May 28, 2011

Review of The Big Short

No economists saw the crisis coming. Well, maybe some did, such as Dr Doom Roubini or Bob Shiller, who had been talking about a housing bubble for a while. But economists didn’t put money where their mouths were. A few people actually did by betting on the collapse of Wall Street. The Big Short recounts their story brilliantly. How did they know it was gonna happen? Well, they weren’t working in huge banks, they were outsiders. One of them was an autistic with only one eye who in 2005 decided to create a fund and invest it all in credit default swaps. He was making a huge bet on the collapse of supbrime loans, like buying a share on a prediction market such as Intrade. These few gamblers were right, and arrogant bankers were ignorant, and some were even more ignorant than others.
All in all, this is a well-written, easy-to-understand, story of the crisis. Michael Lewis, famous for Liar’s Poker but also sports books such as Moneyball and the Blind Side (which became a movie starring Sandra Bullock), makes you understand what happened better than any economist. Bankers and analysts in big banks and rating agencies had no idea what was going on with all those toxic bonds. Because of a lack of market information, mortgage-backed securities were rated way too high and credit-default swaps were priced way too low, failing to reflect the high probability of default and allowing a huge house of cards to build-up. Obvious in retrospect…

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