Inside The Doomsday Machine Study Guide

The Big Short: Inside the Doomsday Machine by Michael Lewis spans the 1980s through 2008, illustrating and explaining the introduction of the mortgage bond, transactions leading to the global financial crisis of 2008, and the resulting sub-prime mortgage collapse and vast bank bailouts. Lewis addresses the basic issue rather evidently in the prologue of the novel. With relatively little experience other than a job on Wall Street in the 1980’s, Lewis identified bank error in investing in subprime mortgages, the general instability of the subprime mortgage market, and the inevitable burst of the housing bubble. Throughout The Big Short, Lewis demonstrates that the 2008 financial crisis resulting in trillions of dollars of losses and billions

of tax dollars was elicited not by an economic recession or other systematic means, but rather by flawed financial models and Wall Street firms fraudulently profiting from subprime mortgage loans as financial products.
Lewis begins with a general overview of mortgage bond development as an understanding of the transactions leading to the housing bubble is fundamental to a deeper understanding of his analysis.

In the early 1980’s Wall Street firms recognized that home mortgages could be used to create bond-like products, functioning similarly to bonds issued by governments and corporations. The “mortgage bond” bundled many individual home mortgages purchased from lenders and the income streams from monthly mortgage payments. The bundle was later termed a Collateralized Debt Obligation (CDO) and was sold by investment banks including Goldman Sachs, Merrill Lynch, Bear Sterns, JP Morgan, and Morgan Stanley on the bond market. In later years, banks generated larger profits by creating mortgage bonds for subprime mortgages, those mortgages with substantially higher credit default risk. A dangerous cycle was established as Wall Street banks bought more subprime mortgages, lenders placed more subprime loans, and individuals, enticed by artificially low interest rates during an initial fixed-term interest period, accepted mortgages that they could not

afford.
Though bank executives nor treasury officials seemed to recognize the dangers associated with this practice, the collapse of the housing bubble was anticipated by select keen investors.

Lewis analyzes the issue of subprime mortgage bonds through the observations and actions of each of these investors. Lewis’ presents his argument in a narrative style and includes the stories of Steve Eisman, Michael Burry, Greg Lippman, and Jamie Mai and Charlie Ledley. Eisman, convinced of the corrupt nature of consumer finance, developed a sufficient knowledge of Wall Street and the housing market. Michael Burry, despite his initial medical career, became intrigued, and even obsessed, with investing and the bond market. Jamie Mai and Charlie Ledley, wealthy from predicting the stock price increase of unfairly undervalued firms, took interest in the subprime mortgage market. Each of these individuals, similarly characterized by their status as outsiders (both generally and on Wall Street), foresaw that subprime mortgage bonds would fail as interest rates rose dramatically at the end of the fixed-term interest period and that the housing market would plummet accordingly. They purchased insurance policies, also known as credit default swaps, against the failure of the mortgage bond, and upon the occurrence of the presumed mass default, stood to profit

substantially.
Lewis draws key conclusions about 2008 global financial crisis through of each of these Wall Street dissidents as their observations parallel his personal insights and foresight. Despite the useful information available in the financial statements of the firms specializing in unreliable subprime mortgage bonds, other Wall Street firms were slow to recognize the dangers associated with subprime mortgages and neglected opportunities to bet against or short these debt-instruments until the losses associated with default were blatant. Though readers were led to wonder if the investors such as Burry would be able to make their credit default swap deals before others recognized similar trends, Wall Street investment banks were ultimately too late to the realization. Lewis also concludes that in addition to Wall Street firms, regulators including the US treasury and the Federal Reserve also failed and consistently fail to recognize and prevent bubbles (such as the housing bubble) despite speculation.
From Lewis’ conclusions, I learned that though some believe that the crisis was unpredictable or that essential information was not available, the crisis was, in fact, foreseeable with information available for public analysis should the public invest time into research. I also learned that the subprime mortgage bond market was built on such unstable foundation that the housing market did not actually need to fail for such a collapse to occur. The certain increase in interest rates after the fixed-term interest period would have caused mass default with any degree of slowed growth. Finally I learned that unlike other financial crises triggered by systematic, undiversifiable causes, the global financial crisis of 2008 was prompted by the greed and fraud of Wall Street investment banks. High risk mortgage bonds were deceptively packaged in a manner in which they solicited ratings equivalent to those of US treasury bonds, increasing their demand for purchase. Borrowers were also deceived into a false sense of wealth and accepted mortgages that they could not afford. American tax payers and the general global economy suffered, and arguable continue to suffer, as a result.