Eighteen Things I Learned from The Big Short by Michael Lewis


Vikram Bath

Vikram Bath is the pseudonym of a former business school professor living in the United States with his wife, daughter, and dog. (Dog pictured.) His current interests include amateur philosophy of science, business, and economics. Tweet at him at @vikrambath1.

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63 Responses

  1. Avatar Saul Degraw says:

    Sometimes I think all of life is just making it up on the fly until you are old and/or dead.

    This was an excellent but depressing summation. I’m reminded of Margin Call where the Bear Sterns-esque entity terminates their Chief Compliance Office and then one of his aides discovers how damned they are. The solution was to sell off all the risk on unsuspecting clients. The junior employees who did this were compensated and told that they would probably be out of the industry for one or two years.Report

  2. Avatar Oscar Gordon says:

    That’s more than a little disconcerting…Report

    • Avatar LeeEsq says:

      It seems to be a good reason why investment banks need to be kept on a very short leash by diligent government regulators in perpetuity.Report

      • Avatar Marchmaine says:

        A leash implies that the regulators know where the banks ought to go. Rather than a leash, perhaps a rope with which they tie their own noose. The goal of the regulators then it to make sure that the only one the rope hangs is the single bank.

        We can agree, perhaps, that this last episode gave us neither leashes nor rope, and if the last stress test shows anything, nor protection from dominoes.Report

      • Avatar Oscar Gordon says:

        I call your attention to this bit:

        Don’t do a deal with an investment bank whose parameters are drawn up by the investment bank. They are almost certainly smarter than you. Yes, you hired lawyers to protect yourself, but their lawyers are smarter than your lawyers.

        So unless the government regulators are even smarter (unlikely), this seems like a recipe for regulatory theater.Report

        • Avatar greginak says:

          The “smarter lawyers” thing regarding regs has never really impressed me. Regulators can regulate pretty well if they have power to get the regs they want. The problem with the gov regulators seems more that the pols who direct them are bought and sold and sometimes that the regulators will want jobs from those they regulate. Smart doesn’t play into those things.Report

          • Avatar Oscar Gordon says:


            Not really. Regulators are a lot like the police, in that we could get perfect compliance if we gave the police absolute authority to enforce it. Give regulators everything they want to enforce regs and the regulated industry will die under the weight of compliance in much the same way that we’d all be a lot more miserable if the police had all the power they needed to enforce compliance with the law.

            So police have to (ideally) do things like respect our rights, and regulators have limits as well. But even then, even if regulators had every power they could get while still respecting rights, the fact is that you have a small number of regulators attempting to regulate a large number people who have a powerful incentive to find ways to keep away from the regulator. It will never be possible for the regulator to be effective except to hammer on the nail that sticks out too far, and that is even before we get to your salient point about political interference making sure they don’t hammer too hard.

            Trusting to regulators is not the answer to systemic issues. This is a Hanley rule (the structuring incentives & policies one).Report

            • Avatar greginak says:

              The thing is I don’t’ hear the same arguments being made about other kinds of regulations. EPA regs to keep water or air clean or the FAA as examples. I don’t here people say that big corps will just hire smarter lawyers or Chemists so why bother regulating what they put in the air or water. Not an exact analogy but nothing is or it wouldn’t be an analogy. Finance seems to held out as a special case where the poor helpless regulators will always be outmatched. But in some places ( states and other countries) there has been effective regs that prevented some problems. One example that comes to mind is banks in TX which, if i remember, had more stringent requirements so the housing crunch didn’t hit them as hard. I think finance can be regulated and the smart lawyer problem is more a projection of the attitudes of big finance.Report

              • Avatar Damon says:

                ” I don’t here people say that big corps will just hire smarter lawyers or Chemists so why bother regulating what they put in the air or water. ” @greginak

                Of course not. Because it’s easier to work with the regulators if you’re a large company. Regulatory capture and all that. You always want a pleasant relationship with your regulators, but that doesn’t mean that you can make decisions and policies that GO RIGHT UP TO THE LEGAL LIMIT or are subject to smart interpretation of the rules. That’s where the action is and that’s where someone skilled is worth what the companies pay them for.Report

              • Avatar Morat20 says:

                Texas doesn’t allow home equity loans. You can take out a second mortgage, but you can’t borrow from equity in your home.

                It was a law from the last housing crash here (the 80s, I think) and one of the two reasons (the other being the jump in oil prices) that saw the ‘Texas Miracle’.

                It’s not that much of a miracle when you realize it’s based on one particularly relevant law that prevented a bubble and the fact that a huge chunk of the Texas economy runs stronger if oil is in high demand.Report

              • Avatar greginak says:

                Yeah i didn’t remember the details but that is what i was thinking of. It’s almost like a regulation that prevented some bad thing from happening based on past experience. Tragically that violates ideological beliefs and can’t happen.Report

              • Avatar Kim says:

                Pittsburgh didn’t get a bubble because we had spare inventory to burn.Report

              • Avatar Lyle says:

                This is is a part of the Homestead bankruptcy exemption in Tx. 100% of your primary residence is exempt from being taken away during bankruptcy. This actually dates from the Republic of Texas constitution. This effectively forces the no cash out feature, as one could in theory take the money out of the house, spend it, and then file for Bk and the bank could not get the house back.Report

              • Avatar North says:

                But the EPA is measuring and regulating a state of nature which has a certain degree of semi-objective truth to it. Financial markets are just games that humans have created all the way down.Report

        • Avatar Saul Degraw says:

          The regulators are plenty smart. It isn’t like the Federal Government can only pick from lower tier law schools. A lot of Federal lawyer jobs pay six figure salaries in order to attract good talent.

          The problem is the so-called revolving door of going back and forth between government work and private industry for many people as admins change.

          To use another example, a lot of law firms pay top dollar for former Supreme Court clerks and these former clerks end up being the ones who write most briefs and do most arguing before the Courts of Appeal and Supreme Court in the United States. The majority end up at Corporate Defense firms and those that don’t end up as judges or academics. Maybe once in a blue moon, you will find one who stays in the Civil Liberties or Crim Defense world.

          The other problem is resources. Goldman Sachs more or less has infinite resources for dealing with government regulators and/or lawsuits from individuals and/or criminal prosecution. Everyone else has very limited resources in comparison including the government. Manhattan’s DA does spend a lot of time and effort going after white-collar crime but he or she still needs to deal with all the other crime in Manhattan and numerous banks and institutions.Report

          • Avatar Oscar Gordon says:

            The problem is the so-called revolving door of going back and forth between government work and private industry for many people as admins change.

            This is the other point I agree with @greginak & you about.Report

          • Avatar Jaybird says:

            The issue where the regulator knows that, if he plays his cards right, he can get a job at the regulated after a dozen years or so has a lot of incentives baked into it.

            The regulated will, of course, want someone who has an established relationship the regulators to facilitate communication, someone who knows the regulations (hell, the regulator should be all over that stuff), and who won’t need to be spun up but who should be able to dive into the deep end on day one.

            And, of course, knowing that, after you pay your dues as a regulator, you’ll have a good job making (a lot) better money if you play your cards right is one hell of an incentive to play your cards right.Report

            • Avatar Saul Degraw says:

              True but I don’t necessarily always see this as bad. The best criminal defense lawyers have some time or a lot of time has prosecutor’s and have the same insider info/contacts.

              Some of the best plaintiff’s lawyers spend a while on the defense side, maybe they even make partner.

              This is a problem but it is not a wholesale reason to scrape regulations as Greginak pointed out.Report

              • Avatar Jaybird says:

                It’s one thing to move from being a prosecutor to defense lawyer.

                It’s somewhat different to move from being the guy at the Bank Inspection Division to being the Bank’s Bank Inspector Liaison.Report

        • Avatar nevermoor says:

          This is why you need to just prohibit areas of activity that are problematic, rather than make fine-tuned/subjective restrictions.Report

        • Avatar LeeEsq says:

          At the same time, do we really want the economic well being of tens of millions or even hundreds of millions of people at the hands of investment bankers? They are capable of doing a lot of damage when they get too greedy or mess up.Report

    • Only if you thought that markets are something other than imperfect systems created by and run by humans. Unfortunately, thinking of them as somehow magically immune to the faults of all other human institutions (e.g governments) is rife these days,Report

  3. Avatar Doctor Jay says:

    This seems a really good thread to drop this link in: Bill Black talks about why the government should have pursued criminal convictions against the top bankers.

    I’m not sure it would have been all that easy to get those convictions, and would it be better to swing and miss or to not swing? I don’t know…Report

    • Avatar nevermoor says:

      The government HATES to swing and miss on high-visibility criminal prosecutions. Makes ’em look like jack-booted thugsReport

    • Avatar Vikram Bath says:

      @doctor-jay , That’s a much more optimistic take than mine. The likelihood that the administration has just now come to have a change in heart is low. This “memorandum” really should be referred to as a “press release”.Report

  4. Avatar nevermoor says:

    I think the lesson is somewhat simpler: look at who is getting rich + nothing is too good to be true.

    Here, it was a bunch of hustlers at places like Countrywide who made $X per issued mortgage while carrying no risk. The banks made money (primarily because the volume got so huge) but also retained exposure and some lost money overall because they didn’t cynically shed that exposure (or make enough on the ramp-up). The ratings agencies made money, and did so by competing against each other to offer friendlier-and-friendlier ratings. That ought to tell you the ratings are BS, the mortgages are BS, and no matter how clever the packaging, it won’t spin that BS into DRAMATICALLY better returns than any other AAA-rated product.Report

    • Avatar Kim says:

      Including bill gates?
      Occasionally people do get rich the old fashioned way…Report

      • Avatar nevermoor says:

        But nothing there was too good to be true (except the idea that Gates invented DOS). He had a wildly popular consumer product that sold a lot of copies against very little competition. That’s a pretty reliable and standard business model that you would expect to get the head of the company rich.Report

        • Avatar Kim says:

          Truth that. Just sayin that it isn’t always too good to be true.
          Most wealth, though, most wealth was stolen.
          From the Carnegies through the Rockefellers down to the Kochs, people have stolen from the little guy.Report

          • Avatar notme says:

            So we just need to let the liberals tax us and redistribute the money as they see fit since they know better?Report

            • Avatar Kim says:

              You do realize I know businessmen?
              Smart businessmen find it easy to make money from the middle class.
              Making new businesses is easy for them…

              Do you want to reward smart people, or toadies?
              I’d think the choice would be clear.

              But on the subject of refugees, I’m all for you buying the children a home in Mexico rather than the United States, and I can send you a link for you to buy their wares. Because I don’t think you need to give charity, when you can support working teenagers so they don’t need to come to the United States and live off of the dole.

              See? Live your beliefs — if you want to help privately, just do it already.Report

  5. Avatar Kazzy says:

    Why can’t robots regulate?

    I’m only half joking.Report

    • Avatar Jaybird says:

      You mean programmers? You mean the people who set objectives for the programmers?

      You mean the people who give money to the people who set objectives for the programmers?Report

      • Avatar Kazzy says:

        Robot programmers. Robot objective setters. Robot money!Report

      • Avatar Brandon Berg says:

        My thought process:

        1. Yeah, that’s a good point.

        2. But what if the source code is made publicly available? Then anyone could inspect it and raise a stink if there are any problems.

        3. But consider the average programmer’s understanding of finance and economics.

        Well, back to the drawing board.Report

    • Avatar Kolohe says:

      1) some people already have a problem with speed and traffic light cameras.

      2) the problem isn’t with the stuff that has clear rules and can be regulated algorithmically. The problem is with the stuff that doesn’t have clear rules and needs to be regulates stochiocastically.Report

  6. Avatar Brandon Berg says:

    A price is only accurate if you can both buy and sell near that price. If someone says their car is worth $10k, one way to determine she is lying is to offer to sell her an identical car for $9k. If the $10k is accurate, she ought to leap at the chance.

    I get what you’re actually saying, but the car metaphor doesn’t work well, because no two cars are identical. The market price of used cars in various conditions is pretty easy to find out. If the seller is cheating you, it’s probably by hiding nonobvious information about the car’s condition.

    Actually…maybe it does work better than it first appears to, given the point about counterparty risk. My original thought was that an option to buy a ton of pork bellies at $200 in December is an option to buy a ton of pork bellies at $200 in December, but I guess counterparty risk is the equivalent of a hidden engine defect.Report

    • Avatar Vikram Bath says:

      Brandon Berg: the car metaphor doesn’t work well

      Yes! It doesn’t!

      To be a good analogy, I’d have had to have picked something whose price is unknown, infrequently traded by a very small segment of the population, and something that you would want more than one of if it were available at the right price. It needs to be something where two parties can hire two experts to do appraisals of and report back wildly different prices in some cases.Report

  7. Avatar Richard Hershberger says:

    I take from this, amongst other things, that I don’t understand rich people. If I had sold my business for $100 Million, what need would I have of dealing with investment bankers who treat me like I am small change? If I stuff the money under my mattress and live a very comfortable $250K per year lifestyle, my money will last me four hundred years. The only problem is that I might know people living a more lavish lifestyle, and be so distressed by this that I feel a need to burn through my money faster. Sure, I get that there are always more ways to spend money, but not everyone needs to spend like a lottery winner.And you don’t have to treat money like it is how you keep score to see who wins.Report

    • Avatar Vikram Bath says:

      Richard Hershberger: If I had sold my business for $100 Million, what need would I have of dealing with investment bankers who treat me like I am small change?

      I asked that. He said that at least up to that point the bank had thrown him some minuscule number of shares of the IPOs they underwrote. This was easy, guaranteed great returns for at least some portion of his overall portfolio. He said the larger tracks were reserved for larger investors. I have no idea if he’s still with them or if he’s moved on to other things.Report

    • Avatar Saul Degraw says:

      I would suggest that really rich people think they are doing the same thing. You can park the 100 million in a trust and live off the interest.Report

  8. To spell out the consequence, investment banks have a lot of interactions with people who aren’t putting their own wealth at risk.

    And they have a constitutional right to use that wealth (i.e. other people’s wealth) to influence elections, according to the Roberts Court.Report

    • Avatar Jaybird says:

      Like we’re trying to influence the election here at OT or in some nefarious way like the way that NPR is trying to influence it?Report

      • Yup, the million dollars Exxon’s management just (hypothetically) contributed to Jeb!’s campaign is exactly like the million bucks I just (hypothetically) contributed to Bernie’s. Other than my money actually being my money.Report

        • Avatar Jaybird says:

          Giving money to a candidate influences elections?

          You’d think that giving money to the electorate itself would do a better job of doing that.Report

          • Avatar LWA says:

            And yet, it really, really doesn’t.
            Almost no one pays the Death Tax yet you can find millions of people who grow apoplectic at the mention of it.

            We have empirical evidence of people voting for policies that directly take money out of their pockets.Report

  9. I wish there were a villain this could be pinned on because the alternative explanation is that no one really ever knew what the right thing to do was, so they made up everything on the fly.

    This was an unprecedented situation, so of course they were making it p on the fly. Unfortunately, the result of the recent AIG lawsuit means that next time they’ll have fewer tools and much less flexibility.Report

  10. Avatar DensityDuck says:

    All investing is risky. Otherwise it wouldn’t create wealth. And it is not as though we don’t know how to put a price on risk.

    Maybe the problem is that people bought the wrong investment products. I guess if you want a solution you could say that investment managers should be willing to refuse to execute transactions they think are inappropriately risky (or when they believe that their clients fail to appreciate the true risk) but that’s such a hugely subjective thing that it would be impossible to enforce. And, ultimately, you are there to do what the client asks, no matter how dumb it actually is.

    “However little respect anyone had for ratings agencies, few would have guessed that bonds they rated as AAA would ever be in question.”

    That’s also the case. Maybe the criminal prosecutions ought to be happening at the ratings agencies who said that what the banks were doing was a good idea…Report

  11. Avatar Burt Likko says:

    Point 2 raises the fearsome spectre of trading with Bear Stearns and then argues “There are a lot of possible points of failures. Even a thesis that is 99.9% correct can lose you money.” This is true. Bear Stearns probably knows a lot more than you do. But then Point 3 argues “It is very, very easy to be the dumb money. There are professionals who are dumb money. They probably aren’t actually dumb people, but they aren’t paying attention to the right things.”

    So why is it that Bear Stearns is necessarily paying attention to the right things and I am not? Point 13 argues precisely this: Bear Stearns’ lawyers are always smarter than my lawyers, no matter how smart my lawyers are. Indeed, wasn’t the crash caused precisely by houses like Bear Stearns, run by smart people with smart lawyers, maybe seeing the right information that was there for everyone to see all along, telling them that the bubble was inflated to its maximum-tension point, but willfully ignoring that information? Indeed, point 12 recapitulates the story of a Cassandra who did read the right signals and interpreted them the right way but no one listened to him.

    It seems to me that the real message the extract here is that the market, being composed of a great many people, none of whom have complete access to information, behaves such that over the long run it repetitiously inflates and then bursts bubbles in capital. Such appears to be the long term history of the monied economy and it doesn’t matter how smart you are, you can’t stop it from happening: it is as inevitable as winter. The depressing lesson here is that for all but a very select and very clever few, and maybe not even them, not only can’t you stop it, you probably can’t even profit off of it personally.Report

    • Avatar Damon says:

      Ah, but underlying cause for the bubbles is the fiat currency and the monetization of the debt that causes these distortions.Report

    • Avatar DensityDuck says:

      “point 12 recapitulates the story of a Cassandra who did read the right signals and interpreted them the right way but no one listened to him.”

      It’s easy to dig up doomsayers after the fact, because there are always people predicting a crash. I remember people in 1994 talking about how all these stupid internet companies were gonna crash real soon because they were obviously based on nothing, and you’d need a pretty expansive definition of “real soon” for them to have been right. The fact that a stopped clock is right twice a day does not mean that we should pay attention to it because sometimes it’s right.

      What Bear Stearns has is a big bank account that can eat losses. They’re a frog that jumps up five feet and falls back three, whereas the rest of us are frogs that jump up two feet and fall back one. We see them jumping higher, but if we fall three feet we’ll break our ass when we land.Report

  12. But the longer answer is – for the vast majority – unfortunately.
    Make a point not to succumb to pressure tactics or even to seemingly polite persuasion. While trading
    trends can be extremely profitable, the odds are unfortunately staked
    unfavorably against the directional traders, even more so
    for directional option traders due to time decay.Report

  13. Avatar Kim says:

    So how often did Dr Doom get mentioned?

    Oooh, he’s got an Upcoming Attractions preview posted!