Literary Insights

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Here is a summary of the book The Big Short by Michael Lewis:

The book examines the build-up of the housing and credit bubble in the U.S. between 2004-2007 and how some investors anticipated and profited from the collapse.
It profiles several individuals and investment groups who realized the bubble was unsustainable and made bets against the housing market and subprime mortgage-backed securities. These “outsiders” struggled to convince Wall Street that a crash was coming.
The book describes how complicated financial instruments like credit default swaps were used by these investors to profit from the downturn. It examines how Wall Street firms were oblivious to the risks accumulating in the system.
When the housing bubble finally burst in 2007-2008, it led to the largest financial crisis since the Great Depression. Tens of trillions of dollars of wealth was wiped out globally.
The book is both an explanation of the housing bubble and the ensuing financial collapse, as well as a profile of the small number of “cassandras” who perceived the coming crisis when almost no one else did. It highlights the enormous costs of Wall Street’s willingness to ignore challenges to its worldview.
Steve Eisman started his career as a corporate lawyer but hated it, so his parents helped him get a job at Oppenheimer securities where they worked.
At Oppenheimer, he began as a junior equity analyst but was put in charge of covering the newly public subprime lender Aames Financial, even though he knew little about the industry.
He established himself by going against the consensus and issuing a “sell” rating for another troubled subprime lender, Lomas Financial, even after the company claimed to be hedged. His criticism of Lomas proved prescient when it later declared bankruptcy.
Eisman took pleasure in researching industries thoroughly and issuing blunt, contrarian opinions loudly and publicly. He dressed casually and had a habit of openly sharing his thoughts, which often outraged important men on Wall Street.
However, those who understood Eisman loved working for him because he was a passionate teacher and protector of women. His outsider analysis would later predict the housing market collapse.
Steve Eisman, a hedge fund manager who predicted the subprime mortgage crisis, had a talent for offending people with his blunt and rude manner.
He listened to Eisman explain why the head of a large brokerage firm didn’t understand his own business, then Eisman abruptly left the lunch and the brokerage head said he’d never be in the same room as Eisman again.
Eisman told the president of a Japanese real estate firm that he didn’t even own stock in his own company, despite coming to solicit Eisman’s investment. When told Japanese management don’t typically own stock, Eisman called the financial statements “toilet paper.”
Eisman’s straightforward and rude manner upset many people, though some admired his intelligence and honesty. His background studying the Talmud for inconsistencies showed his curiosity in contradictions.
The growth of the mortgage bond market in the 1990s allowed subprime lending to extend credit to less creditworthy homeowners through mortgage-backed securities. Some saw this increasing access to credit as beneficial, while others recognized the potential for abuse in an industry where lenders could sell off loans with less responsibility for performance.

The passage describes Steve Eisman hiring Vincent Daniel to help analyze the subprime mortgage industry. Eisman had a hunch something was wrong but needed help understanding the details. Daniel was skeptical by nature due to his upbringing. When analyzing loan data from Moody’s, Daniel discovered high default rates, particularly for manufactured homes/mobile homes. Defaults were being disguised as “involuntary prepayments.” This indicated the subprime lenders were misleading investors about the true performance and riskiness of the loans. Eisman and Daniel believed they had uncovered problematic practices in the subprime industry and wanted to write a report highlighting the issues, but needed to be careful given Eisman’s role promoting subprime companies at Oppenheimer.

Vinny analyzed pools of subprime mortgage loans and realized that subprime lending companies were growing rapidly through dubious accounting that masked their lack of real profits. They relied on an unsustainable Ponzi-like model of using new capital to fund more loans.
Eisman published a report exposing deceptive accounting and high delinquency rates at over a dozen subprime originators. This disrupted the subprime lending industry and led to mass bankruptcies when capital dried up due to the Russian debt crisis.
Eisman analyzed the consumer lending company Household Finance and discovered they were disguising high-interest second mortgages as low-interest 30-year loans through deceptive marketing materials. This was blatant fraud that hurt many borrowers.
Eisman campaigned against Household by alerting reporters and activists. The company was finally fined $484 million in a class action settlement but the CEO made $100 million, showing a failure to properly regulate predatory lending to lower-income groups.
This experience further increased Eisman’s pessimism about finance and highlighted the need for regulations to properly protect vulnerable consumer groups from exploitation.
Michael Burry, an unconventional hedge fund manager, became fascinated by the subprime mortgage market in the mid-2000s. He saw similarities between fairy tales being rearranged in unfamiliar ways and the subprime market.
Steve Eisman, a former hedge fund manager, had already soured on the industry after seeing Household International CEO collect $100 million while preying on poor consumers through subprime loans.
Eisman further realized the subprime mortgage industry existed to “rip people off” at an industry conference where the CEO of Golden West Financial said banks profited off overdraft fees from poor customers.
Despite initial struggles raising money, Eisman started his own hedge fund focused on shorting financial companies through FrontPoint Partners. He recruited a team that shared his skeptical views of Wall Street, including Vinny, Porter Collins, and Danny Moses.
By 2005, the subprime market had ballooned to $625 billion in loans, $507 billion of which were securitized into bonds. The terms also became riskier with floating rates. Eisman’s team believed many in the industry did not understand the risks they were creating.
Michael Burry became interested in the bond market in 2004 and studied subprime mortgage bonds extensively by reading their 130-page prospectuses. He noticed declining lending standards over time as riskier loan types like interest-only adjustable rate mortgages became a larger portion of the pools.
Burry coined the term “extension of credit by instrument” to describe how lenders were constantly degrading standards to grow loan volumes. He believed the end buyers of subprime MBS were “dumb money” and would later study who they were.
A challenge was that subprime MBS tranches were impossible to short directly. However, Burry had previously discovered credit default swaps, which functioned like insurance policies that allowed investors to bet on defaults without owning the underlying bonds. This gave him a way to potentially profit if the subprime market collapsed, though it was an asymmetric and high-risk bet.
In summary, Burry did deep research on declining lending standards and wanted to short the subprime market, but traditional shorting was not possible - credit default swaps were his proposed method.
Michael Burry realized that credit default swaps could allow him to bet against the housing market and subprime mortgage bonds in a way that defined his downside risk but offered huge upside potential if housing crashed.
In 2005, he began contacting major Wall Street banks to try and get them to create credit default swaps on subprime mortgage bonds, since that market didn’t exist yet. Only Deutsche Bank and Goldman Sachs showed real interest.
Burry had a rare cancer as a child that cost him his left eye. He felt this made social interaction difficult and led him to be an outsider. It also contributed to traits like obsession with fairness and the ability to intensely focus on topics of interest.
He realized credit default swaps could help him solve the timing issue, as the subprime loans being made would likely default in a few years as teaser rates expired, but the market may not recognize this immediately. The swaps would allow him to place a bet now that would pay off when the risks materialized.

So in summary, Burry spotted an opportunity to bet against the housing market by creating a new type of derivative, and used credit default swaps to implement this view and hedge the timing issue, based on his unique analytical approach and perception of the subprime market’s risks.

Mike Burry was diagnosed by psychiatrists as bipolar, but he didn’t think the diagnosis was accurate. He was intensely driven and obsessive about his work and interests, including studying the stock market. While working long hours as a neurology resident, he started posting his stock market analyses online late at night. Word spread in the finance community and people started following his picks, which were often opposing the dot-com bubble picks of others. By the time he moved to Stanford Hospital, his blog had made him something of an expert, though he kept his side investing activities quiet from his medical colleagues who were enthralled by internet stocks. He eventually quit neurology to become a money manager full-time, using his modest savings and a settlement from his father’s misdiagnosed death. His intense work habits and perceptions of being different were attributed, by him, to the impacts of his fake left eye.

Dr. Michael Burry proved successful investing on his own and used money from family settlements to start his hedge fund, Scion Capital, with over $1 million.
He initially struggled to attract other investors due to his lack of social skills and unconventional style. However, two large investors, Gotham Capital and White Mountains, saw his talents as an analyst and invested $1 million and $600k respectively based solely on his writings.
Burry significantly outperformed the market in his first three years managing money, returning 55%, 16% and 50% compared to losses and gains of around 12-28% for the S&P 500.
Despite his success, Burry preferred communicating with investors through writing rather than in person. He modeled his approach after value investor legends like Warren Buffett and Charlie Munger who also struggled socially but found success through their analytical abilities.

So in summary, Burry succeeded in attracting sizable early investments and significantly outperforming the market through his investment talents, despite difficulties interacting with people in person due to his unconventional personality and style.

Mike Burry saw incentives in the hedge fund industry that rewarded simply amassing assets, rather than generating returns. He structured his fund, Scion Capital, differently by only charging actual expenses rather than a percentage of assets.
Scion was enormously successful in its early years, generating returns of over 240% while the market fell. Burry found unconventional “ick” investments by closely reading financial filings and court documents.
One of his early major successes was Avant!, a software company accused of theft. While others avoided the stock due to scandals, Burry saw the value and bought heavily at $2 per share before it was acquired at $22.
Burry began warning of a housing bubble as early as 2003, noticing irrational lending practices. In 2005 he decided to place a major bet against subprime mortgage bonds by buying credit default swaps, but Wall Street was initially skeptical of this new market.
Burry worked to standardized swap contracts through ISDA to facilitate his large trade, helping launch what would become a major new market almost overnight once the housing crisis emerged.
Mike Burry bought $60 million in credit default swaps from Deutsche Bank in May 2005, insuring against defaults on six different subprime mortgage bonds.
The credit default swaps paid out incrementally as individual homeowners defaulted on their mortgages, rather than all at once if the entire bond pool defaulted.
Burry analyzed the mortgage loans to identify the riskiest bonds to bet against. He was surprised banks like Deutsche Bank and Goldman Sachs did not differentiate between bonds.
Burry was able to buy hundreds of millions of dollars in CDS contracts from multiple banks to bet against his chosen high-risk bonds.
By the end of July 2005, Burry owned CDS contracts providing insurance against $750 million in subprime mortgage bonds. He believed no other hedge fund had such a large bet against the subprime market.
Burry wanted to start a new fund exclusively to buy more CDS contracts, but most investors were skeptical of his negative housing market view.
Mike Burry believed the US housing market was in a bubble that would eventually burst, causing the mortgage-backed securities it supported to lose value. He saw an opportunity to short, or bet against, the riskiest mortgage-backed securities through credit default swaps.
While his investors had done well from his stock picks previously, they were skeptical of his big “macro bet” against housing and worried it could backfire. Some wanted him to stick to stock picking instead.
As the housing market started showing signs of weakness, Wall Street firms like Goldman Sachs and Deutsche Bank began reaching out to Burry, interested in unwinding some of the short positions he had built up through credit default swaps. This showed the risk was now being recognized on Wall Street as well.
Burry believed the fundamentals supported his view that the housing bubble would pop in the long run, even if it took years, and that shorting the riskiest mortgage bonds through credit default swaps had tremendous profit potential if the bubble burst. However, he struggled to convince skeptical investors to stay patient and committed to his bet.
Greg Lippmann, a trader at Deutsche Bank, visits FrontPoint Partners to pitch an idea to bet against subprime mortgage bonds.
Steve Eisman is wary of Lippmann due to skepticism of Wall Street bond traders, given the opaque and unregulated nature of the bond market.
Lippmann is an eccentric character who freely shares details about his compensation and critical views of management, violating the code of secrecy on Wall Street. While controversial, he is acknowledged to be a truly gifted bond trader.
In a 42-slide presentation, Lippmann argues that housing prices have risen too fast in recent years and are unlikely to continue at the same pace. He shares data showing an alarming rate of early defaults on loans, indicating many homeowners cannot afford their mortgages if prices don’t keep climbing rapidly.
Lippmann’s pitch focuses on the risk that stagnating home prices, rather than price declines, could trigger widespread defaults on subprime mortgages and problems for bonds backed by these risky loans.
Greg Lippmann, a Deutsche Bank trader, was pitching the idea of shorting (betting against) subprime mortgage loans by buying credit default swaps (CDS) on risky subprime mortgage bonds. CDS allow investors to bet on losses in those bonds without putting down much cash upfront.
Lippmann argued defaults were likely to rise significantly given low underwriting standards, teaser rates that would balloon, and widespread fraud. His “quant”, Eugene Xu, provided supporting data.
Shorting these bonds via CDS was very attractive due to leverage (potential large profits for little risk) and not needing perfect timing of a crash. Worst case was paying a 2% annual premium for 6 years.
Steve Eisman from FrontPoint Partners was interested in the trade but skeptical of Lippmann given his firm Deutsche Bank’s role in creating and rating these bonds. However, Eisman couldn’t see downsides given his view of the troubled subprime market.
Unbeknownst to Eisman, the party on the other side of many of these CDS bets was AIG through its AIG Financial Products division. AIG FP took on billions in risk from firms like Goldman Sachs without regulators’ knowledge. This allowed risks to be dispersed without proper oversight or capital reserves.
In the 1990s and early 2000s, AIG’s Financial Products division (AIG FP) became hugely profitable by selling insurance (credit default swaps) to banks against the risk of corporate defaults.
In the late 1990s, AIG FP entered the market for credit default swaps on corporate bonds, which proved low risk and profitable.
Starting in the early 2000s, AIG FP was persuaded to apply this model to insuring consumer debt like mortgages, which was riskier but seemed diversified.
In the mid-2000s, the deals changed to insuring only subprime mortgage bonds. AIG FP insured $50B in subprime mortgages for very low fees, unaware of the rising risks.
Goldman Sachs created synthetic CDOs made of subprime mortgage bonds and got the ratings agencies to rate them AAA. They then got AIG FP to insure $20B of these through credit default swaps.
Burry realized the subprime market was overvalued and bought $1B of credit default swaps, effectively betting the subprime bonds would default.

So in summary, AIG FP gradually took on vastly more risky subprime mortgage exposure through credit default swaps, unaware of the looming housing crisis and financial risks.

Mike Burry took a short position on subprime mortgage bonds by buying credit default swaps (CDS) that would pay off if the bonds defaulted. The 2.5% annual premium he paid mimicked the returns investors earned from holding the actual bonds.
Goldman Sachs created “synthetic CDOs” made entirely of CDS contracts, allowing them to replicate subprime mortgage bonds without actually originating loans. This removed constraints on betting sizes.
Ratings agencies like Moody’s and S&P gave high ratings to these synthetic CDOs based on models provided by the banks themselves.
AIG sold billions in CDS to Goldman without reserving capital, essentially acting as insurer for the mortgage market without regulation.
Traders at Deutsche Bank like Greg Lippmann were initially reluctant to short the market but saw an opportunity to profit from the arguments around pricing complex mortgage securities.
Lippmann realized default rates did not need to collapse for subprime bonds to suffer losses, as rising rates were already causing issues, strengthening his conviction to short the market.

So in summary, new financial instruments like synthetic CDOs and unregulated CDS enabled huge bets for or against the mortgage market without actual loan exposure, magnifying risks as the housing bubble grew.

Greg Lippmann was a Deutsche Bank bond trader who developed a large short position betting against subprime mortgage bonds. His position grew to over $1 billion by the end of 2005.
Lippmann faced pressure from Deutsche Bank executives questioning why he was taking this position, which was losing money at the time.
In an effort to validate his trade, Lippmann flew to London to meet with AIG executives and convince them to stop insuring subprime bonds through credit default swaps. He thought he had succeeded.
However, the first person at AIG FP to recognize the risk was Gene Park, not the executives Lippmann met with. Park noticed AIG was taking on huge volumes of credit default swap deals without proper risk management or capital reserves.
Joe Cassano, the head of AIG FP, had a management style focused on control and obedience. He would bully and humiliate subordinates who questioned risk exposures. This created a culture of fear within AIG FP.

So in summary, Lippmann took a large short position against subprimes but faced internal pushback, and his effort to influence AIG failed to shift their behavior at that point, though risks were beginning to be noticed by some at AIG like Gene Park.

Joe Cassano was the CEO of AIG Financial Products (AIG FP), known for his extreme temper and authoritarian leadership style. Employees felt they had to constantly appease him and avoid any criticism of the company.
Under Cassano, AIG FP increasingly took on risk by insuring billions of dollars worth of mortgage-backed securities through credit default swaps. However, Cassano and others did not fully understand that these securities were predominantly backed by risky subprime mortgages.
One employee, Gene Park, realized the risky nature of these positions and tried to convince Cassano to stop taking on more risk. This angered Cassano but he eventually agreed after meetings with Wall Street firms did not reassure him.
Still, AIG FP did not take steps to reduce its existing $50 billion exposure to subprime mortgage bonds. The subprime market continued to boom.
Deutsche Bank trader Greg Lippmann had been shorting subprime mortgages, believing the market was overvalued. He tried to convince AIG FP and others to also short the market as a hedge, but most investors did not see the risks.
Lippmann eventually found an ally in Steve Eisman’s hedge fund FrontPoint Partners, which was also shorting subprime lenders like New Century, believing a collapse was coming. But the subprime bubble continued inflating for now.
Eisman wanted to short subprime mortgage companies like New Century but the costs were high to borrow shares and maintain the short positions.
Lippmann, who believed in the subprime doomsday scenario, met with Eisman’s team multiple times to convince them to short the market. They were suspicious of his motives since he worked for Deutsche Bank.
News emerged that rating standards were changing and home prices began declining in 2006, which should have raised insurance costs on subprime bonds, but costs fell instead. Eisman’s team did their first trade with Lippmann but remained cautious.
Eisman’s team analyzed the specific loan pools, locations, and originators to identify the riskiest areas to bet against. They found many bonds had over 50% no-doc loans. Their research involved visiting affected areas to see the problems first-hand.
The best shorts had bonds backed by loans concentrated in states like California and Florida that saw the biggest house price increases and thus were most vulnerable to declines.
Long Beach Savings, owned by Washington Mutual, was aggressively originating subprime mortgages with few questions asked. It pioneered no money down, deferred interest payment loans.
Eisman saw stories of people taking on huge mortgages they couldn’t repay, like a Mexican strawberry picker lent $724k.
Moody’s and S&P rating models were flawed and exploitable. They didn’t examine individual loans but just loan pool characteristics.
Wall Street firms figured out how to game the models, for example by offsetting high risk loans with seemingly good ones to hit target averages. They found loopholes like ignoring second mortgages.
Immigrants with thin credit files but good scores on paper helped offset riskier loans. Figuring out how to best game the rating agencies became a competitive advantage.
Eisman realized the markets were not rationally pricing risk but based on flawed ratings. He worked to understand how the rating models had been exploited to identify the most overrated bonds as short targets.
Greg Lippmann at Deutsche Bank had been pitching the idea of shorting subprime mortgage bonds to hundreds of investors since around 2005. Only about 100-200 investors took part in the new market for credit default swaps (CDS) on subprime mortgages.
A small number, less than 20 investors, made outright bets against the entire subprime mortgage market. These included hedge funds like Paulson & Co, Whitebox, Baupost, Passport Capital, Elm Ridge, and others who heard Lippmann’s argument directly or indirectly.
Individual investors like Kyle Bass, Jeff Greene, and others also placed large bets against subprimes after hearing about it from Lippmann or others. Even a Goldman Sachs trader flew to meet Lippmann based on hearing his view.
Within this small group, an even smaller handful including John Paulson made investments so large relative to their funds that it became an obsession, allowing them to foresee not just risks to the financial system but broader society.
Paulson in particular managed to raise billions from investors by framing it as a “cheap hedge” rather than outright bet against the market, though he himself had over $20 billion short subprime mortgage bonds through CDS.
Charlie Ledley and Jamie Mai founded Cornwall Capital Management in early 2003 with $110,000. Neither had much investment experience.
Their idea was to search globally for market inefficiencies across stocks, bonds, currencies and commodities. They would take a big-picture view rather than focusing on narrow areas like other investors.
Their first big opportunity came from Capital One Financial. Its stock crashed in 2002 over a capital dispute with regulators. Cornwall studied the issue and concluded Capital One was likely not committing fraud as suspected.
Ledley and Mai embarked on an unusual diligence process to assess Capital One’s character, including contacting former classmates of the CEO and a lower-level executive at the company.
They decided Capital One’s subprime lending tools were probably sound. This indicated the stock was undervalued due to overblown fraud concerns, presenting an investment opportunity for Cornwall.

So in summary, Ledley and Mai took an unconventional approach focused on global market views rather than narrow expertise, exemplified by their deep dive on Capital One to assess its true risk profile versus the market’s fears.

Charlie and Jamie visited the founder of Capital One, John Schnall, to evaluate the company and decide whether to invest. They concluded the company was probably honest, not crooks.
Capital One’s stock price stayed stable around $30 despite regulatory issues that could cause it to go to $0 or $60.
Jamie had an idea to buy long-term call options on Capital One stock, assuming it would move dramatically one way or the other once regulatory issues were resolved. The options were cheap based on the Black-Scholes pricing model.
Cornwall Capital bought cheap options and made a large profit when Capital One’s stock rose after being cleared by regulators.
They used a similar strategy successfully on other companies, turning small bets into millions.
They dubbed their approach “event-driven investing,” betting on binary outcomes for companies facing major events or regulatory decisions.
Though successful, they weren’t sure if it was luck or skill. They hired experts but also taught themselves financial theory and option pricing models.
Within a few years they were managing $12 million from their own money and opened an office in Manhattan.

Here is a summary of the key details about Julian Schnabel’s art studio:

Julian Schnabel is a prominent American artist known for his large-scale paintings.
No other details are provided about Schnabel’s specific art studio. The passage does not mention the location, size, facilities, or any other characteristics of his studio space.
The passage does not contain any information about Schnabel’s artistic process, techniques, materials used, or how he utilizes his studio space.
There are no quotes from Schnabel or other descriptions of his studio from his own perspective.
In summary, the passage does not provide any substantive details about Julian Schnabel’s art studio. It does not characterize or describe his studio space in any way. The artist’s name is mentioned but no information is given about his actual studio.
The passage discusses Cornwall Capital, a small hedge fund run by Charlie and Jamie, and their efforts to gain access to complex derivatives trades usually only available to large institutions.
Their friend Ben helps them get a crucial legal agreement (ISDA) from Deutsche Bank that allows them to trade these derivatives. However, their small office space in an artist’s studio raises questions from Deutsche Bank in their review process.
Obtaining the ISDA opens doors for them to trade credit default swaps (CDS) with major banks like Goldman and Deutsche. In particular, they see an opportunity in CDS on subprime mortgage bonds, which are being priced too low given signs the subprime market is already souring.
However, they still don’t fully understand the vehicles (CDOs) on the other side of these trades driving pricing. They embark on research to understand what CDOs are and how they relate to the underpricing of CDS on subprime bonds.
In summary, the passage details the challenges a small fund like Cornwall faced in gaining access to complex derivatives, and their efforts to take advantage of an opportunity they saw in underpriced subprime CDS markets once they overcame those challenges.
The language used in the bond market was deliberately obscure and confusing, using terms like “rich” instead of “expensive” to describe overpriced bonds.
Risky tranches (levels) of mortgage bonds and CDOs were given euphemistic names like “mezzanine” instead of terms that conveyed the real risk, like “ground floor.”
Determining what exactly backed asset-backed securities (ABS) and CDOs was very difficult, as they used layers of abbreviations and acronyms to describe the underlying mortgages and bonds.
Even the ratings agencies like S&P did not fully understand what assets backed the CDOs they were rating. The models assumed diversification without verifying the actual assets.
Charlie, Jamie, and Ben began betting against the higher rated double-A tranches of CDOs, seeing they effectively carried the same risk as the triple-B tranches but had a much lower insurance cost.
Through research sites like LehmanLive, they aimed to identify CDOs with the highest percentages of subprime mortgage bonds and other CDOs as collateral, recognizing these as most risky. The obscurity of terms and assets in CDOs masked the true high risk nature of these investments.
Charlie and Jamie attended the annual subprime mortgage conference in Las Vegas, accompanied by their market expert David Burt. They hoped to find someone who could explain why they were wrong to bet against the subprime mortgage market.
Steve Eisman attended the conference as well, going golfing beforehand with his partners Vinny and Danny. Eisman dressed casually in violation of typical Wall Street golf attire, retrieving balls from sand traps without penalty.
After golf, Eisman and his partners went to a dinner hosted by Deutsche Bank. This was Eisman’s first bond market conference and he had put himself in Greg Lippmann’s hands to attend events, though his partners were wary of Lippmann’s agenda given his role trading subprime bonds.
Charlie and Jamie went to a firing range outing hosted by Bear Stearns, as their first experience shooting guns. They attended the conference seeking perspectives on their bet against subprime markets, which they still did not fully understand despite finding an expert in Burt.

In summary, key figures met at the Las Vegas subprime conference, with Eisman golfing casually and attending an event, while Charlie and Jamie went to a firing range, all searching for insight into the subprime market turmoil they predicted.

Based on the passage, Lippmann’s idea of bringing together short sellers and long investors at the teppanyaki dinner must have had a hidden purpose of reassuring the short sellers that the long investors were foolish and unaware of the real risks, so that the short sellers would not lose faith in their bet and quit paying insurance premiums to Lippmann. Lippmann was worried that without reassurance, more of his team might quit like Eisman threatened to do, leaving Lippmann with large subprime bets that were losing money daily. So the dinner was a shrewd attempt to shore up his short selling coalition.

Charlie Ledley and his partner Ben Hockett from Cornwall Capital attended a subprime mortgage conference in Las Vegas, even though they hadn’t preregistered.
Before the conference, some Bear Stearns employees they had been in contact with invited them to an indoor shooting range. Charlie was surprised by the invitation but went along. They fired various guns, including an Uzi, using a Bear Stearns credit card to buy ammunition.
At the conference, Charlie and Ben struggled to find relevant people to talk to about their negative view of subprime mortgages and CDOs. People were confused as to why Cornwall was there since they took an opposing view.
The market insiders they spoke to didn’t provide persuasive counter-arguments to Cornwall’s position. Their main arguments were that CDO buyers would never go away and that subprime loans had never defaulted significantly in the past.
Overall, the passage describes Cornwall’s experience as outsiders at the conference who took a bearish view, in contrast to most participants who were involved in the subprime lending industry.
The casino’s listing of recent roulette spins gives gamblers the false confidence that the next spin is more likely to land on red or black based on recent outcomes, even though each spin is independent. The subprime mortgage market was similarly deluding itself by using short-term past performance to predict the future.
Cornwall Capital realized the subprime mortgage market was headed for trouble by listening to insider John Devaney, who candidly said at a conference that the ratings agencies were “whores” and the securities were worthless, even though everyone had publicly claimed the opposite.
At the Las Vegas conference, Eisman saw that the subprime mortgage industry had ballooned tremendously in just a few years and now drove much of Wall Street profits, even though it made no economic sense. Thousands of financial professionals were now gambling on craps with the money they made from subprime bonds.
Eisman met with insiders like Deutsche Bank to understand the market better, though Deutsche Bank was clearly trying to convince Eisman and others that subprime bonds were still a good investment, not acknowledge the looming problems. The purpose of the conference was to keep the unsustainable market going through deception.
Steve Eisman went to a conference in Las Vegas to learn more about the subprime mortgage market from industry players like lenders and bankers.
At a speech, he publicly doubted a mortgage originator’s claims about low default rates, using hand gestures to indicate the real rate was zero. He then took a fake phone call to end the confrontation.
Eisman was trying to determine if there was something he was missing, or if his view that losses would be much larger was really that obvious.
In private meetings, he probed for insights but found the people underwhelming and still trusting the ratings agencies.
Eisman realized the ratings agencies’ employees were low-level and timid, unaware of the real players exploiting loopholes in their models. Their primary concern seemed to be keeping their jobs rather than ensuring accurate ratings.
This reinforced Eisman’s view that the agencies were incompetent and would not restrain the excessive risk-taking in the markets. He was shocked at how much the whole industry relied on such inadequate ratings.
Charlie Ledley and Ben Hockett from Cornwall Capital returned from a Las Vegas mortgage industry conference in January 2007 convinced the financial system had lost its mind.
The subprime mortgage bond market began cracking after the conference, with prices falling sharply.
Cornwall raised its short position in subprime mortgage bonds and CDOs to over $500 million, overwhelming its small $500 million portfolio.
They struggled to buy more credit default swap insurance from banks like Morgan Stanley to increase their short position, but the banks suddenly changed their policies and refused to sell more.
When a CDO index started trading publicly, it revealed the bonds were worth just pennies on the dollar, contrary to how the banks were still valuing them.
Despite willing sellers still existing like Wachovia, Cornwall found it impossible to significantly increase their short position due to the sudden change in bank risk policies. They believed a crisis was coming but were disturbed they couldn’t short more.
Charlie had suspicions that Bear Stearns traders were buying credit default swaps on CDOs for themselves, as an impending disaster in the market.
In early 2007, subprime mortgage bonds began falling rapidly in value, yet new CDOs were still being created and sold. Wall Street firms like Bear Stearns continued publishing research downplaying issues.
Charlie and his partners saw this as obvious fraud, rigging the market to dump losses or make profits from a corrupt system. Reporters and the SEC showed little interest in their concerns.
In June 2007, Bear Stearns Asset Management lost billions on subprime bets, revealing Bear had been a major actor propping up the market. This exposed Cornwall Capital, which had sold most of its credit default swaps to Bear.
Steve Eisman at FrontPoint wanted to short more subprime securities but was constrained by Morgan Stanley risk management. While the housing issues grew, the stock market and CNBC coverage remained bullish in denial. Eisman thought players in securitization should have known the true risk but let spreads tighten for profits.
Eisman’s hedge fund FrontPoint Partners was growing increasingly concerned about the subprime mortgage market and ratings agencies in 2007. They conducted research and questioned analysts to try to understand what was really going on.
Eisman learned troubling details about how subprime loans were structured and how ratings agencies modeled them, assuming prices would always rise. The agencies lacked key data on individual loans.
FrontPoint took substantial short positions in subprime bonds, ratings agencies’ stocks, and banks. As bonds declined, they knew their positions were paying off but others must be losing money.
Meetings with ratings agencies like Moody’s revealed a shocking denial of problems. Eisman believed the securitization machine driving Wall Street profits was collapsing and would take the banks down too.
New evidence emerged in 2007 that even “good” banks like HSBC had subprime losses, and Merrill Lynch owned meaningful subprime bonds, contrary to Eisman’s assumptions that banks offloaded risks. This confirmed his view that the banks’ fate was tied to subprime meltdown.
Steve Eisman attended a presentation by a senior executive at Deutsche Bank who dismissed concerns about the subprime mortgage market. There was an awkward silence afterwards.
Eisman decided the executive “didn’t get it” and didn’t see a point in further discussion. He became convinced the big banks were hiding risks and may not fully understand their own balance sheets.
Eisman and his team at FrontPoint Partners began looking for hidden subprime exposure at large financial firms like Merrill Lynch, Citigroup, UBS, etc. and shorting them.
In July 2007, FrontPoint hosted an unusual conference call where Eisman warned losses could be far greater than expected and the situation would get much worse. Over 500 people listened.
That same day, investors in collapsed Bear Stearns funds learned their AAA CDO investments were now worthless, validating Eisman’s warnings.
An article by Jim Grant questioned whether anyone truly understood what was inside complex CDO products and if ratings agencies could properly rate them.
Reading this, Eisman felt vindicated in his thesis while Michael Burry, who had made early bets against subprimes, was still largely ignored and skeptical no one else saw the problems.
Michael Burry was betting heavily against subprime mortgage bonds through credit default swaps, believing the subprime market was in a bubble.
By 2007, the housing data was showing the loans underlying the bonds were defaulting at higher rates. However, the price of insuring those loans through CDS was still falling according to Wall Street banks like Goldman Sachs, Morgan Stanley.
Burry was frustrated he couldn’t explain the disconnect between the declining housing data and rising prices of his CDS. His fate depended on the daily pricing of the CDS set by the big banks.
He realized the banks were opportunistically dictating the CDS prices as no other traders had the same portfolio as him. Without real buy/sell activity, prices were arbitrary.
This enabled the banks to dictate the value of Burry’s portfolio against what the housing data actually showed. It determined whether his bets made or lost money each day.
By early 2007, Burry remained isolated in his bearish subprime view, as the banks appeared to only share good news about housing to manipulate the declining CDS prices.
Michael Burry started betting heavily against subprime mortgages in 2005 by purchasing credit default swaps (CDS) that would pay off if subprime mortgage bonds defaulted.
However, the CDS market was not reflecting the increasing risks in subprime mortgages. Banks like Goldman Sachs who dominated the CDS market were reluctant to acknowledge problems because they had exposure on their books.
By 2006, Burry had built a $1.9 billion position betting against subprime through CDS, but the market was still not responding. He couldn’t find counterparties to sell him more CDS at the prices being quoted.
Burry began to realize the CDS market was “controlled” and “a fraud.” It was ignoring clear signs of deteriorating loan performance and home prices.
As 2006 progressed, Burry’s bets were losing money on paper. Many investors wanted to redeem from his fund. He side-pocketed about half the fund to prevent redemptions, going against investor demands, insisting his subprime bet needed more time to play out.
Burry believed the CDS market was so distorted it no longer qualified as a “public market,” allowing him to side-pocket under the fund’s terms. This locked investors into seeing his subprime bet through to the end.
Michael Burry’s hedge fund Scion Capital had a large short position betting against subprime mortgage bonds through credit default swaps.
In early 2007, with the subprime market starting to sour, many of Burry’s investors grew frustrated with his unconventional strategy of “side-pocketing” the short position rather than closing it out.
Two of Burry’s original investors, Gotham Capital and Joel Greenblatt, threatened to sue him and pressured him to abandon the short. Burry refused as he was convinced the problems in subprime were just beginning.
As losses mounted, many investors came to despise Burry. Rumors spread about him and his personal life. Burry became increasingly isolated at Scion.
Through the first half of 2007, facts on the ground continued to show problems in housing, but Wall Street firms largely ignored this. Burry’s short position continued performing well in Q1 2007.
However, tensions remained high with investors. Burry braced for the subprime situation to further unfold and validate his controversial bet.
Howie Hubler was a loud, direct, and bullying bond trader at Morgan Stanley who ran their asset-backed bond trading, putting him in charge of their subprime mortgage bond bets. Up until 2004, his career had been successful like Greg Lippmann’s, as the subprime market was booming with few risks.
At Morgan Stanley, the subprime lending boom created issues as it combined with their financial technologies for packaging loans. This introduced risks they hadn’t faced before as subprime mortgages started defaulting in greater numbers.
Hubler strongly rejected any intellectual arguments against his subprime trades. He remained convinced the market would recover and prices would rise again as they always had before. Others at Morgan Stanley started getting concerned about the risks in 2007.
By mid-2007, the defaults in subprime mortgages were spiking severely, wiping out the bonds Hubler was invested in. He refused to acknowledge the worsening situation or reduce his bets. Morgan Stanley demanded he sell, but it was too late as the market was collapsing.
Hubler’s huge subprime positions led to massive losses that would hammer Morgan Stanley and played a major role in triggering the wider financial crisis. His stubbornness in the face of warnings and data cost the company dearly.
In the early 2000s, Morgan Stanley’s subprime mortgage desk led by Howie Hubler was creating mortgage-backed bonds at a fast rate. This exposed them to market risk while loans were “warehoused” between purchase and inclusion in bonds.
To hedge this risk, Morgan Stanley invented bespoke credit default swaps (CDS) on asset-backed bonds, essentially buying insurance. This allowed Hubler to eliminate risk from rising/falling prices.
Later, Morgan Stanley traders like Mike Edman created CDS that referenced the riskiest loans in pools, guaranteeing payout even if some loans were repaid. This amounted to nearly risk-free bets on pool defaults.
Hubler found “fools” like German investors willing to sell these one-sided CDS contracts, seemeingly for free money. By 2005-2006 Hubler had $2B in these positions.
Meanwhile standardization of CDS was occurring. In 2006 Hubler got approval to run a proprietary trading group, GPCG, betting against the market with Morgan Stanley funds for huge profits and compensation.
However, the CDS positions were expensive. So Hubler rapidly sold $16B in CDS on triple-A CDOs, taking short positions far beyond what the positions would reasonably support. This represented a delusional belief in low risk of triple-A assets.
Howie Hubler, a proprietary trader at Morgan Stanley, had taken on $16 billion in risk by purchasing triple-A-rated CDOs composed entirely of triple-B-rated subprime mortgage bonds.
Hubler believed the risks were low as he didn’t think all the underlying subprime loans would default. However, he underestimated how correlated their performance would be.
At Morgan Stanley, Hubler’s trades were reported in risk reports as virtually riskless since the CDOs were labelled triple-A. The true risks were obscured.
In early 2007, stress tests showed that if subprime losses reached 10% rather than the assumed 6%, Hubler’s $16 billion bet would result in a $2.7 billion loss rather than the projected $1 billion profit.
Hubler dismissed this, insisting such high losses would never occur. However, subprime losses ultimately reached 40%, exposing Morgan Stanley to massive losses from Hubler’s high-risk, undisclosed subprime bets mislabeled as safe investments.
In early July 2007, Deutsche Bank informed Morgan Stanley that the $4 billion in credit default swaps that Morgan Stanley trader Howie Hubler had sold them were now worth $1.2 billion in Deutsche Bank’s favor. Hubler disputed this valuation.
Over subsequent phone calls, Deutsche Bank trader Greg Lippmann insisted the CDOs were only worth 70 cents on the dollar, contrary to Morgan Stanley’s internal model saying they were worth 95 cents. Lippmann ultimately allowed Morgan Stanley to exit at 7 cents on the dollar, resulting in a $3.7 billion loss for Morgan Stanley on just the first $4 billion of Hubler’s $16 billion trade.
Hubler fought the valuation all the way down but was allowed to resign in October 2007 with millions in promised compensation. The total losses from his trade were reported as over $9 billion, the largest trading loss in Wall Street history to that point.
In the lead up to the market crash, Hubler had offloaded $3 billion of his CDO positions to Mizuho Financial Group and UBS. UBS in particular would later lose $37.4 billion from similar subprime exposures.
In December 2007, Morgan Stanley’s CEO took responsibility but blamed the losses on “an error in judgment” by one trading desk, though the market conditions were not truly extraordinary and losses were simply from the market accurately repricing risk.
William Tanona of Goldman Sachs asked John Mack of Morgan Stanley how the company could have taken an $8 billion loss from one trading desk, given that they have risk limits in place.
Mack responded evasively, saying the loss was recognized in their accounts and risk system. He admitted their risk management division did not properly stress test for the potential losses.
Tanona followed up, questioning why Morgan Stanley’s trading Value at Risk (VaR) did not increase dramatically given the large loss on trading assets.
Mack could not provide a clear answer, saying he would have to get back to Tanona later once things had calmed down, as he did not fully understand the situation himself.
This exchange revealed that Mack, despite being a former bond trader himself, did not truly comprehend the risks his company was taking or how such a large loss could have occurred. It showed the lack of oversight and risk management at Morgan Stanley that allowed the $8 billion loss.
Michael Burry had successfully bet against subprime mortgage bonds through credit default swaps, making over $720 million in profits for his fund. However, he found no joy in making money this way and felt something was dead inside him.
FrontPoint also made huge profits betting against subprime through credit default swaps, doubling their fund size to $1.5 billion. But they wanted to cash out, not fully trusting Greg Lippmann who had set them up with the trades.
Steve Eisman also held onto his short positions, seeing it as a moral crusade against the corrupt financial system that enabled predatory lending. But as 2008 progressed, the crisis threatened to crash the entire system, putting even short sellers at risk. Now it felt more like being on Noah’s ark - safe, but unhappy watching the flood.
Burry and others began to realize their subprime bets were not just trading positions but had exposed deep problems that could sink the financial system. The optimistic vs pessimistic “tug of war” metaphor no longer applied - now it was two men tied together fighting to the death, with both at risk of drowning.
Steve Eisman was scheduled to speak at an event hosted by Deutsche Bank alongside Alan Greenspan and famous bullish investor Bill Miller, who owned $200M of Bear Stearns stock.
Eisman was very bearish on subprime loans and financial firms exposed to them. His fund had shorted stocks of firms connected to subprime.
At the event, Miller spoke briefly in favor of Bear Stearns. When Eisman took the stage, he launched into a detailed argument about why the deleveraging of the financial system would continue for a long time.
As Eisman spoke, Bear Stearns stock started dropping on news of liquidity issues. It fell from over $50 to under $30 while Eisman warned of problems at banks.
Eisman’s partners had shown up but were distracted by the dropping stock price. They sold the small amount of Bear Stearns shares Eisman had surprisingly bought the day before.
Eisman blamed the collapse of Bear Stearns on excessive leverage taken on by Wall Street firms, but recognized the causes were more complex involving a sudden loss of confidence by the market.
The subprime mortgage market went through two phases - first AIG took on a lot of risk until late 2005, then from late 2005 to mid 2007 Wall Street firms created $200-400 billion in CDOs backed by subprime mortgages.
By March 2008 it was clear at least $240 billion had been lost, but it was unclear who specifically held the losses. Firms like Ambac, MBIA, Morgan Stanley and others held CDOs and exposure, but the full scale was unknown.
Bear Stearns in particular was highly exposed, with $40 in subprime bets for every $1 of capital. It was unclear how Bear could survive given this exposure.
At an investor presentation, Steve Eisman noted Bear’s precarious position, while Bill Miller downplayed the risks. Later that day Bear’s stock fell sharply and the audience rushed to leave and sell shares, realizing the risks.
By the following Monday, Bear Stearns had been sold to JPMorgan for just $2 a share, highlighting the risks that had now materialized for the firm.
FrontPoint Partners was a hedge fund investing in stocks, with flexibility to be 25% net short or 50% net long the market. Their gross positions could not exceed 200% of their $100 million fund.
In September 2008 after Lehman Brothers collapsed, all their short positions in bank stocks were rising rapidly as financial stocks fell. Danny was anxious as the situation developed quickly.
On September 18th, as Morgan Stanley and Goldman Sachs stocks tanked, Danny experienced symptoms like wavy vision and a racing heart. He thought he was having a heart attack.
Porter dismissed Danny’s concerns at first but then recognized he may really need medical help. Danny was able to walk to the hospital on his own.
Cornwall Capital had quadrupled their capital by correctly betting against subprime bonds. But they were anxious about preserving their wealth given the troubled situation.
Charlie Ledley and Jamie Mai from Cornwall spent time thinking of ways to address perceived corruption in the financial system, like suing rating agencies, but lawyers were skeptical of their ideas.
Investment banks had pressured rating agencies into labeling lower-quality mortgages as safe investments. This enabled the lending of trillions of dollars in mortgages to ordinary Americans, who willingly took on loans beyond their means.
The complex securities created from these loans obscured the true risks, so investors stopped properly evaluating risk.
Charlie Ledley, who was not a finance person, correctly predicted the impending financial crisis years before it happened. He warned that the problems in the mortgage market had grown so large that a calamity was inevitable with big social and economic consequences.
When the crisis hit in 2008, Charlie was surprised to see how unprepared the big Wall Street firms and regulators were, despite the problems being visible for years. No one seemed to understand the risks or know how to respond to the crisis.
Michael Burry had also accurately predicted the crisis but faced criticism for being right while others were wrong. The recognition he thought he deserved never came. The stress took a personal toll and he eventually shut down his fund.
Eisman and his colleagues Danny Moses and Porter Collins were sitting on the steps of St. Patrick’s Cathedral in New York, watching the people pass by. They felt insulated from the financial crisis unfolding but knew it would deeply impact many people.
They had successfully predicted the coming collapse by shorting subprime mortgage bonds and making a fortune. However, they also felt partially responsible for “feeding the monster” by providing liquidity in the market that kept it going.
The full effects of the crisis were not yet visible on the streets, as the consequences would take time to ripple through from loan defaults to foreclosures to losses on securities. People were not yet aware of how the crisis would impact their lives.
The author reflects on past interviews given about his book Liar’s Poker, which chronicled the excesses of 1980s Wall Street. While changes in culture occurred, the underlying misalignment of risks and incentives on Wall Street remained, sowing the seeds for later crises. Deeper reform was slow to happen despite public outrage.
The roots of the 2008 crisis extended back to ideas that emerged in the financial world of the 1980s. Real cultural change on Wall Street proved difficult due to how entrenched its assumptions had become over decades.
The first mortgage derivative was created in 1986 by a former Salomon Brothers employee. Derivatives can be like guns if not used properly.
The mezzanine CDO was invented in 1987 by Michael Milken’s junk bond department at Drexel Burnham.
The first mortgage-backed CDO was created in 2000 at Credit Suisse by Andy Stone, who had worked at Salomon Brothers and was Greg Lippmann’s first boss.
The author meets John Gutfreund, his former CEO at Salomon Brothers, for lunch. Gutfreund had been forced to resign after the firm was sold. They discuss the lack of control CEOs had over subordinates and businesses.
Gutfreund’s decision to take Salomon Brothers public shifted the psychological foundations of Wall Street from trust to blind faith. No partnership would have taken the same risks that led to the financial crisis.
Prop traders at Salomon Brothers generated more profits than the rest of the firm’s employees some years, showing the incentive for risks.
Charlie Ledley of Cornwall Capital was worried regulators might prevent subprime borrowers from failing, but they instead bailed out big Wall Street firms that failed due to dumb bets. This included Bear Stearns and later other major financial institutions.
The government took over Fannie Mae and Freddie Mac, replacing management and diluting shareholders while protecting creditors.
Lehman Brothers was allowed to fail, causing market turmoil. The government later claimed they lacked authority to rescue Lehman.
AIG received an $85 billion loan from the Fed (later increased to $180 billion) to cover losses from subprime bets.
Washington Mutual was seized by the Treasury, wiping out creditors and shareholders. Wachovia failed and was encouraged to sell to Citigroup.
By late 2008, Henry Paulson convinced Congress to approve the $700B TARP program. He then bailed out Wall Street firms rather than buy troubled assets as promised.
Over a trillion dollars of losses from bad investments were transferred from Wall Street to taxpayers by early 2009 through TARP, Fed programs, and guarantees.
Critics like Steve Eisman argued the real problem was an unknown amount of credit default swap bets on these “too big to fail” banks, not the banks themselves. Allowing the banks to fail would trigger payouts on those unknown bets.
Turning partnerships into public corporations made the banks objects of speculation and moved their risks to taxpayers when things went wrong.

Here is a summary of the key events:

A former king of Wall Street confronts the author, blaming his book for destroying his career. He angrily offers the author a deviled egg.
The author reflects on how the deviled egg is a simple yet appealing dish. He takes one, thinking “something for nothing never loses its charm.”
The passage acknowledges several people who helped the author with research and editing for the book. It expresses gratitude to subjects who shared their insights and experiences.
Some explanatory notes are provided on financial terms like rating agencies’ ratings, mortgage default rates, CDO structures, and the London Interbank Offered Rate (LIBOR).
The author promises to explain who took the other side of credit default swap bets that investor Michael Burry made predicting the housing market collapse. It notes other players like Goldman Sachs were involved on both sides of these trades.
In summary, the passage acknowledges assistance with the book, provides some context around financial terms, and previews explaining other actors involved in the mortgage-related bets against the housing market.
A hedge fund called managed credit estimates lost $6.8 billion betting on natural gas in early 2006 and collapsed spectacularly.
Alt-A borrowers had slightly better credit scores than subprime but loans were still poorly documented. Alt-A and subprime loans from 2004-2008 totaling $3 trillion had similar default rates.
A “silent second” mortgage supplements a first mortgage for a home purchase but is concealed from the first lender, making repayment less likely.
People involved in the crisis are reluctant to discuss what they saw due to non-disclosure agreements and fear of consequences for past actions.
There were conflicts of interest when firms made proprietary bets while also brokering trades for customers, giving incentive to use customers to benefit their own positions.
Selling credit default swaps on assets leaves the same risk as owning the assets directly.
Goldman may have waited until spring/summer 2007 after New Century’s bankruptcy to fully exit risky subprime positions, in contrast to their later claims of exiting in late 2006.
There is dispute over conversations where Morgan Stanley trader Howie Hubler may have warned of risks but was overruled by his boss Zoe Cruz, though this version is seen as less plausible.
No one at Morgan Stanley really understood the risks Howie Hubler was taking with the structured bonds.
If AIG FP had taken on all the risk from subprime bonds, it may have redirected blame away from Wall Street onto AIG alone.
Bear Stearns bond fund managers Cioffi and Tannin were acquitted due to lack of proof they deliberately deceived investors rather than lacked understanding of real risks.

#book-summary

The Big Short Inside the Doomsday Machine - Michael Lewis