If you thought reading about derivatives trading would be boring, think again. Michael Lewis, who wrote "Liar’s Poker" and "The Blind Side" tells the story of the 2008 financial meltdown through the eyes of a half dozen men, none of who are likely be recognizable names to you, but who made big bets against the subprime mortgage market and were rewarded.

These men, mostly from small boutique—and sometimes barely solvent—investment firms are an idiosyncratic bunch. One is a certified sufferer of Asperger’s disorder. They are thought out of their minds because they had what was lacking on Wall St.: commonsense. They were sometimes ostracized because of their beliefs.

Much of the story is about how these half dozen or so men first did what every investor should do: examine what they are buying. When they did, they found mortgages bonds rated aaa but which contained mostly mortgages to people who could not afford the homes.  Many of the subprime mortgage bonds were full of mortgages that could not possible be repaid. Some mortgages were structured so that the borrower was likely to default when the first payment came due.

If only a small portion of the mortgages failed, the bond itself would implode. Their stories are sometimes hilarious and their methods often unorthodox as they tried to find out what the market saw in these bonds that they didn’t.  Many were filled with self-doubt, unable to believe that they could see disaster coming whereas the titans of Wall St. saw nothing but blue skies ahead. They spent a lot of their time trying to prove themselves wrong.  Fortunately, they made the investment in CDOs against the bonds, despite their self-doubt.

Their story, told with Lewis’s sense of humor, is delightful. They reveal a Wall St. that is insular, aloof and not nearly as smart as it think it is.

What is most frightening about this account is that the 2008 crisis was totally avoidable, if only Wall Street wasn’t so oblivious to the obvious. Anyone who looked behind the mortgage bonds being traded during the early 2000’s would see that they were doomed to fail. The market was simply unsustainable.

But the almighty traders and leading Wall St. firms never looked closely at what they were trading. Those putting the mortgage bonds together—as well as those in the rating agencies who dared not look into them—did so without scrutiny, not just from the SEC or the CFTC, but from the executives of Wall St. firms.

It’s clear that when it comes to evaluating investments in the traditional sense, that is without complex derivatives, most on Wall St. are no more sophisticated than the common investor.

But we, of course, get to pay the price of their incompetence.

Posted in: Books.
Last Modified: January 6, 2011