Tuesday, December 7, 2010

Review Tuesday: 'The Big Short'

Today’s ‘Review Tuesday’. How do you explain the importance of a credit default swap on a double-A tranche of a sub-prime-backed collateralised debt obligation? It’s not an easy thing to do. But in The Big Short [1, 2], US economist and financial writer Michael Lewis [3] tries. And succeeds. The Big Short is a non-fiction account of the GFC: its origins, processes and outcomes. And to his considerable credit, Lewis has written it in a manner that even I – a world financial system ignoramus – can understand. Ergo his book doesn’t include, or need, a glossary. The villains of the GFC story are too many for Lewis to mention. Though he writes, tellingly, that most of them emerged from the GFC wealthier than ever. But Lewis’s focus is a handful of men (but no women, apparently) who foresaw the GFC. Specifically they predicted the US housing bubble would burst when subprime mortgage borrowers defaulted on their mortgages once their honeymoon (‘teaser’) interest rate period ended. These prescient men (one with Asperger’s) bet against the bubble by buying credit default swaps, i.e. insurance policies against mortgage defaults [4]. Of course their prediction was correct. And it earned them millions of dollars. But initially they didn’t know where to put these millions because no US bank was safe from collapse. In The Big Short, Lewis tells a complex story in an absorbing and digestible way. It’s far and away the scariest book I’ve read this year.

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