Ever since the stock market went belly-up a year and a half ago, I've been trying (with considerable Girl Scout diligence, I might add) to understand why. I read Fool's Gold by Gillian Tett, which was over my head and rather incomprehensible, and numerous articles in the finance magazines I subscribe to. I watched the PBS Frontline special about the crash. And while I learned from all of those things, the book that has finally clicked for me is Michael Lewis's The Big Short: Inside the Doomsday Machine, which focuses on the subprime lending and credit default swaps that made the crash possible, if not inevitable.
OK, so part of the problem is that I've never fully understood until now what a credit default swap even is. (I just accidentally typed "credit default swamp." Freudian slip?) Lewis gave me an "aha" moment when he said to think of it less like a bond and more like life insurance. When we buy life insurance, we're betting on a negative -- that Grandpa's gonna croak. And when that happens, we cash in. A CDS is kind of like life insurance that you buy when Grandpa is already 110 and on life support -- except that you get to pay ridiculously low premiums. A CDS bets on the idea that hundreds of thousands of homeowners are going to default on their mortgages -- and that when that happens, it's payday for you. Most of it is perfectly legal (except for the shenanigans by the rating industry, which demonstrated insane grade inflation in giving BBB bonds an A rating).
What's most interesting about the book is that Lewis gets to the heart of the meltdown by means of human interest stories, much as he did in The Blind Side and his other books, which I now want to read. (The Huff Po called him America's "non-fiction novelist," which I thought perfectly captured his eye for character and detail.) He focuses here on several outliers in the finance industry who saw what was coming and made a huge profit because they understood that rampant subprime lending was like having an EZ-Pass to the Apocalypse. Lewis considers them heroes; I would call them anti-heroes. They win our admiration for their cleverness, but we don't want to emulate them. Or at least, I don't. Who could cheer for them while they profit from the misfortune of others during and after the crash--which is precisely what they accuse the subprime industry of doing in the years before the crash?
Lewis tells the story as a cautionary tale about how "even smart people can deceive themselves when they're paid to do so." In a post-book interview in the audio version, he assesses the few changes our government has made to ensure that this won't happen again. Short version: we still have almost no safeguards in place to regulate the speculative trading of negative capital. He expects that at some point, speculative trading will be bracketed out from ordinary banking, so that the Goldman Sachses of this world won't fall apart when the bubble bursts, bringing Middle America down with them. For my part, I hope Lewis's next book deals with what the government could and should do to protect Americans from this far-reaching greed and predation. So far, as Lewis puts it, it looks like our bailout propped up not only the financial system but the very people who brought on its collapse in the first place.