Summary and Analysis of The Big Short: Inside the Doomsday Machine

Based on the Book by Michael Lewis

• Publisher: Worth Books
• Year: 2017
• ISBN:
  9781504044295
• Topic: Economics
• Subtopic: Economic History
• Index: Economics

So much to read, so little time? This brief overview of The Big Short tells you what you need to know—before or after you read Michael Lewis's book. Crafted and edited with care, Worth Books set the standard for quality and give you the tools you need to be a well-informed reader. This short summary and analysis of The Big Short by Michael Lewis includes:

• Historical context
• Chapter-by-chapter overviews
• Character profiles
• Detailed timeline of events
• Important quotes
• Fascinating trivia
• Glossary of terms
• Supporting material to enhance your understanding of the original work

About The Big Short by Michael Lewis: The writing was on the wall long before the extent of America's worst financial meltdown since the Great Depression was made public. The mortgage bond market had become burdened with subprime loans, most of which were deceitful in their origination and ultimately resulted in delinquencies and foreclosures. Michael Lewis's The Big Short: Inside the Doomsday Machine takes the reader behind the scenes, introducing the players and Wall Street institutions that unscrupulously helped fuel the housing bubble as well as the few who, not only foresaw the crash, but placed bets on the outcome. The summary and analysis in this ebook are intended to complement your reading experience and bring you closer to a great work of nonfiction.

Summary

Chapter One: A Secret Origin Story

It had to be in his blood. Both of his parents had worked for years as brokers at Oppenheimer, the esteemed financial services firm. They urged him to join them. Steve Eisman surely felt the desire to get into the financial sector, too. He eventually did, but only after graduating from Harvard Law School and realizing that being a lawyer wasn’t what it was cracked up to be. Eisman was outspoken with little desire to be like everyone else. He didn’t seek consensus from those in the room before expressing his point of view, and was known to speak out of turn. Such brashness would make some of those around him cringe, but it would be welcomed by those he championed and a few associates in the years to come as the subprime mortgage debacle started to overheat.

Eisman’s first foray in the subprime mortgage industry would come during his days as an attorney representing the Money Store, which was active in the subprime mortgage market in the 1990s. Management at Oppenheimer viewed this as good experience, using it to propel him to lead analyst covering Ames Financial, a subprime mortgage lender. And along the way, he became something of a Pied Piper, a surrogate for those he knew were being misled.

Wall Street’s initial interest in subprime mortgage lending had started at least two decades before the Great Recession, which ran from December 2007 to June 2009. Those in the bond industry began speculating on the rate that solvent Americans would repay their mortgage through refinancing. Wall Street was wading into waters it hadn’t treaded before: Americans’ ability to pay their debt, in this case, home loans.

Need to Know: The subprime mortgage market evolved astonishingly fast. In the 1980s, the quality of loans underpinning a mortgage bond was good because standards for the loans were being met. The 1990s ushered in a new era of subprime mortgage lenders, poorer quality of loans, and second mortgages.

Chapter Two: In the Land of the Blind

In 2004, Michael Burry, a neurologist turned hedge fund manager, decided to get into the bond market. He was especially interested in subprime mortgage bonds. He knew about the towers—the “stacking” or “bundling” of home mortgage loans. There were the designated top and bottom floors that investors could get in. Top floors were low risk and low return, but you saw profits quickly; bottom floors were high risk and potentially high return, but they took longer to pay off. Top floors housed bundled loans, or bonds, that rating agencies Moody’s and S&P labeled triple-A (the highest possible rating). Burry didn’t want either of these. His focus was on shorting or borrowing and betting against the subprime mortgage bonds.

Burry began earnestly reading mortgage bond prospectuses—an activity few investors would have the patience for—and soon saw a trend developing in the subprime mortgage industry. Within a matter of months in 2004, the number of adjustable rate mortgages (ARMs) in a pool of loans increased from 5.85% to 17.48%. How could this be, he wondered, when other categories like the FICO scores and percent of no-documentation (no-doc) loan-to-value measures remained unchanged? With the increase of ARMs, one would expect to see higher FICO scores and lower loan-to-value measures. However, what Burry saw was a higher rate of “interest-only” mortgages leading him to believe that the quality of loans wrapped up and bundled for investors was substandard.

Burry wondered how standards set for home loans could be compromised, not just by the lender but by the borrower as well. Within a two-year timeframe, between 2003 and 2005, restraint had become an obsolete word for both lenders and borrowers.

There was a way for Burry to capitalize on this market, as he had come across credit default swaps (CDS) a couple of years earlier. CDS is a misnomer of sorts as there were no actual swaps of any kind. At the time these were, essentially, insurance policies on corporate bonds. Burry was concerned about the real estate market and the potential for a free fall, given the lower standards by which lenders were doling out home loans. He suspected that there was trouble ahead for players including the lenders, insurers, and firms that owned subprime mortgage bonds. Constantly educating himself on finance issues, he began studying credit derivatives, which led him to the idea of applying CDS to the subprime mortgage bonds. He believed there was cause for concern regarding the quality of subprime mortgage loans made in 2005: Most of them, he felt, would go bad. But it was a timing issue.

At the end of the first half of 2005, defaults on credit cards were at an all-time high. Home prices continued to climb and, astonishingly, Wall Street was finding even more ways to loan money to people. Following the latest data, Burry was even more convinced that the subprime mortgage industry was going to collapse. He wasn’t pining for an Armageddon in the industry. After all, his responsibility was to his investors.

He saw an opportunity to make money on an overheated financial sector and he took it. He was determined to short the sector. Upon learning that Burry’s Scion Capital fund was increasingly focused on credit default swaps, his investors were none too pleased, as they counted on his accurate stock predictions on the equity side of the house. However, he knew what they didn’t: A fortune was coming their way via these credit default swaps, even if the number of defaults was small.

Need to Know: In 2004, it became apparent that subprime mortgage lending standards had started to decline. Lenders were eager to hand over credit to borrowers who, in prior years, would not have qualified for such loans. Borrowers with little or no credit took the loans knowing they would not be able to afford them. New investors in the market began to see the insanity of the subprime market loans and began to short the bonds that housed the loans.

Chapter Three: “How Can a Guy Who Can’t Speak English Lie?”

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