Monday, May 17, 2010

Review: The Big Short

The Big Short is Michael Lewis' book about the financial crisis. The book rolled out without a Kindle edition, prompting me to borrow it from the library and costing W.W. Nortin as well as the author a sale.

The book is a quick and easy read, and tells several compelling stories, mostly from the point of view of the people who saw it coming and found ways to profit from the sub-prime mortgage disaster. His ability to get into the heads of folks like Steve Eisman, Michael Burry, and several other traders makes for a fun read, and provides a way to explain the financial crisis without several chapters of what would have been boring exposition.

We really do get to see how incompetent the big investment banks were, in some cases willfully so, because the incentive structure was completely messed up: in many cases (and in the case of Wing Chau, what was good for the individual (Chau made millions running his sub-prime trades) was decidedly not good at all for the market or for the corporate sponsors (Merril Lynch) in this case. There were basic fundamental flaws in the ways the big banks viewed mortgages (such as assuming an extremely low default rate in the face of insufficient history) that makes you realized that Krugman was right in that nationalizing these institutions couldn't possibly hurt: they were so incompetently run that they did not deserve to live, and sad as the government was, it could probably have run those banks better, even if simply by liquidating them. By the way, I once brought up similar incentive problems at an employer, and the VP of Engineering dismissed my concerns, claiming that incentives were no big deal since "people would do the right thing anyway, since when they move on to other companies they'd want their reputation to stay intact. That's the kind of stupidity that hit the big investment banks, apparently simultaneously. Which begs the question, Why the Rush to get Big?

Lewis points out something sad: everyone involved in the sub-prime crisis at the financial level made huge amounts of money. The CEOs (and Wing Chau) made millions, as did Eisman and Burry. But the press did not glorify Eisman and Burry, and did not vilify the CEOs of Merril Lynch, Bear Stearns or AIG for being complete idiots. In many cases, the same guys just went ahead and started new businesses to screw people all over again. Lewis also points out what sweetheart deals Hank Paulson and other government officials offered the various investment banks with the TARP money: they were essential giveaways with no strings attached!

I definitely think that going back to strong financial regulation and making banking an extremely boring and sedate occupation is the right thing to do. The same people would probably cause a lot of social damage at other big companies, but I can't think of any other situation in which they could have caused so much misery.

This book is highly recommended for a unique perspective on the financial crisis. If enough people read it, maybe politicians wouldn't be so willing to bail out big investment banks during the next financial crisis. Or maybe I'm just being too optimistic this morning.
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