I finished up Michael Lewis‘s The Big Short and I think I found it worthwhile and poignant. It’s a character-driven piece that follows some of the players — as the title suggests — who shorted the housing market and went to the bank. To Lewis’s credit, he seems to do a pretty good job of explaining the crazy financial instruments created and deployed to bet against subprime mortgages. To my debit (?), I still don’t understand what was going on with all of this.
The big villains of the story are certainly the ratings agencies, who could have stopped much of this chicanery in its tracks by rating garbage as garbage rather than as AAA investment-grade bonds. But, perhaps a pithier point comes in the book’s denouement and is worth quoting at some length:
The people on the short side of the subprime mortage market had gambled with odds in their favor. The people on the other side — the entire financial system, essentially — had gambled with odss against them. Up to this point, the story could not be simpler. What’s strange and complicated about it, however, is that pretty much all the important people on both sides of the gamble left the table rich…
Wing Chau’s CDO managing business went bust, but he, too, left with tens of millions of dolalrs… Howie Hubler lost more money than any single trader in the history of Wall Street — and yet he was permitted to keep the tens of millions of dollars he made. The CEOs of every major Wall Street firm were also on the wrong end of the gamble. All of them, without exception, either ran their public corporations into bankruptcy or were saved from bankruptcy by the United States government. They all got rich, too.
There is certainly a lot to ponder here. One area is the ascension and continued profitability of the financial sector. Although I believe free markets are better than fettered markets, I’m not convinced that the financial sector is doing a great job allocating capital to its highest-value use.
Another has to do with Tyler Cowen’s thesis about the causes and consequences of rising inequality. It’s one thing for folks to make smart bets and go bank. It’s quite another when people make dumb bets and go bank. This is the classic “moral hazard” problem that makes the losing end of the distribution irrelevant for gambling purposes. Consult Russ Roberts for more on this point.