Books: The Big Short

Michael Lewis. That guy is awesome.

So. The Big Short is my first pick of books that must be read on the Subprime Crisis. It is that good that I have bought it, given it away, bought it again, given it away again, and finally bought it as an iBook. But that doesn't stop me trawling secondhand bookstores in the hope that I might find more copies to be distributed amongst the nearest and dearest.

Why am I so enamoured?

Well - because it has this uncanny continuity to its storyline. Michael Lewis was a trader at Salomon Brothers back when John Meriwether and his team were playing with the first Mortgage-Backed Securities. His book "Liar's Poker" was written in the 80s, and it's quite the industry classic. I've reviewed it before here. And then the MBS turned around and caused a crisis. Literary gold.

Also, on a personal bias front, I just really appreciate the fact that Michael Lewis began life in the industry. Often, I read articles published by so-called "financial journalists" - and I wonder if they really understand what they're talking about. And having met a few, I get the feeling that many financial journalists did BA degrees and went into the business section because that's where they found an opening. And then the years of experience have led to a lot of industry savvy but not very much know-how.

So really, what I'm saying is, I like Mr Lewis' CV.

Okay - back to the book. Firstly, I guess, what does the title mean?

Well - a "short" is generally financial jargon for selling. When I short the market, it means that I'm voting with the market going down, so I'm going to sell my investments now. But actually, that doesn't allow me to make money, because I've just limited my losses. When we talk about "shorting the market", what I'd really like to be doing is the following:

1. Borrow the actual investment from someone;
2. Sell it;
3. Buy the investment back once the price goes down;
4. Give the investment back to the guy I borrowed it from; and
5. Keep the profit I made.

That, in a nutshell, is "short-selling". I get to take a bet on the market falling. And from whom would I borrow the investment (usually shares - referred to as "scrip" in the industry)? Institutional investors like pension funds. Pension funds are not into short-term movements in the price of investments. In terms of their mandates, they invest for longer periods of time. So if I borrow scrip from them in return for a fee, they get to generate a little extra on the side, whilst continuing to abide by their investment policies. And their exposure is the same, as they still end up with the same scrip at the end of the day.

Win. 

So why is this the Big Short? Well - the investors that the author is interviewing and writing about were the guys that made the right call on the collapse of the subprime mortgage market. These guys (hedge-fund managers, asset managers, etc) wanted to short the market, so they approached the big boys (the investment banks and insurers), and started entering into Credit-Default Swap arrangements.

Brief recap: a CDS arrangement is basically an insurance policy over a security issue without the annoying obligation to own the securities. These kids went and bought plenty of these CDSs.

And then when the market crashed, they made a fortune. A mind-blowing one. 

Read it.

Today.