Otis Chandler's Reviews > The Big Short: Inside the Doomsday Machine

An extremely well-written account of the 2008 financial collapse. It explained complex ideas like subprime mortgage bonds and CDO's in a clear way, and almost read like a fast paced thriller.

Essentially it seems that a bad ratings system and human greed created an economy that fostered the creation of a lot of bad debts, that eventually went bad, and caused a lot of big companies to go under (Lehman brothers, Bear Sterns), or require a bailout (Goldman Sachs, AIG). This is the real crime. These big companies were so focused on short term profits that they failed to see that long term what they were doing wasn't going to work. They should be appropriately punished for this, and instead many of them were saved by Uncle Sam. Would we have had a worse recession if Obama hadn't done that? Maybe. Maybe not. Lewis should write another book about that :)

Let me see if I can get this right. The book explains that mortgages are sold by the banks that issue them, passing off the risk. Mortgages are aggregated into groups in mortgage bonds, which are then packaged into tranches, which are rated by agencies such as Moody's and S&P's. The math was complex, but apparently somehow tranches that consisted almost entirely of "subprime" (aka risky) mortgages were being given high A ratings. I guess the theory was that by spreading out the risk across lots of mortgage bonds it lowered the risk. Too bad this didn't work.

Many of these mortgages were the variety that started 2 year fixed then went floating. They were largely taken out in 2005 - 2006, and as they hit 2 years the interest rates jumped as they went floating, and hoards of people defaulted. This explains why we teetered in 2007 and crashed in 2008. One of my favorite quotes to illustrate the madness:

"In Bakersfield, California, a Mexican strawberry picker with an income of $14,000 and no English was lent every penny he needed to buy a house for $724,000."

And it wasn't just in Bakersfield. All over the country people were taking out loans that were too big for their britches, because the banks were encouraging it:

"The simple measure of sanity in housing prices, Zelman argued, was the ratio of median home price to income. Historically, in the United States, it ran around 3:1; by late 2004, it had risen nationally, to 4:1. “All these people were saying it was nearly as high in some other countries,” says Zelman. “But the problem wasn’t just that it was four to one. In Los Angeles it was ten to one and in Miami, eight-point-five to one."

Economics is about incentives, and this book explained how they went very awry. But it was also a story about greed, and how even unintelligent people made a lot of money by riding the subprime mortgage train. The book followed several investors who noticed what was happening, but when they tried to tell people and test their "crazy" hypothesis that the financial world was going to collapse, they were mocked or ignored. So they just ended up shorting (betting against) the whole thing to make some money, which is what a good investor does.

"What are the odds that people will make smart decisions about money if they don’t need to make smart decisions—if they can get rich making dumb decisions?"

I think the lesson in the end is that if it looks to good to be true, it is. That, and we need smarter people working at the ratings agencies.