I picked up Michael Lewis's new book, The Big Short, pretty much as soon as it hit the Kindle a few weeks ago. It's a post-catastrophe account of the subprime mortgage crisis, told through the eyes of a small group of traders who shorted the supposedly unshortable mortgage backed securities that made everyone rich five years ago.
It's partially a financial story, but to me it's also a story about assumptions. I've been thinking a bit about the effects of unspoken, day-to-day dependencies that we all rely on in our lives. Can we live without them? Are we light enough on our feet to adjust when they shift? Do we even know what they are, and can we explain how they fit together? In a small company like mine, these questions can lead to some fairly serious existential crises. A few years ago, our client base seemed disproportionately tied to the galloping Web 2.0 economy. More recently, the brash announcement by Apple that Flash would be unsupported on the iPad confirmed a long-held suspicion that the platform was on rocky ground. In the trenches of my day-to-day as technology director, I've become excessively sensitive to the problems of cross-dependencies among projects, code bases, and servers. This is not so much an issue of identifying single points of failure as it is a matter of understanding which doorknobs you've tied your teeth to and subsequently forgotten.
- Do you depend on anything outside your control? What is it?
- Can you repeat past successes with those same externalities?
- Could you quarantine, isolate, or replace them, if you had to?
The Big Short is the story of one particular set of external dependencies that turned out to be hopelessly intertwined. Specifically, it's about the revelation that an entire class of financial products based on the performance of mortgage payments was more deeply interdependent and market-distorting than anyone had imagined. It's the moment near the end of a Stephen King novel where all the townspeople are revealed to have first names that start with "K" and they're sitting silently in their cars waiting for you up the road. NPR's Planet Money does a better job of explaining the details ("we bought the toxic asset..."), but the underpinning of the story shows how difficult it is to reject a lie when your livelihood depends on believing it.
Loc. 476-82, an opening anecdote showing the matter-of-fact cultural role of Wall Street greed:
When a Wall Street firm helped him to get into a trade that seemed perfect in every way, he asked the salesman, "I appreciate this, but I just want to know one thing: How are you going to fuck me?" Heh-heh-heh, c'mon, we'd never do that, the trader started to say, but Danny, though perfectly polite, was insistent. We both know that unadulterated good things like this trade don't just happen between little hedge funds and big Wall Street firms. I'll do it, but only after you explain to me how you are going to fuck me. And the salesman explained how he was going to fuck him. And Danny did the trade.
Loc. 483-87, Steven Eisman is one of the main characters, a brusque gadfly with odd listening habits:
Working for Eisman, you never felt you were working for Eisman. He'd teach you but he wouldn't supervise you. Eisman also put a fine point on the absurdity they saw everywhere around them. "Steve's fun to take to any Wall Street meeting," said Vinny. "Because he'll say 'explain that to me' thirty different times. Or 'could you explain that more, in English?' Because once you do that, there's a few things you learn. For a start, you figure out if they even know what they're talking about. And a lot of times they don't!"
Loc. 985-89, on the undesireability of defending an idea:
Inadvertently, he'd opened up a debate with his own investors, which he counted among his least favorite activities. "I hated discussing ideas with investors," he said, "because I then become a Defender of the Idea, and that influences your thought process." Once you became an idea's defender you had a harder time changing your mind about it. He had no choice: Among the people who gave him money there was pretty obviously a built-in skepticism of so-called macro thinking.
Loc. 1788-96, on the role of research that seemingly no one else wants to do. This is actually one of the most interesting aspects of The Big Short for me, the relative rarity of legwork compared to the ease of sticking to first appearances:
It wasn't a question two thirty-something would-be professional investors in Berkeley, California, with $110,000 in a Schwab account should feel it was their business to answer. But they did. They went hunting for people who had gone to college with Capital One's CEO, Richard Fairbank, and collected character references. Jamie paged through the Capital One 10-K filing in search of someone inside the company he might plausibly ask to meet. "If we had asked to meet with the CEO, we wouldn't have gotten to see him," explained Charlie. Finally they came upon a lower-ranking guy named Peter Schnall, who happened to be the vice-president in charge of the subprime portfolio. "I got the impression they were like, 'Who calls and asks for Peter Schnall?'" said Charlie. "Because when we asked to talk to him they were like, 'Why not?'" They introduced themselves gravely as Cornwall Capital Management but refrained from mentioning what, exactly, Cornwall Capital Management was. "It's funny," says Jamie. "People don't feel comfortable asking how much money you have, and so you don't have to tell them."
Loc. 1830-34, on arguing convincingly:
Both had trouble generating conviction of their own but no trouble at all reacting to what they viewed as the false conviction of others. Each time they came upon a tantalizing long shot, one of them set to work on making the case for it, in an elaborate presentation, complete with PowerPoint slides. They didn't actually have anyone to whom they might give a presentation. They created them only to hear how plausible they sounded when pitched to each other. They entered markets only because they thought something dramatic might be about to happen in them, on which they could make a small bet with long odds that might pay off in a big way.
Loc. 2206-11, more on Eisman's listening habits:
Eisman had a curious way of listening; he didn't so much listen to what you were saying as subcontract to some remote region of his brain the task of deciding whether whatever you were saying was worth listening to, while his mind went off to play on its own. As a result, he never actually heard what you said to him the first time you said it. If his mental subcontractor detected a level of interest in what you had just said, it radioed a signal to the mother ship, which then wheeled around with the most intense focus. "Say that again," he'd say. And you would! Because now Eisman was so obviously listening to you, and, as he listened so selectively, you felt flattered.
Loc. 3260-64, on $1.2 billion:
In early July, Morgan Stanley received its first wake-up call. It came from Greg Lippmann and his bosses at Deutsche Bank, who, in a conference call, told Howie Hubler and his bosses that the $4 billion in credit default swaps Hubler had sold Deutsche Bank's CDO desk six months earlier had moved in Deutsche Bank's favor. Could Morgan Stanley please wire $1.2 billion to Deutsche Bank by the end of the day? Or, as Lippmann actually put it - according to someone who heard the exchange - Dude, you owe us one point two billion.
Loc. 3413-22, on eight days of chlorine for all of Chicago:
His wife's extended English family of course wondered where he had been, and he tried to explain. He thought what was happening was critically important. The banking system was insolvent, he assumed, and that implied some grave upheaval. When banking stops, credit stops, and when credit stops, trade stops, and when trade stops - well, the city of Chicago had only eight days of chlorine on hand for its water supply. Hospitals ran out of medicine. The entire modern world was premised on the ability to buy now and pay later. "I'd come home at midnight and try to talk to my brother-in-law about our children's future," said Ben. "I asked everyone in the house to make sure their accounts at HSBC were insured. I told them to keep some cash on hand, as we might face some disruptions. But it was hard to explain." How do you explain to an innocent citizen of the free world the importance of a credit default swap on a double-A tranche of a subprime-backed collateralized debt obligation? He tried, but his English in-laws just looked at him strangely. They understood that someone else had just lost a great deal of money and Ben had just made a great deal of money, but never got much past that. "I can't really talk to them about it," he says. "They're English."
Loc. 3747-52, on being dumb and looking for grownups:
The big Wall Street firms, seemingly so shrewd and self-interested, had somehow become the dumb money. The people who ran them did not understand their own businesses, and their regulators obviously knew even less. Charlie and Jamie had always sort of assumed that there was some grown-up in charge of the financial system whom they had never met; now, they saw there was not. "We were never inside the belly of the beast," said Charlie. "We saw the bodies being carried out. But we were never inside." A Bloomberg News headline that caught Jamie's eye, and stuck in his mind: "Senate Majority Leader on Crisis: No One Knows What to Do."
Loc. 3880-82, a last word on dependencies:
The changes were camouflage. They helped to distract outsiders from the truly profane event: the growing misalignment of interests between the people who trafficked in financial risk and the wider culture. The surface rippled, but down below, in the depths, the bonus pool remained undisturbed.