Sunday, March 06, 2011

Nobody went to jail, everybody got rich

The Big Short: Inside the Doomsday MachineThe Big Short: Inside the Doomsday Machine by Michael Lewis

My rating: 4 of 5 stars

I've written before about the subprime mortgage crash and how it happened. We learned shortly after it happened that a major element was the Republicans' insistence on the Commodity Futures Modernization Act, which they snuck into the budget at the end of 2000. This act prohibits the federal and state governments from any regulation of derivatives, and this led to the creation of the credit default swaps that were the direct cause of the collapse of AIG and the other mortgage-backed bond funds. (An interesting sidelight is that the provision was inserted at the insistence of Texas senator Phil Gramm, whose wife Wendy directly benefits from this kind of trading.)

The Big Short looks at this from a different perspective. Author Michael Lewis, whose first book, Liar's Poker, was a view of Salomon Brothers from the inside, set out to find out if any of the people who were claiming, after the crash, that they had seen it coming really had.

What he found was that there were a very few, literally a handful, of investment analysts and investors who had seen the crash coming, and had made major investments that took advantage of the vulnerabilities they were able to find in the mortgage bond sector. What he also found was that these mortgage bonds, which were supposedly Triple A, virtually risk-free investments, were in fact based mainly on what we now know were mortgages that were guaranteed, and even designed, to fail. And finally, all the information needed to find these vulnerabilities was in the public domain, and it was only by a combination of corruption and gross incompetence that the market swallowed up these worthless bond instruments.

This is a fascinating account of how people who supposedly know what they're doing, and supposedly know way more about investments than you or me, conspired to cause the collapse of the American economy and throw millions of people out of their houses. As such, it is required reading for anyone who wants to understand how we got into our current economic situation.

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