While playing ball in Springfield Missouri, I read The Big Short by Michael Lewis. I devoured the pages - screen, actually, as I read it on my Father's Kindle. The book was extremely interesting and informative. It detailed the experiences of some of the investors that saw right through Bank fraud in the Subprime mortgage market. Characters such as Steve Eisman, Michael Burry, Charlie Ledley, and Greg Lippman.
Now then, due to my knowledge of Austrian economics, I was fairly well informed of why America is facing this current recession. I knew that it was the result of malinvestment triggered by credit expansion by the central bank; too many people took out loans that they couldn't afford, so in the moment of mass default, the banks failed, and the artifically low interest rates prompted too much spending without the needed amount of savings to ultimately back up the future investment.
However, I merely assumed that the Federal Reserve lowered the interest rates and the banks were eager to give out bad loans because of a failed economic paradigm. I thought they did so because they believed that giving people more money to spend was a good thing that would not have detriment consequences in the future, even if it was a Mexican lawn mower buying a half million dollar house.
I had heard that there was unmitigated greed and fraud going on in wall street, but I didn't know how it actually happened, so I was eager dispel this mystery by reading The Big Short. The book proved to be enlightening in that it revealed the insides of Wall Street and the motivation that guided the bankers to pursue those reckless policies. What I found was a grand conspiracy of massive proportions.
What happened in the pre-crises days of Wall street was that the Subprime Mortgage market was expanded into its biggest revenue producer. The big banks such as Morgan Stanley and company were no longer satisfied performing their role in serving the consumers by providing credit to those worthy of it, and thus they allocated capital efficiently. Instead, the became enamored by the idea of repackaging subprime mortgage loans into bonds that could be then sold for a profit. There was one problem, however, in finding a buyer for bonds that largely consisted of junk loans that most certainly were not going to pay off. The way they worked around this problem, though, was to assemble a CDO of filled with sour bonds but could somehow be rigged so as to be rated at Triple A status by the Rating agencies such as Moodies and Standard and Poor. This is precisely what they did; they found loopholes in the Rating agencie's risk models and exploited them so that a bond filled with 6 figure loans given to
strawberry pickers would be rated as "riskless." So then entities like AIG would buy the bonds in mass under the illusion that what they were buying was about as safe as a U.S Treasury bond.
The theme of the book is the experiences of a few smart investors that saw the fraud going on and its ramifications for the American economy. These men were in the distinct minority, all contrarians by heart. In fact, one gets the feel that it is only those that harbor a deep-seated cynicism coupled with contrianism that can clearly see what no one else sees. So while the consumers were under the housing hysteria, and the bankers enamored by the way they could make pure profit by packaging junk loans into reliable bonds, renegades like Eisman, Burry, and Ledley saw a massive ponzi scheme that was mathematically bound to fail. The way they ended up making jack was buying billions of dollars worth of credit default swaps on Subprime Mortgage CDO's - essentially a bet that those loans will go sour.
The book is very much worth reading, and will forever alter your conception of the roots of the ongoing financial crises.