Michael Lewis' The Big Short- Initial Observations

After writing this post earlier this month about Michael Lewis' 20+ year old book Liar's Poker and exchanging comments with a reader presenting himself as a young prospective investment banker, I went ahead and bought two of his subsequent books, Moneyball and The Big Short. Incidentally, in keeping with the times, I ordered both as nearly-virgin, used copies from Amazon resellers for no more than $10 each, including shipping. The latter arrived looking every bit like a brand new, unopened book.

Despite my intentions to save The Big Short, published last year, to read in a classic summer situation of electronic unconnectedness, I have read roughly one-fifth of it already. Being the second of Lewis' financial books that I've read, and having reread Liar's Poker, his first, in the past few weeks, I have a few observations to offer on The Big Short.

The first is simply how Lewis focuses on people with amazingly good luck. In Liar's Poker, he made the point of how few people were granted the exalted status he enjoyed by being hired by then-dominant Salomon Brothers.

In The Big Short, he initially profiles a one-eyed doctor-turned-equity portfolio manager, Mike Burry. Burry first attracts attention from Joel Greenblatt and his colleagues, New York-based hedge fund managers, rather unbelievably from their following his selections as posted on stock trading message boards of the time, and his own nascent AOL 'blog.' Later, Lewis confirms that Burry was the only person Greenblatt's firm ever subsequently approached with an offer to buy part of his firm. Then Burry, seeking to profit from the troubles of companies involved in sub-prime finance, shifts from equities to debt, buying derivatives on CDOs which he is certain will lose the bulk of their value due to underlying defaults. His investors, learning of this, want to, but can't redeem their funds because of Burry's lock-up rules.

Then Burry manages to coax, badger and persuade several banks to sell him the derivatives he wants on selected mortgage-backed CDOs. Eventually, the banks catch on and begin doing the same, all the while Burry and the traders at these banks lie to each other about exactly what they are doing.

What's ironic is that Lewis paints Burry as the most honest of hedge fund managers, eschewing a fixed management fee. But he doesn't adequately, in my opinion, explain the very serious fraud Burry committed when he informed his investors and backers that he'd completely changed the investments in his portfolio. That Burry survived this is even more immense luck.

It's likely that Burry's being a subjective stock picker had a lot to do with his intellectual property not simply being stolen. I have friends who unwisely approached GE Capital years ago with a financial concept. The management at GE officially rejected the concept, but only months later were seen having appropriated the idea and implemented it at the unit, at scale. Suffice to say, my friends were out millions due to unrealistic expectations of GE Capital's operating procedures.

Similarly, when, a few years ago, an intermediary offered to introduce a then-business partner and me to Goldman Sachs, in order to obtain investment funds, we declined. We realized we weren't going to be, for example, in a private meeting with the firm's CEO or any other single senior officer. Instead, the intermediary was probably going to have us presenting our IP to, and answering the questions of, a dozen or more smart, hungry Goldman junior staffers all eager to climb over each other- and us- to make their fortune.

One of my business partner's colleagues in private equity later confirmed that it was imperative we never let a large investment bank or fund manager, like Goldman, have any whiff of the details of our approach, lest they move heaven and earth to obtain information on our trades and mimic them for free. And that we were correct to avoid providing any details of my equity portfolio management approach to anyone at Goldman.

More often than not, an existing financial firm will take what they can, rather than formally approach someone with a new, profitable concept and offer value for it.

Thus, it's very difficult to adequately explain, or overstate, just how wildly improbably Burry's good fortune was. First, to be a subjective equity analyst-cum-investor who actually beat the S&P500 is pretty rare. To have divulged his selections online and then have a hedge fund find, track and ultimately buy a piece of his operation is even rarer. And to survive essentially completely changing the nature of his fund without giving investors a chance to redeem.

Think rare as in the exceedingly long odds of any one low-income, uneducated minority youth devoting all his time to playing basketball, and eventually making it through a college basketball program to be selected by an NBA team and actually playing for at least a few seasons, thus scoring the sports equivalent of a lottery win.

Lewis writes engaging, interesting and true stories. He has a wry manner of educated the novice in the arcane ways of finance, while exposing fraud, luck, and many other aspects of the human condition.

The way in which Lewis has, so far as I have read at this point, composed The Big Short gives the appearance of a few honest, initially-naive souls at Oppenheimer and elsewhere standing up to widespread housing finance fraud, fighting the good fight and, I'm assuming, ultimately triumphing through immense financial gains.

As I read Chapter Two, In The Land of the Blind, about Burry, I couldn't help but think about the legions of other analysts and investors who could and probably did have other equally-profitable approaches, but, at some stage of their efforts, failed to receive the luck which found Burry.

In short, I think Lewis' tales of finance give the illusion of skill trumping fraud and greed, when, more accurately, it's luck and some skill accidentally getting a lightning strike amidst greed, fraud and herd investing mentality in the fund management, trading and investment banking businesses.