The Big Short

I just finished The Big Short by Michael Lewis.  I read a lot of books and this may be the best book I have ever read.  I read Too Big to Fail, by Andrew Sorkin, which was also a great book, but it was more about what happened to the banks after the crisis hit.  It told the story of the effects of the crisis on the big banks and how they tried to survive.   However, when I finished the book I still didn’t understand why the banks were so close to failing.  Lewis’ The Big Short answered all my questions.

The book follows three groups of people who foresaw the mortgage crisis.  They then figured out a way to “invest,” or place bets, that would increase in value if mortgages went bad.  The book gets very detailed about how they did this, but the basic idea is that they bought insurance against mortgage bonds.  Mortgage bonds are groups of mortgages bundled together.  Their intent was to reduce risk and be able to be rated.  The ratings would tell investors the riskiness of the bonds and charge higher interest rates for riskier bonds.  A mortgage bond made up of interest only mortgages would be graded lower (riskier) and pay a higher interest then a mortgage bond made up of all 30 year conventional mortgages.

These separate groups at different times all came up with the idea to look through these mortgage bonds and find the groups most likely to default.  They bought insurance that would pay out the full value of the bond if the price went down.  The price of the bond would go down if the mortgages that made up the bonds stopped being paid.  They all realized that there were mortgages that the homeowner had to put very little money down to get and received a teaser rate for the first two years.  They predicted that after 2 years, when the rate reset to a higher interest rate, homeowners would begin defaulting.

The information provided in this book was so interesting, but the stories of the investors who shorted the mortgage bond made the book read like a fiction.   The investors had the foresight to see that the housing market was unstable.  They then created an investment that would pay out if the housing decreased in value.  Lastly they had the courage to put hundreds of millions of dollars on the line that supported their idea, and to stick with it for 2 years or more, while they waited for what they thought would happen to actually occur.

The book was interesting, informational and inspiring.  I would recommend it to anyone who is even remotely interested in business or the housing market.

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