The Big Short: Required Reading (and watching) for Dirt Lawyers



Super Bowl 50 was the big entertainment news of the weekend, but coming in at a personal close second were the book and movie The Big Short. I rushed to finish the former before dragging my husband to a Saturday matinee of the latter. Then, a friend pointed me to an NPR special “The Giant Pool of Money”, which provided a fascinating diversion for my Saturday afternoon walk.  (I confess to being easily entertained by all matters involving real estate.)

I encourage everyone involved with “dirt” to read the book, watch the movie and listen to the podcast. All relate to the 2008 financial crisis. At the center of the book (and movie) were several eccentric investors/money managers, who predicted the fall and brilliantly crafted a method to cash in on it. At the center of the podcast was the “giant pool of money”, the trillions of dollars in the economy that constantly need a place to be invested.

Locally, we heard the stories about real estate investors who lost properties and funds in the crash. In our office, we compared the crash to a game of musical chairs. The investors who sat in the chairs when the music stopped (the ones who held titles to the properties) were the ones who lost.

All areas of South Carolina were affected, but our coastal areas were hardest hit. Property values were phenomenal!  A contract on a yet-to-be-constructed residence might change hands several times at increasing prices before the final purchase. And loans were easy to procure at all income levels. No one thought property values would ever soften, and it didn’t matter if adjustable rate loans would reset in two years at staggeringly high fixed interest rates because refinances were readily available. Properties and mortgages churned like butter. There was apparently no end in sight.

The book’s author, Michael Lewis, who also wrote Moneyball and The Blind Side (back to football, which really is the center of the universe), said in explaining the mindset of the people who would borrow again and again, “How do you make poor people feel wealthy when wages are stagnate? You give them cheap loans”.

One of the money managers in The Big Short had his eyes opened by a story from his own household. His babysitter revealed she and her sister owned five townhouses in Queens. When he questioned asked how that possibly could have happened, she responded that after they bought the first townhouse, the value increased, and lenders suggested they refinance and take out $250,000, which they used to buy another townhouse. And so on….

The “giant pool of money” that at one time had been invested safely in boring assets like Treasury bonds, needed a place to land with higher interest rates. With mortgage rates being at 3.5% and higher, no better place could be found.

How did the money managers cash in?  They looked at pools of mortgages that were being sold on the secondary market, saw that the interest rates would collectively begin to reset in early 2007, and bet against the housing market.

They created a “credit default swap” market that bet against collateralized debt obligations. Huh?

One of the points of the book is that the financial markets created fancy terms that average individuals could not possibly understand. In this particular case, it turned out that that the big Wall Street firms, the people who ran them as well as their regulators, did not understand what was happening either.

“Credit default swap” is a confusing term because it is not a swap at all. It is an insurance policy, typically on a corporate bond, with semiannual payments and a fixed term. The money managers who predicted the subprime lending crisis bought credit default swaps that paid off, like insurance policies, when the market crashed.  These eccentric money men were able to predict that there would be a crash of the subprime mortgage market even if housing prices only stalled because borrowers would not be able to refinance or make payments.  When prices dropped, the money men were able to cash in at astonishing levels.

The most horrifying point of the book was that the government’s response to the crisis, the so-called bailout, will not prevent the crisis from happening again. We can only hope that we are all better educated the next time around. As I opened Outlook this morning, though, the first article that caught my eye was from Housingwire entitled “Risky home lending really on the comeback?”  Let’s collectively hope not!

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