Book SummaryThe Big Short, by Michael Lewis

1-Page Summary1-Page Book Summary of The Big Short

The Big Short by Michael Lewis explores the 2007-2008 financial crisis through the eyes of a handful of eccentric and oddball investors who saw that the US housing market—and, by extension, the entire financial system—was built on a foundation of sand. These investors were lifelong iconoclasts who refused to worship at the altar of high finance. Simply by reading financial statements and exercising basic due diligence in their investment decisions, they saw that Wall Street was caught up in a cycle of irrational exuberance regarding mortgage-backed securities. Major financial institutions had deeply overvalued these securities and had passed them off to investors throughout the financial system.

Before becoming a best-selling author, Lewis got a first-hand view of the investment world while working as a trader at the Salomon Brothers investment firm, the financial institution that invented the same mortgage-backed securities that led to the housing market crisis. In addition to his career in journalism, Lewis is known for his books on sports and finance, including Liar’s Poker (1989), Moneyball (2003), The Blind Side (2006), and Flash Boys (2014).

By detailing how a group of individuals discovered they could profit from the greed and stupidity of some of the world’s leading financial institutions, The Big Short helps make sense of an event that most of us remember but few understand. It’s more than a story about mortgage-backed securities, credit default swaps, subprime loans, collateralized debt obligations, and systemic risk. At its heart, The Big Short is a tale about the perils of greed and short-sightedness that asks the reader to question the wisdom of the financial elites who wield so much economic and political power in our society.

The Rot at the Core of the Housing Market

The virus that infected the global financial system in 2008 was a relatively new class of asset: the mortgage-backed security. Lewis explains that at its most basic level, a mortgage-backed security was a bond, but it was very different from a traditional bond that might be issued by a government or a corporation. These latter types of bonds were essentially loans, for which the lender would be paid a fixed interest rate over a given period of time until the bond matured and the bondholder received the principal (or “face value” as it’s sometimes known).

Traditional bonds always entailed some level of risk (the company or government from which you purchased your bonds could default, or fall behind on; payment or interest rates could rise and erode the value of your bond on the open market), but these risks were relatively transparent and easy-to-understand for most investors. This was not to be the case with mortgage-backed securities.

Mortgage-Backed Securities

Mortgage-backed securities brought the world of high finance into the lives of everyday Americans—even if they had no idea that their homes had become chips on the table in the vast casino of global finance. A mortgage-backed security was a bundle of home mortgages that had been packaged together into a tradable asset. When an investor purchased one, she was purchasing the cash flows from the individual home mortgages that made up the security.

Lewis says that at first, the bonds were made up of rock-solid mortgages to creditworthy homeowners who were at little risk of default. Ironically, this made them less profitable. Home owners could pay off their mortgages any time they wished, which would cut off the cash flows the investor had purchased the asset for. Therefore, buyers of mortgage-backed securities weren’t concerned about people defaulting on their loans: They were worried about being paid back too quickly.

This created a perverse incentive structure: Mortgages made to uncreditworthy borrowers could actually be worth more than mortgages made to qualified borrowers. Lewis writes that if your biggest fear as an investor was that you’d be repaid too soon, the last thing you wanted was a bunch of financially secure, stable, low-risk mortgages. You wanted high-risk mortgages that stood little chance of being repaid early. Such borrowers wouldn’t qualify for refinancing, and would instead be on the hook for the entire life of the mortgage—making them the ideal borrowers for mortgage-backed security investors.

These investors believed that even if a few of their mortgages defaulted (as they invariably would), there were enough other mortgages for the bundle as a whole to be considered safe.

Subprime Loans and the Housing Market

The home loans issued to un-creditworthy borrowers became known as subprime mortgages. Although subprime mortgages only represented a small fraction of the total US credit market at this time, Lewis suggests that they received a boost from the nation’s growing income inequality. A more skewed income distribution created more and more potential subprime borrowers. Subprime mortgage loan originators were happy to issue loans to almost anybody, even those with no credit, no income, or a history of foreclosure.

The boom in subprime loans went hand-in-hand with a growing housing market. Home prices seemed to be going up and up with no end in sight. For this reason, subprime lenders were largely unconcerned with the risk of default. With the price of their homes always rising, borrowers would always be able to refinance easily. Refinancing simply meant using the equity in one’s home as a form of collateral to obtain a new loan. With this cash, people could pay their original mortgages (thus eliminating the possibility of default) and just take on new debt. It was a way to use a home as a piggy bank, a source of easy cash for...

The Big Short Summary Chapter 1: An Untapped Asset—The Home

The deadly virus that infected the global financial system in 2008 was a relatively new class of asset: the mortgage-backed security. At its most basic level, a mortgage-backed security was a bond, a debt instrument. But it was very different from a traditional bond that might be issued by a government or a corporation. These latter types of bonds were essentially loans, for which the lender would be paid a fixed interest rate over a given period of time until the bond matured and the bondholder received the principal (or “face value” as it’s sometimes known).

Traditional bonds always entailed some level of risk (the company or government from which you purchased your bonds could default, or fall behind on; payment or interest rates could rise and erode the value of your bond on the open market), but these risks were relatively transparent and easy-to-understand for most investors. This was not to be the case with mortgage-backed securities.

Mortgage-Backed Securities

Mortgage-backed securities brought the world of high finance into the lives of everyday Americans—even if they had no idea how much their homes had become chips on the table in the vast casino of...

The Big Short Summary Chapter 2: Placing the Bet

We’ve seen how the big banks had foolishly hitched their wagons to the subprime mortgage-backed securities market, which suffered from fatal structural weaknesses. But for some savvy investors who saw the mortgage bonds for what they really were, the banks’ short-sightedness represented an unparalleled opportunity. They could bet against Wall Street’s position and reap enormous profits. This was the world of short-selling.

Dr. Michael Burry: An Eye for Value

Dr. Michael Burry was, along with Steve Eisman, skeptical (to say the least) about the confidence with which Wall Street sold mortgage-backed securities. Burry was another outsider to finance, who’d come to Wall Street with an unconventional background and unique life story.

He had lost his eye at the age of two, when it was removed during surgery for a rare form of cancer. He wore a glass eye to replace the one he’d lost. Burry later would observe that this caused him to see the world differently, both literally and figuratively. Perhaps out of self-consciousness, he had trouble with interpersonal relations and thought of himself as something of a loner. To compensate for his social struggles (he would...

Shortform Exercise: Questioning Conventional Wisdom

Think about how wrong popular opinion can be.

Like the investors we’ve met, have you ever been convinced that the conventional wisdom on some topic was wrong? Describe the situation in a few sentences.

The Big Short Summary Chapter 3: Doubling Down

By February 2006, many of the savviest players on Wall Street had their eyes on Dr. Burry’s big bet. Other traders were curious why Scion Capital, Burry’s fund, had taken such a dramatic short position against mortgage securities and why Goldman Sachs, in particular, had been so eager to sell him the credit default swaps. What did he know that everyone else didn’t? Greg Lippmann, the head subprime mortgage bond trader at Deutsche Bank, wanted in on the action.

Greg Lippmann: Financial Mercenary

Greg Lippmann was a bond trader with a reputation for being bombastic, crass, and nakedly self-interested. He was known for humble-bragging about how much money he made from his annual bonuses and loudly complaining that he wasn’t being paid enough. Even within the money-obsessed culture of Wall Street, this was beyond-the-pale behavior. Everybody was greedy, but you weren’t supposed to be so transparently greedy.

Although his nominal employer was Deutsche Bank, everyone who met him saw that he had zero loyalty to the bank or its leadership—he was in it purely for himself. This was also something he refused to disguise about himself, openly remarking, **“I don’t have...

The Big Short Summary Chapter 4: Bubble Nation

Despite Steve Eisman’s keen awareness of how depraved, corrupt, and outright ludicrous the subprime mortgage market was, he still viewed Lippmann with deep suspicion. Lippmann seemed to be a caricature of a sleazy Wall Street bond trader, only out to screw the customer. If it was such a great deal, why was Lippmann offering them a cut of the action?

The answer was that Lippmann needed co-investors like Eisman for his plan to work. While he was confident that his bet against the market would pay off in the long-run, in the short-run, it was expensive. He was sustaining losses on the premiums due on the credit default swaps before the mortgages started failing. He needed other investors to help him share those losses. And, for once, he really wasn’t trying to screw his partners over—they would end up getting rich just like him.

Into the Belly of the Beast

As Eisman dug deeper into the subprime market, he became more and more convinced that Lippmann was right. The market was even worse than he could have possibly imagined. Lending standards, he saw, had deteriorated to the point where **lenders were throwing money at people in the bottom 29th percentile of the...

Shortform Exercise: Examining Greed

Think about how greed and short-sightedness drive bad decisions.

Can you think of an incident from your personal experience in which greed led to a bad decision? Describe the event.

The Big Short Summary Chapter 5: Event-Driven Investing

By fall 2006, Gregg Lippman’s proposal (again, largely copied from Michael Burry’s strategy at Scion Capital) to short the housing market through credit default swaps had made the rounds in the financial world. But he still had few takers. Too many investors, it seemed, were leery about the idea of taking a short position against an asset that major players like Goldman Sachs, Deutsche Bank, and Merrill Lynch seemed so sure about.

Two young, obscure start-up investors, however, heeded the call and saw the opportunity of a lifetime staring them in the face. Charlie Ledley and Jamie Mai had established their (admittedly short)financial careers by betting big on events that Wall Street seemed certain wouldn‘t happen. Profiting off the impending collapse of the subprime market fit perfectly into their theory of how the financial world worked.

Charlie Ledley and Jamie Mai: Garage Band Hedge Fund

Ledley and Mai weren’t career Wall Street guys. They barely had careers at all. Starting their fledgling money management fund, Cornwall Capital Management, with just $110,000 in a Schwab account, they were the sort of bit players that couldn’t even get a phone call returned at...

The Big Short Summary Chapter 6: House of Sand

By early 2007, Greg Lippmann’s big gamble should have been paying off. Housing prices were falling, defaults were creeping up, but subprime bonds were somehow still standing strong. To him, it was almost as if the market had believed its own lies about the value of these assets.

And Wall Street’s continued delusions about subprime were costing him. With the swaps he’d purchased, he was paying $100 million in premiums, waiting for the bonds to go rotten. He was sure it was a profitable bet in the long-run, but it was costly in the short-run. He needed co-investors like Eisman and the team at Cornwall in order to maintain his position. And even a dyed-in-the-wool market cynic like Steve Eisman was beginning to have his doubts. Lippmann had to act. He had to show Eisman just how arrogant and dumb the people on the other side of their bet truly were.

Sin City

In January 2007, Lippmann flew Eisman and his team out to a giant annual convention of subprime lenders, speculators, and investors, dwarfing the similar convention Eisman had already attended in Miami. Given the excesses and financial hedonism of the subprime industry, the irony of the convention being...

Shortform Exercise: Parsing Pessimism

Examine why skeptics and cynics turned out to be the big winners in the financial crisis.

Why were Eisman and the Cornwall Capital team so cynical about the financial system and CDOs specifically?

The Big Short Summary Chapter 7: Payday

While Eisman, Lippmann, and the Cornwall Capital team were looking into the eye of the coming storm in Las Vegas, Michael Burry was trying to placate his investors at Scion. He was confident that his bet against the housing market would be vindicated. But it was an expensive position to maintain, and one that was costing his wealthy clients significant money in the here and now, as he continued to owe the banks the premiums on the credit default swaps he’d purchased. For the first time, Burry was underperforming the market. In 2006, the S&P had risen by more than 10 percent—Scion had lost 18.4 percent.

Burry was baffled by how the market was behaving. The data from the mortgage servicers kept getting worse and worse as 2006 turned to 2007 (and the teaser rates expired). The loans were faltering at higher and higher rates, yet the price of insuring the bonds composed of these loans kept falling. It was as if a fire insurance policy on a house had become cheaper after the house was on fire. Logic, for once, had failed Dr. Burry. And he was facing an investor revolt, as his clients began to clamor for their money back out of his fund, thinking that he was either a...

Shortform Exercise: Long View of The Big Short

Explore the main takeaways from The Big Short.

Why do you think the eccentric clique of investors we’ve followed pursued such a different strategy and had such a unique view of the financial system?