Wednesday, April 21, 2010

The Big Short: Sequel to Liar's Poker?

"The Big Short." The book by author Michael Lewis that has raced to the top of the New York Times best-selling list only a month after publication. The book many in finance are talking about over the last week. The book that has become a must-read after last week's Goldman Sachs allegations by the SEC--if only to understand better CDO's and CDS's tied to mortgage markets. Collateralized-debt obligations. Credit-default swaps linked to subprime loans.

Several weeks ago, when the financial press hinted at the new book, one had to wonder what else was there to say or write about regarding the financial crisis. What could possibly be Lewis' spin on the collapse of mortgage markets and the subprime debacle after a dozen or so books have already attempted to pontificate over what happened in 2006-08?

In his epilogue, he acknowledges he thought of doing a soft sequel to his best-selling book "Liar's Poker." That book chronicled his experiences as a junior bond trader at Salomon Brothers. It reached the top of best-selling lists, describing with candid humor the sometimes-vulgar, wealth-generating culture of trading bonds at a major investment firm. That book, at least among finance types, is regarded a classic. MBA students today, who were barely toddlers when it was published, still discuss it or put it on their summer reading lists.

This book, "The Book Short," is "Liar's Poker" with a 2010 twist. In the 1980's, Lewis was a player and participant. In 2010, Lewis is an outsider--older, distant, and more confident in his survey and assessment of what happened in the subprime debacle. Lewis' prior stint on Wall Street gives him an advantage to explain the daily pressures, grind and intoxication of profits in derivatives trading. He has authored many successful books (including "Blind Side" and "Moneyball"). This experience and special skill allow him to tell a polished story and keep his readers intrigued, no matter the subject--even if the subject is shorting markets via the credit-default swaps.
Lewis tells how a handful of traders and fund managers painstakingly made hundreds of millions by betting on the collapse of the subprime mortgage market. Did they have special insight? Did they do proper homework or analysis? Did it take a special, neurotic character to forecast doom? Or were they just plain lucky?

It was as if he picked up decades later where Liar's Poker ended and described a more advanced, more insane (to him) chapter in bond markets--CDO's and CDS's in subprime loans. Or get this: synthetic CDO's, based on counterparties taking different sides in a credit-default swap tied to subprime mezzanine bonds linked to subprime loans.

If that doesn't make sense immediately, then some second-year MBA finance courses can delineate it mathematically. Or you can read Lewis' book, a primer on CDO's and CDS--without the math, without the fragile, bewildering deal structures, and without the bell-shaped statistical curves. He describes CDO's as a multi-floor office tower, where the sludge was supposed to be in the basement--not on the middle and top floors (where it turned up). At his best, he describes the opaqueness and whims of the market, the day-to-day "marking to market," the collateral required to maintain positions, the ugly pricing disputes, the highly paid dealers, panicking investors, and the general empty feeling that nobody is overseeing it all.

If you want to understand thoroughly the Goldman Sachs Abacus transactions the SEC has targeted, read this book.

This sequel is not a reflection of a disenchanted twenty-something trader. It is the wisdom of an informed outsider who decided to take a peek at his old world. Sardonic, cynical, drawing humor from chaos. Lewis explores motivation by greed, but zooms in on most people's disregard of the possibility that the worst case can happen.

The actual story centers around three disillusioned investment groups who aspire to find a way to bet their convictions that the mortgage markets will collapse at some point in the future. Meanwhile, they watch their positions, suffer anxiety attacks, and fend off investors.

Lewis explains derivatives with parables and analogies and tries to show how personalities and behavior can move markets. He describes the market with a talent to amuse and make any CDS pricing dispute interesting.

With Goldman allegations under watch for the next several months, Lewis may need to add a chapter or two. He's doing so with regular appearances in the financial media to sell the book and to present the chapter he would have written.

Lewis says there will surface more CDO and CDS deals (subject to SEC investigation or presented to the public for similar scrutiny) that will get headlines or be subject to public backlash.

And he knows he'll need to add not one, but two or three more chapters in the book's inevitable second edition.

Tracy Williams

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