Recently Michael Lewis was in news as he wrote a compelling piece on Serge Aleynikov, the former Goldman Sachs computer programmer convicted of stealing the bank’s secret algorithms, in the Vanity fair. Where he shared one of the famous line from his book Big short There’s a line in The Big Short; one of the characters, who was cynical about the subprime-mortgage market, says,
“When I hear Chinese Wall, I think you’re a f—ing liar.” I feel that way about liquidity. When I hear the word liquidity, I think you’re a f—ing liar. If this is liquidity, we don’t need it.
The book is a fabulous read because of its simplicity. It’s not just for finance geeks, rather the stuff narrated by Michael lewis is easy to digest. Although I still believe Liar’s Poker was one of the best work by Michael, but the Big- short seems to me is one of the best journalism written on the sub prime crisis.
The book is more focused on the vulnerability of the sub prime crisis, how the big guns shorted the subprime market making it worse as they provided the fuel which kept the subprime mortgage furnace burning even when the US was running out of new junk mortgages to write. The book quotes an example of a deutsche bank trader Greg Lippmann ended up making billions of dollars for his employer — not to mention a $50 million bonus for himself — by aggressively going out and finding fund managers to put on the short bets needed to keep the market ticking.
How the Govt agencies Fannie and Freddie started accepting increasing amounts of subprime paper. Then banks started selling private-label subprime CDOs directly to investors, bypassing the GSEs; a lot of the profits in that activity came from taking the unattractive lowest-yielding tranches and insuring them with AIG.
In the process AIG was over leveraged it was not selling Credit default swaps any more. But then it gave rise to the synthetic subprime CDOs which were bought by Greg Lippmann sold by the banks.
This was the market with almost no pricing transparency in the secondary market: because all securitization deals are unique, the only way to get a feel for the health of the market is by looking at where primary deals are pricing. Whenever anybody said that the marks being put on subprime assets by banks and hedge funds were delusional, it was easy to point to the booming market in synthetic subprime CDOs to prove them wrong. No one, of course, remarked on the irony that the synthetic subprime CDO market was only booming because John Paulson and others were providing a huge amount of demand for bearish bets.