The Big Short: Inside the Doomsday Machine

Mortgage bonds have never failed in the twenty years they have existed since the mid-1980s, and everyone casually assumes this will always be true. Sales people certainly don’t want to entertain doubts in front of their customers; when signs of trouble appear, accompanied by a few sorehead investors who carp about the dangers, the Wall Street sales force brushes these concerns aside.

In a strange twist of logic, bond sellers deliberately create a risky bond that appears to be high-quality, which fools the regulators, who give the bonds high ratings. This, in turn, convinces the sellers that they really are high-quality. Nearly everyone, from CEOs on down, persists in believing this fantasy right up to the day the market crashes.

The chief lesson of the subprime mortgage crisis is that perfectly sane professionals, goaded by a touch of larceny and a large dose of wishful thinking, can believe with virtually no reservations a dangerous myth until it nearly destroys their industry. This kind of insanity is difficult, if not impossible, to prevent, since the incentives of the people involved point them away from the truth, and naysayers are quickly silenced.

Investing is a hard game; it involves predicting the future, which is chancy in any endeavor. With so many smart players in the game, it’s tough to get an advantage. Nonetheless, a small collection of investors come to believe, against overwhelming Wall Street opinion, that subprime mortgage bonds will fail in large numbers sometime in 2007. It develops that the doubters are right, while those who are certain turn out to be wrong.

Cautiously, these few groups—FrontPoint Partners, headed by Steve Eisner; Scion Capital’s Michael Burry; Cornwall Capital’s Jamie Mai and Charley Ledley; and a handful of lone investors, including Greg Lippmann—perform extensive research and conduct many interviews to determine if they are on the right track. It’s a lonely quest since they can find almost no one who agrees with them.

Burry’s investor group tires of his obsession with subprime bonds and threatens to sue him if he doesn’t release their funds. Even after he is proven right, his investors continue to criticize him. The experience ruins what little faith in humanity Burry has left; in the end, he collects his millions, closes the fund, and retires from investing.

Mai and Ledley cannot escape their nervous fear that shorting the bond market will prove correct but fail anyway because the banks that have accepted their bets become insolvent from the same market forces that give the Cornwall team their win.

Eisner and Lippmann collar anyone who will listen to their sky-is-falling story and manage mainly to alienate their audiences. The crash makes them rich, but the destruction it wreaks overcomes Eisner, who is humbled by the vastness of the forces at play. This tragedy transforms him from an angry prophet of doom to a quieter and nicer person.

Even the author, Michael Lewis, must suffer from winner’s guilt when, after the crash, he meets with his old Wall Street boss, John Gutfreund, whose leadership Lewis criticizes in his first book, Liar’s Poker. Gutfreund agrees with Lewis’s assessment of the 2008 bond disaster, then says, “Your fucking book destroyed my career and it made yours” (264).