This elucidates how the firms were engrossed in the subprime
mortgage market and how it grew big and ultimately damaging for each of them. In case of
the second metaphor, we see that although Greg Lippmann originally pictures a tug of war
between Wall Street vs. the short sellers (who bet against the loans), soon he is forced to coin
it as two men in a boat who are tied together by a rope. This metaphor is a demonstration of
how the fate of the short sellers and the people on Wall Street became dangerously entangled
i.e. when the market was about to collapse, it became impossible for one side to win without
also hurting themselves. However, I’m unable to point out my favorite character from the
book. This is because I cannot fathom whether the people on Wall Street were deliberately
ignorant or purposefully evil. Either they overlooked the risks they were taking or they were
intentionally choosing to make money for themselves at the cost of others. For instance,
Burry, Eisman, Ledley could predict the crash before time but they didn’t put any effort to
alert the world. Even though they felt remorse afterwards but their indulgence in self-interest
has quite appalled me. But in the end, I’ve developed a soft spot for Eisman when he risked
losing the bet so that banks wouldn’t suffer a bigger damage. Needless to say, I am baffled at
the fact that the rating agencies, investment firms and banks were not put on trial for such
negligence and erratic course of actions. Furthermore, the closing image ‘Watching people
pass by in New York’ depicts some traders sitting on the stairs of a church in early 2008 and
contemplating how the upcoming recession would hit hard the ordinary Americans. This was
indeed a heart rendering scene.

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So to conclude, the author Michael Lewis did a splendid job in explaining the financial crisis
of 2007-08 and its underlying cause (subprime mortgage crisis) for the readers.

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