The Big Short by Michael Lewis
I came late to the Michael Lewis party, but I’m enjoying it now that I’m here.
In The Big Short, the latest book by the author of Liar’s Poker, Lewis looks at the market meltdown of 2007-2008 from the point of view of the investors who saw the disaster coming and hoped to profit from it. His lively and irreverent style (his standard term for poor mortgage bonds isn’t risky or low-quality but “crappy”) makes for an absorbing read.
Many people have commented on the complexity of the bonds and derivatives created to exploit the mortgage market. On p. 127, Lewis describes how the artful use of language helped shed additional darkness on the subject.
The subprime mortgage market had a special talent for obscuring what needed to be clarified. A bond backed entirely by subprime mortgages, for example, wasn’t called a subprime mortgage bond. It was called an ABS, or asset-backed security. When Charlie [Ledley of the hedge fund Cornwall Capital] asked Deutsche Bank exactly what assets secured an asset-backed security, he was handed lists of abbreviations and more acronyms—RMBS, HELs, HELOCs, Alt-A—along with categories of credit he did not know existed (“midprime”). RMBS stood for residential mortgage-backed security. HEL stood for home equity loan. HELOC stood for home equity line of credit. Alt-A was just what they called crappy mortgage loans for which they hadn’t even bothered to acquire the proper documents—to verify the borrower’s income, say. “A” was the designation attached to the most creditworthy borrowers; Alt-A, which stood for “Alternative A-paper,” meant an alternative to the most creditworthy, which of course sounds a lot more fishy once it is put that way. As a rule, any loan that had been turned into an acronym or abbreviation could more clearly be called a “subprime loan,” but the bond market didn’t want to be clear. “Midprime” was a kind of triumph of language over truth....
“It took me a while to figure out that all of this stuff inside the bonds was pretty much exactly the same thing,” said Charlie. “The Wall Street firms just got the ratings agencies to accept different names for it so they could make it seem like a diversified pool of assets.”
Eventually, like a con man who starts to believe his own con, professional investors were fooled and confused by the very language they created.
Howie Hubler [of Morgan Stanley] was taking a huge risk, even if he failed to communicate it or, perhaps, understand it. He’d laid a massive bet on very nearly the same CDO tranches that Cornwall Capital had bet against, composed of nearly the same subprime bonds that FrontPoint Partners and Scion Capital had bet against. For more than twenty years, the bond market’s complexity had helped the Wall Street bond trader to deceive the Wall Street customer. It was now leading the bond trader to deceive himself.
The result of Hubler’s bet was a loss of nine billion dollars for Morgan Stanley, “the single largest trading loss in the history of Wall Street.”
