This summary of The Big Short: Inside the Doomsday Machine by Michael Lewis explains what exactly went down during the 2007 Global Financial Crisis (GFC), the causes of the crisis, and how a few people managed to profit from it.

As usual, the key takeaways are below, and you can find the full summary by clicking the link above.

KEY TAKEAWAYS

• What happened in the GFC?
  • Thousands of borrowers took out home mortgages when they did not have the incomes to repay them.
  • These loans were bundled up together into collateralised debt obligations (CDOs) and sold to other investors. In other words, the banks making the loans passed on the risk of default to other people.
  • The ratings agencies gave the CDOs higher credit ratings than they should have. In some cases, they even gave AAA ratings (the highest rating possible, generally only available to ‘riskless’ investments like government bonds).
• The problems:
  • Moral hazard. Mortgage lenders didn’t bother doing due diligence on the borrowers because they just passed the risk onto other investors.
  • Complexity. CDOs were very complex, and few people — including the ratings agencies — understood how they really worked. The investors who bought CDOs put too much faith in the ratings.
  • Conflict of interest. The ratings agencies earned fees from the banks selling the products, so were incentivised to give them good ratings.
  • Correlated risk. The instruments were much riskier than their ratings suggested, because the ratings agencies did not appreciate that underlying risk was all correlated. That is, the circumstances that lead one borrower to default (e.g. rising interest rates or falling house prices) are likely to lead other borrowers to also default.
• A few actors — Michael Burry, Steve Eisman and Cornwall Capital (Charlie, Ben and Jamie) — realised what was happening and tried to “short” these mortgage bonds. Lewis takes us through their journeys in detail.
• It took a long time for everything to collapse:
  • It took a while for borrowers to default. The underlying mortgages had low interest rates for the first few years before increasing. When house prices were rising, borrowers could refinance when their low ‘teaser’ rate expired.
  • The market for credit default swaps was very opaque and illiquid, so banks stayed in denial for months even as defaults mounted.
• Many people did not end up bearing the costs of their bad decisions.
  • The traders and CDO managers buying the subprime assets made a lot of money before everything collapsed — and often got to keep that money when they did.
  • Wall Street firms and AIG did suffer losses, but the government also bailed out many of them.
  • The CEOs and staff of the big firms didn’t end up paying much of a price for their risky gambles, which effectively meant the taxpayer ultimately bore the cost.

You can find the full summary on ToSummarise.com​.

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