The Big Short By Michael Lewis

To the author, bankers do not provide much social utility and they are highly overpaid. Not enough attention is paid to the fraud cases. Meredith Whitney, a nobody, shocked the bankers in Citigroup in Oct 2007 by claiming that they had mismanaged their assets. She was basically saying that bankers were stupid. People like John Paulson, Steve Eisman made a fortune betting against the banks.

Steve Eisman is from a research firm, Oppenheimer, which was run like a family business. He started off as an equity analyst. He built his reputation and eventually his opinions had the ability to stir the market. His peers described him as fearless, smart and honest. People on Wall Street think he’s rude, obnoxious and aggressive. In the early 1990s, subprime mortgage loans started. The plan was to turn all these loans into bonds/securities that can be marketed. The loans underlying the mortgage bonds were guaranteed by several government agencies. Many took to buying these mortgage backed securities (MBS). The point was to take the consumer from a high interest rate category to a lower one. Eisman hired Vincent Daniel to work for him. When you buy the MBS, you also assume part of the risk. Cheap loans are a way to make people feel rich. The subprime lending companies used shady accounting. Eisman moved to a hedge fund, Chilton Investment and analyzed consumer loans. The poor and middle income group gets neglected as the regulation does not really protect them. The teaser rates that the subprime companies offered were not true rates. Fuck the poor. Eventually, Eisman started his own equity fund. The credit quality was still good until the second half of 2005. ‘It was the golden rule. The people who have the gold make the rules.’

You have to understand. I did subprime first. I lived with the worst first. These guys lied to infinity. What I learned from that experience was that Wall Street didn’t give a shit what it sold. – Steve Eisman

The market might have learned a simple lesson: Don’t make loans to people who can’t repay them. Instead it learned a complicated one: You can keep on making these loans, just don’t keep them on your books. Make the loans, and then sell them off to the fixed income department of big Wall Street investment banks, which will in turn package them into bonds and sell them to investors. – Michael Lewis

Michael Burry got in on the act and short subprime mortgage bonds. He pored through financial statements and prospectuses. By 2005, the lenders had lost their game. They degraded their standards to boost loan volumes then sold the loans to the big investment banks. It was hard to borrow stocks/bond in the market. Therefore, Michael Burry decided to buy credit default swaps on subprime mortgage bonds instead (limited downside, max upside). He pestered the big banks to create that instrument. He was socially awkward and preferred emailing others instead. He had bipolar disorder. ‘My nature is not to have friends. I’m happy in my own head.’ He started his own investment blog. He started Scion Capital, which was a huge success. Michael avoided shorting stocks and engaged in value investing. This meant analyzing company financials closely; even those in the short term, the share price might be falling. He bought millions of dollars’ worth of credit default swaps from big banks, betting against the subprime loans. Many of his investors didn’t like the fact that he was moving away from value investing in equities. The banks become desperate and wanted to buy the credit default swaps he owned. He sold back those he owned to Greg Lippmann, a trader at DB/ However, Greg thought that being in the short position for these CDS would be beneficial as it was eventually sold to AIG.

I don’t take breaks in my search for value. There is no golf or other hobby to distract me. Seeing value is what I do. – Michael Burry

To succeed in a spectacular fashion, you have to be spectacularly unusual. – Michael Burry

The stock market is lot more regulated than the bond market. Therefore, it is easier to manipulate the bond market. Lippmann was a bond salesman for DB. Greg Lippmann (DB trader) was selling bonds (short position) offered by Deutsche Bank to Eisman even though he knew the bank would lose a lot of money. Eugene Xu, a Chinese national was responsible for churning the hard numbers for Lippmann. AIG were the ultimate insurers on the credit default swaps. Since it was unlikely that many investment-grade companies would default at the same time, it seemed like offering corporate credit default swaps made sense. However, the banks tricked them and sold them in essence ‘subprime mortgage CDS’. Goldman Sachs created the Collateralized Debt Obligation – to redistribute the risk of corporate and government bond defaults to the risk of subprime mortgage bonds. Goldman Sachs paid the rating agencies a huge sum of fees to get them from BBB rated initially to 80% triple A rated. GS got the rating agencies to think that the different ‘towers’ of BBB loans were diversified. Lippmann eventually when short on subprime mortgage bonds. Not many were willing to bet against the market at that time.

Senior management’s job is to pay people. If they fuck a hundred guys out a hundred grand each, that’s ten million more for them. They have four categories: happy, satisfied, dissatisfied, and disgusted. If they hit happy, they’re screwed up: They never want you happy. On the other hand, they don’t want you so disgusted you quit. The sweet spot is somewhere between dissatisfied and disgusted. – Greg Lippmann

Gene Park from AIG realized they were in trouble. Joe Cassano, head of AIG FP, was terrifying. Nobody dared to challenge him. He was like a dictator. It was like a bet on whether house prices would fall. In 2006, the subprime mortgage machine roared on despite AIG stopped insuring such CDS. AIG stopped selling credit default swaps to Wall Street. Lippmann met Eisman at a meeting. ‘The problem with someone who is transparently self-interested is that the extent of his interests is never clear.’ S&P changed its model to value subprime mortgage bonds. Loans made to poor immigrants were most likely to default. ‘Guys who can’t get a job on Wall Street get a job at Moody’s. FICO aimed to measure the creditworthiness of individual borrowers. The rating agencies used an average rating for FICO and the information could be easily rigged, such as placing greater weight on ‘thin-file’ FICO score. Even the people at the rating agencies didn’t know what they were up to.

We were doing every single deal with every single Wall Street firm, except Citigroup. Citigroup decided it liked the risk, and kept it on their books. We took all the rest. – Gene Park

Many institutional investors bought insurance on subprime as a hedge against their real estate stocks. Only a handful noticed that the market was collapsing. Even John Paulson heard Lippmann’s pitch. Housing prices started falling in the summer of 2006. Charlie Ledley sought to make money by betting on what was the least likely to happen on Wall Street. He believed private markets were more efficient than public ones. Charlie bought options on companies. They engaged in event driven investing. Ben Hockkett, a trader, joined Jamie and Charlie’s team. The losses were trivial compared to the gains. Eventually, they got DB to trade with them and an approved ISDA. They bought CDSs for Greg Lippman at DB. They soon exploited CDOs as it was cheaper than CDSs.

It’s really hard to know when you’re lucky and when you’re smart. – Charlie Ledley

As a private investor you are a second class citizen. The prices you get are worse, the service is worse, everything is worse. – Jamie Mai

Lippmann had to fork out huge premiums as the credit default swaps had not gone bad yet. The triple-B tranche of mortgage bond (CDO) was ‘the equivalent of three levels of dog shit lower than the original bonds.’ Wing Chau, a CDO manager, sold the CDOs to big multinational banks. He didn’t give a damn about whether the investors won or lose money. Charlie and Ben began to doubt what they were doing. None of them believed in gambling at the casino. Almost everyone there was in a long position. Many relied on the ratings from the agencies. They were all like underpaid government employees.

Who the fuck lends money to people who can’t make the first payment? – Steve Eisman

You know when you’re with someone who is intellectually powerful: You just know it. When you sit down with Richard Posner (the legal scholar), you know it’s Richard Posner. When you sit down with the ratings agencies, you know it’s the ratings agencies. – Steve Eisman

They weren’t getting satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn’t afford. They were creating them out of whole cloth. One hundred times over! That’s why the losses in the financial system are so much greater than just the subprime loans. – Steve Eisman

It was Jan 2007. The banks stopped offering CDS at this point, apart from Wachovia. Moody didn’t want to re-rate the bonds. The market was still surprising upbeat at this stage. Steve Eisman wanted to short a lot more positions, such was his confidence.

They didn’t know. They didn’t know their own balance sheets. I was sitting there listening to him (CEO of BOA, Ken Lewis). I had an epiphany; I said to myself, ‘Oh my God, he’s dumb!’ A lightbulb went off. The guy running one of the biggest banks in the world is dumb! – Steve Eisman

When I read it, Oh my God, this is like owning a gold mine. When I read that, I was the only guy in the equity world who almost had an orgasm. – Steve Eisman

Wachovia was a gift from God. It was like we were in a plane at thirty thousand feet, which had stalled, and Wachovia still had a few parachutes for sale. No one else was still selling parachutes, but no one really wanted to believe they were needed, either. After that, the market completely shut down. – Charlie Ledley

We turned off CNBC. It became very frustrating that they weren’t in touch with reality anymore. If something negative happened, they’d spin it positive. If something positive happened, they’d blow it out of proportions. It alters your mind. You can’t be clouded with shit like that. – Danny Moses

New financial instruments were created with the aim of lending to people who can’t repay. Michael Burry has Asperger’s syndrome. He can’t control what he was interested in. The banks will continue to attract such investors and hide from them their actual losses. ‘One of the oldest adages in investing is that if you’re reading about it in the paper, it’s too late.’ The big banks call the shots. Burry’s investors were extremely dissatisfied. Some even tried to sue him. People are always quick to criticize. To him, the market seemed fraudulent and delusional. The third quarter of 2007 was when the market truly headed downhill. This was the time the bankers started to bet against the market too. Despite the fact that he was now making money, his investors did not mention a word of gratitude.

I have always believed that a single talent analyst, working very hard, can cover an amazing amount of investment landscape, and this belief remains unchallenged in my mind. – Michael Burry

Howie from Morgan Stanley kept thinking of trades in order to fool the customer. It is possible to make loads of money at hedge funds. He took a huge risk by buying excessive CDOs on ‘triple A’ rated tranches of loans. He deceived himself. ‘The subprime mortgage market resembled a giant helium balloon, bound to earth by a dozen or so big Wall Street firms.’ Like most, he was delusional and was overly optimistic. Success is attributed to the particular individual, failure is collectively spread. ‘The correlation among triple-B rated subprime bonds was not 30%. It was 100%.’ ‘CDO were either worth 100% or 0%’. Howie left the firm. He made the single largest trading loss in history. 9 billion dollars. Even the CEO could not explain this. Even UBS got in on the act. Banking is a very important business and has repercussions on other sectors. It is very dangerous when customers start withdrawing their deposits.. Michael Burry was sick of finance and he decided to buy a guitar. LOL. ‘It was as if bombs of differing size had been placed in virtually every major Western financial institution. The fuses had been lit and could not be extinguished.’

This refers to both the financial institutions and the US citizens. In the same boat. All the banks were heavily leveraged. At 20:1 on average. Many of the CDOs were off balance sheet. People panicked and started to withdraw their money from money market funds. Interest rates spiked. Michael Burry eventually closed his hedge fund as he didn’t feel appreciated.

In 2008 it was the entire financial system that was at risk. We were still short. But you don’t want the system to crash. It’s sort of like the flood’s about to happen and you’re Noah. You’re on the ark. Yeah, you’re okay. But you are not happy looking out at the flood. That’s not a happy moment for Noah. – Steve Eisman

I sort of feel sorry for him because he’s a guy who is really smart who was basically wrong about everything. – Steve Eisman on ex-Fed Reserve Chairman, Alan Greenspan

Bonuses remained excessively high just before the crisis struck. The current crisis took its ideas from 1985. The crisis was caused by greed by both the investors and bankers. People were just interested in short term gains and neglected the possibility of long term losses. Freddie and Fannie Mae was nationalized. AIG had to be bailed out. Lehman Brothers, Bear Stearns, Wachovia, Washington Mutual collapsed. Merrill Lynch got bought over by BOA. Objective of TARP was to buy the lousy positions held by banks. The US Treasury simply gave billions to banks, as a ‘gift’. A major problem was the lack of sufficient regulation.

Derivatives are like guns. The problem isn’t the tools. It’s who is using the tools. – Michael Lewis



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