Back in 2005 and 2006, few people really accepted the notion that our rising national average home prices constituted an unsustainable bubble. Fewer still understood that the sub-prime lending that was driving speculation and the real estate boom had the potential to create a calamitous crash in the credit markets. But, even among the handful of people who understood what was really happening, there was no way to capitalize on that knowledge — until a few renegades came up with a way to short the mortgage-backed securities market.
Curiously, the instrument they used — a form of insurance on mortgage-backed bonds, the now-infamous credit default swap — was considered all-but-unnecessary by the key players in the market. The insurance would only pay off if housing prices fell — an outcome no one on Wall Street felt a need to plan for. So, initially, the challenge for the would-be hedgers was to find a market maker for the insurance the wanted to buy.
Michael Lewis’s tale of three sets of contrarian investors who saw what no one else saw (and had the courage to act on it) is a fascinating, fast-paced read. Each approached the situation from a different angle: one a refugee from the equities world, betting against the street partly in reaction to the corruption he saw; another a group of three business-world dropouts who found their niche in researching value opportunities and stumbled upon massive mortgage market misinformation; and the third an information-addicted doctor whose insightful analyses made his fund participants rich, but they almost turned on him before his dire (and correct) predictions about the CDO market could pay off.
The Big Short