Jeff Hirsh Read: June 2023
Inspiration: Had seen the movie, and studied the Great Financial Crisis, but never had read the original book
Summary
Written with the help of ChatGPT, below is a brief summary to understand what is covered in the book.
“The Big Short”, published in 2011 by author Michael Lewis, is a gripping narrative that unravels the complex financial events leading up to the 2008 global financial crisis. The book follows a group of quirky and insightful investors who predicted the impending collapse of the housing market and made enormous profits by betting against the system. Lewis exposes the flaws and unethical practices within the financial industry that contributed to the crisis, such as subprime mortgage lending and the creation of complex financial instruments. Through vivid storytelling and in-depth research, the book sheds light on the greed, ignorance, and systemic failures that ultimately led to the devastating economic fallout. “The Big Short” offers a compelling and accessible account of the financial crisis, exploring its far-reaching implications and urging readers to question the stability and ethics of the financial system.
Unedited Notes
Direct from my original book log, below are my unedited notes (abbreviations and misspellings included) to show how I take notes as I read.
Steve Eisman went to Penn then Harvard Law and was doing well but hated law so hired by parents at Oppenheimer as research analyst early 90s, first accounts got sole coverage of were first subprime mortgage lenders to go public, most researchers paid to support companies but Eisman put sell ratings since he thought appropriate, was honest in a way that made many dislike him but those close loved him and saw him simply as committed to his work and his thoughts, subprime loans created to get lower income consumer out of high interest credit card debt and into lower interest mortgage debt as leverages mortgage as asset (supposed to be helpful), Eisman hire Vincent Daniel 1996 to dig into subprime lenders and sept 1997 release report essentially calling all Ponzi scheme, only account profits, hide deliquencies, Russian default and LTCM collapse soon prove correct in 1998, 2002 Eisman at new hedge fund dig into Household Financial Corp making consumer loans—find deceiving owners into taking on 15 year loan disguised as 30 year so say 7% rate when really 12%, was largest subprime lender at the time, then sold to HSBC for $15bn—drive Eisman’s cynicism of finance, should be criminal, 04 set up own fund but could only get $50mm from one insurance company, fund was under Morgan Stanley who let him focus on American finance, consumer finance was essentially ripping off the poor and by 05/06 up to $500bn in subprime lending (even as int rates rise), and increasingly subprime loans were floating rates (so not know how bad ripped off), originate and sell model take off as make loans but not keep on books—sell to massive banks who package into bonds, loan companies were same characters Eisman saw in 90s which he predicted go bankrupt, wall street simply not care, Michael Burry another investor digging into bonds/subprime lending, credit default swaps=not really swaps but more an insurance policy with fixed term and semiannual premium pmts (fixed downside, unlim upside), CDS originally way banks hedged w/o denying clients (if default CDS buyer gets huge payout or just loses premium), Burry have idea for subprime loans CDS, subprime loans had 2 year teaser rate so in 05 as Burry do this he thought had 2 years, however CDS of subprime mortgage bonds not exist so needed a bank to create it but needed bank to survive a crash so payout, Burry had obsessive personality, loner, went to med school but no interest in practicing, happy though just not have friends, 1996 began stock blogger in free time late a night and had knack for right moves in internet stocks, 1998 leave medicine to start Scion Capital and decently known for his blog, started with $1mm and by 2004 over 600mm AUM and had to turn money away, crushed the market, Burry also refuse to take standard 2% mgmt fee on assets—only take profits, just read 10K’s and made good buys, Burry create CDS contract mortgage bonds and trade with GS and DB at first, looked for worst mortgages in a pool—study prospectuses to asses location, lack of income proof, loan to value ratio, in 05 began accumulating swaps and begging banks for more, banks happily sold him CDS swaps on worst bonds (most likely to default and make Burry money), banks didn’t understand, by July 2005 had $750mm in swaps, zero sum game, GS was seller but really ultimate seller was insurance company, later 2005 credit card deliquincies rising, int rates rising but mortgage rates falling nonsensically as banks lend out at all costs, grow to $1bn and try to get more/standalone fund but investors concerned since known as stock picker, Oct 2005 big bank trading desks see writing on the wall and want to buy back, Greg Lippman at DB on other side of Burry trades then take idea to Eisman and pitch CDS, Eisman intrigued as solve issue of timing market and at worst out annual premium for handful of years and best make multiples of that, but Eisman confused why bond trader Lippman insist Eisman short his own market, on the other side of Burry trades was really AIG Financial Products unit, critical cog in financial plumbing since JPM invented CDS in 90s—sell policies and collect premium, did for all sorts of consumer loans in 00s such as credit cards, student loans, auto, then banks tack on subprime and AIG simply think another consumer loan—negligent to distinction/risk and became worlds largest owner of subprime, any triple A company with strong BS could have insured these things (Berkshire, GE) but AIG first, GS invent synthetic subprime mortagage backed CDO, mortgage bond consisted of thousands of loans and CDO gathered 100 mortgage bonds (usually riskiest levels) and made new tower of bonds, took 100 diff slices out of mortgage bonds (worst slices) and combine and convince ratings agencies was diversified/safer, Burry CDS essentially a speculative bet with no real home underneath as AIG take full risk on principal if sour, if default then bond holder suffer and AIG suffer with CDS (essentially a replica of bond without need for loan), AIG sold CDS to GS for which GS gave 0.12%, GS got 2.5% from Burry for CDS, filtered via synethic CDO to be triple A, no new loans needed as long as AIG take other side, by early 2006 AIG stop insuring new CDOs—but market roar forward, AIG do nothing to offset $50bn already had), no one also believe housing prices across US could fall at once—though models show not even falling price but simply slowing rise would induce default, May 2006 S&P announce July 1 to change ratings model for subprime and bonds flood market b/c know overrated, also Case Shiller house price index fell summer 2006 but market go on, did on the ground digging on homes/loan docs, example: a strawberry picker in CA with income of 14k was lent every pennt to buy $724k home, lots of immigrant based lending by shady lenders, pools of mortgages rated off average FICO of borrowers (barbell shaped loan pools cheapest but pass 615 avg), also had low income people who never borrow “thin file FICO score” but artificially high, Black Scholes option pricing mode of early 2000s assume bell shaped stock prices (more likely for small mvmt than large jumps, which simply not the case for many) so long dated options particularly cheap on stock where see some jump accelerator, Cornwall Capital Mgmt founded by Jamie Mai and Charlie Ledley—$100k into $12mm in 2 years with options model misalignment trades (event-based trading), eventually get into trading as institutional client of DB with Lippman in 2006, not understand how national home prices falling and underlying loans souring but bond prices not budging and only 200bps to take the risk when buy CDS, bond market terminology not designed to convey meaning but rather bewilder outsiders, not understand who was on other side of CDS (just get answer “the CDOs”), example: mezzanine layer of subprime mortgages just mean riskiest ground floor layer/bottom tranche (mezz sound desireable), not a “subprime backed CDO” but a “structured finance CDO”, subprime mort bonds call asset-backed securities, midprime was term that meant same as subprime (simply designes to obscure reality and make seem diversified, lots of acronyms), CDOs never vetted for underlying slices of mort bonds pulled together to see loans truly underneath, CDOs sometimes include slices of other CDOs couldn’t sell, Jamie and Charlie look at double A Tranches of CDO not just triple b/c same risk at less cost to them, $30mm fund get into $110mm of CDS on double A tranches of asset-backed CDOs (really was synthetic cdo), had mezz CDO on one side and synthetic CDO on other (mezz was triple B subprime, synthetic was CDS on triple B mort bonds), CDO managers were unsophisticated and fill AIG role in 06/07 —package and sell the bad slices of bonds, in Vegas conference Eisman met Wing Chau who was massive CDO “manager” and learn how broken machine was—chau make money on volume and push off CDOs to investors, CDS filtered through CDOs were used to replicate bonds backed by actual home loans b/c investors love end product without actual loans so risk is multiples beyond subprime loans, Eisman want to short everything Chau selling literally, want to buy more CDS, at this conference of those optimist on subprime see that the ratings agencies were just morons—least elite job finance when should be most trusted and coveted, blindly stamp ratings and others trust when have no idea on their clients b/c paid by them so not care, credit ratings analysts were morons and execs crooks, first 6 months of 2007 had subprime bonds default/souring but CDOs price flat—propped up by big banks and agencies not downgrading which made no sense, banks investing in own creation which amplify risks, Eisman and Burry continue to short but facing banks who prop up price, agencies admit had no underlying loan data as rate instruments, had same data as Eisman, GS BoA get to mark the trades end of month and do so in their interest until end of June 07 as now accurately reflect collapsing prices—b/c they got in on trade as well, Bear Stearns’ sister funds belly up on subprime bets that month, June and July 2007 was when unravel and deliquency data spike as teaser rates reset post-2 year period, Burry trades profit, Howie Hubler was MS trader who made $2bn CDO long trade—did quite well until summer 2007, Hubler trust ratings agencies, Hubler insists 10% decline in housing couldn’t happen—would create $2.7bn loss, Hubler thought just collecting free money on interest, key misunderstand at MS was correlation of subprime loans in CDO—thought max was 30% when really 100%, one bad then all bad as same forced at work, models so wrong, Hubler lead to $9bn loss at MS, UBS lost 37bn, still early on no one think Bear Stearns woild fail, Cornwall and Burry offload position at massive profits (cornwall 1m to 80mm, Burry 720mm profit), IMF cited $1tn losses in US subprime market made by banks, Eisman from 700mm to 1.5bn at Frontpoint with bets, March 14 2008 Bear collapse, levered 42:1, Eisman had shorted everyone and certain on Bear—Mar 14 was speaking alongside Bear investor on how screwed all were, Mon Sept 15 2008 Lehman file, Merrill sold to BoA after 55bn losses on subprime backed CDOs, Tues Fed lend 85bn to AIG to payoff subprime CDS selling losses (largest chunk sold to GS), stocks plummet to 4 year lows by Thurs, stocks moving wildly down and no market to exit position, Eisman concerned in MS collapse then fund gone, Citi lost 60bn, Burry fund from Nov 2000 to June 2008 return 489% after fees vs SP500 2%, October gvt step in for rescue and Burry become long stocks but stress killing him and shut fund late Oct, never got recognition for his foresight, crisis was greed on both sides and poor incentives—dumbest still got rich in crisis so not incentivize smart actions, wall street since 1980s became black box, not even CEOs understood own banks, important element is Salomon pioneer banks as public corp where offload risk to shareholders, wouldn’t lever up 35x as partnership or employee owned and take same risks, then came big transfer of risk from wall street to taxpayers via $700bn TARP to buy subprime mort assets from bank and then Fed buying more direct from banks since not enough, free money for banks and free markets for all else, issue was not allowing Lehman to fail but allowing Lehman to succeed, not really that banks were too critical to economy but simply had side bets of incalculable magnitude
