Book Review: Big Short

Few weeks ago, I watched the movie ‘Big Short,’ starring Christian Bale, Brad Pitt, Ryan Gosling and Steven Carell — a handful of big names which isn’t necessarily a good sign for a movie. But the movie turned out to be great and I decided that I should pick up the book to get more details. If the movie focused on the absurdity of what we witnessed in one of the biggest financial crises in history, the book will give detailed accounts of why such absurdity happened.

Looking back at 2007, it seems almost idiotic that none of the people in Wall Street saw what was coming: the boom and bust of the subprime market. Michael Lewis’ “The Big Short” vividly notes how the executives of Wall Street firms failed to understand their own business, how the smartest people in the industry failed to see the shortcoming of their own thoughts, and how only selective few saw what was really coming.

The book makes the whole series of events between 2005 and 2008 look almost like a quirky movie filled with absurd jokes. How could such smart and talented people do something so stupid? After all, millions of people lost their jobs and trillions of dollars evaporated in our economy due to moronic behaviors done by people in the exclusive circle in our society. What makes this book so comical is the fact that even the smartest people were exposed to simple mistakes. The book briefly mentions about Charlie Munger’s speech at Harvard University in 1995 called “the Psychology of Human Misjudgment.” While the book doesn’t explore the details of human fallacies that Munger defines in his speech, it shows how the people in Wall Street were vulnerable to these fallacies regardless of how smart they were. On the other hand, those who had unconventional backgrounds were more likely to avoid this trap.

It is easy for readers to think that the subprime crisis could have been avoided if Wall Street used a bit more of brain power than they had. But this is precisely what the book warns about to the readers. The subprime crisis was a Black-Swan effect occurred by a chain of events that clearly had many red flags along the way, but it was difficult to predict the outcome prior to the event. As Michael Burry wrote in his letter, after the market collapsed, so many pundits came out in the media saying how the crisis was foreseeable, while nobody agreed with Burry’s view before the crisis happened. In fact, a lot of the poor decisions made by investors and firms were due to their tendencies to make judgements by relying on the historical figures. Nothing in the history textbooks or backward looking models could predict the possibility of such unprecedented event. This tendency to make a judgement based on past outcomes is one of the psychological fallacies that most people have. Without a historical or numerical evidence to support the thesis, it is likely for people to dismiss any argument that sounds even slightly unfamiliar.

Another fallacy that propelled the crisis was the tendency to underestimate the human nature that is part of the machine. This tendency is strong especially when the system is highly sophisticated. If something can be explained simply by a formula, people will overlook the qualitative aspect as it will seem to be too unscientific. But what runs the machine is a human being after all, and human beings are prone to mistakes. What the book clearly showed was that people make decisions based on individual interests and agendas, rather than rational thinking, and, in Wall Street, greed is the driving force of what moves the chess piece across the table. Greg Lippman, a bond trader at Deutsche Bank who pitched the investors to short the subprime market, for example, really understood the game as he clearly saw how the market evolved into a “tug-of-war.” He was successful at using his political sense to survive in the Street and make a fortune by facilitating the CDS trades.

Finally, the most obvious fallacy that blinded everyone was the tendency to have a view that is more acceptable to the society. What set Michael Burry, Steve Eisman, James Mai and Charlie Ledley apart from the others was their ability to think differently, and they were capable of doing so due to their unconventional backgrounds. Most notably, what they had in common was their unwillingness to conform with others’ views. Burry was not only able to come up with a radical idea to short the subprime market, but he was also able to stick to his ideas when his investors were openly revolting against him when he was losing money. Eisman, who studied Talmud when he was a child to find any inconsistencies in the script, also navigated the world by questioning everything he faced. Without having the pressure to conform with the society and the system that surrounds them, they were able to pursue their goals independently.

The moral of the story is that human beings are not as rational as we think, and people are often shortsighted no matter how smart they are. Despite the fact that the lending companies were giving out predatory loans, consumers nonetheless took those deals. Even when the fundamentals were deteriorating to the brink of collapse, Wall Street ignored these because of their greed. Only the ones who could detach themselves from social conformity could survive this catastrophe and turn it into an ‘once in a lifetime opportunity.’