The Big Short: A Must Read/See

big shortGet your popcorn ready, Michael Lewis’ The Big Short is coming to a Cinemark near you.  If you haven’t already read the book, do so.  If you can’t make it to the movie on opening day, please get your priorities straight.

The book centers on the mortgage crisis told through the experience of five investors who were able to see the oncoming crisis.  Their stories are fascinating from a character perspective, but Lewis’ ability to weave a historical narrative and context into the tales of these individuals is both fascinating and oddly exciting.

I cannot recommend the book enough.  A few investment takeaways from the book relate to risk.

By assuming that one pile of subprime mortgage loans wasn’t exposed to the same forces as another….the engineers created the illusion of security.

Whenever an investment opportunity is presented with a high degree of security and confidence, it should warrant extra scrutiny.

For example, take this comment regarding auto loans from this article:

I asked Sylvain Raynes, an expert in structured finance and owner of R&R Consulting, what he thought of the AMCAR and DTAOT deals. Raynes has a history of raising the alarm bells about Wall Street deals at the first instance of trouble. He began to raise red flags about problems in the mortgage market back in 2003. This time around, he doesn’t see problems in the auto lending market. “These bonds are safer than U.S. Treasuries,” says Raynes.

All investments have risk.  The more marketing that goes into convincing the buyer of the absence of risk, the more likely it is that there is risk lurking somewhere in the investment.  Howard Marks has a great line on this topic, “The riskiest thing in the world is the widespread belief that there is no risk.”

The other takeaway from The Big Short is the underlying thread that all the “bad actors” in the book were acting rationally and in their own self-interest, however such collective rational self-interest lead to a widespread systematic failure.  The zeitgeist comment on this topic comes from Chuck Prince, the former CEO of Citibank, “As long as the music is playing, you’ve got to get up and dance,” he told The Financial Times on Monday, adding, “We’re still dancing.” Prince was “fired” 4 months after this comment.

The dinner conversation between Eisman and Wang Chau in the story is worth the price of admission.  Chau subsequently sued Lewis (and lost) for this portion of the book claiming it was inaccurate.

Another great read on the same topic is The Greatest Trade Ever.  Although the topic is the same, it has one additional lesson worth the time.  Paulson, the investor in this book, waited until he saw the cracks in the housing system before beginning to short the housing market.  This insight made his trade much more lucrative than all of the characters in Lewis’ book combined.

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