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The Big Short by Michael Lewis

The Big Short: Inside the Doomsday Machine by Michael Lewis was a book that had been on my “to read” list for a very long time. I finally had a chance to finish reading it when I was travelling recently.

Michael Lewis tells the story of the subprime crisis and its subsequent implosion by following a few central characters. Not famous people like Ben Bernanke, Timothy Geithner or Dick Fuld, but less well known people like Steve Eisman, Michael Burry, Greg Lippmann, Jamie Mai and Charlie Ledley.

Most of these people understood the subprime problem well before it erupted into a full blown crisis. They managed to put the pieces together and subsequently profited immensely from the crisis.

The background stories of these central characters are intriguing by themselves and combined with the inside story of the financial markets, makes the book a very compelling read.

The story of Michael Burry would serve as an inspiration to fund managers wannabes. Michael was a doctor but had a passion for the inner workings of the stock market. In his free time, he would do research on stocks and publish his findings on a personal blog. His work was so good that both ordinary investors and people from Wall Street started following his trades.

When Michael Burry decided to quit his medical career and focus on managing his own money, he had just $40,000 in assets and owed $145,000 student loans. But when he announced his decision to go into full-time portfolio management, he was immediately approached by a couple of fund managers who had been following his blog. One gave him $1 million to acquaire a 25% stake in his firm. Another gave him $600,000 for a smaller stake in the company, but invested $10 million into his fund.

Michael did not disappoint and outperformed the market significantly. Within three years, he was managing a portfolio in excess of $600 million and turning investors away.

The story of Jamie Mai and Charlie Ledley was even more astonishing. They were a bunch of 30 year-olds managing a sum of $110,000 out of their garage. By exploiting inefficiencies in options pricing and taking calculated bets, they were able to grow their portfolio in ways we can never imagine.

Their first trade of $26,000 on a call option grew into $526,000.

Their second trade of $500,000 turned into a $5 million profit.

Their third trade of $200,000 quickly turned into $3 million.

Two years after they opened for business, Jamie and Charlie were running a portfolio of $12 million of their own money. Later on, they were to hold $205 million worth of credit default swaps on subprime mortgage bonds.

The Big Short: Inside the Doomsday Machine was a book that I found hard to put down after I got started. I will certainly want to read other books written by Michael Lewis. I understand that they have also received very positive reviews.

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9 comments
Mike says 12 years ago

Thanks for the post, I know it was awhile ago but I have a question. Since they bought the right to buy the stock at 40 doesn’t that mean part of the cost of the trade is 8000*40? So if the stock went to 60, that means they really made (60-40)*8000 = 160,000. I can see how owning 8000 shares at 60 is around 500,000, but don’t they essentially loose the 8000*40?

Reply
    Martin Lee says 12 years ago

    Hi Mike,

    When you buy options, you do not pay the full price of the stock. In the example you quoted, it could be a few dollars only. A $20 gain on a few dollars investment is a huge multiplier.

    Reply
      MIke says 12 years ago

      Thanks for the response. So they sold the options at around $20? (8000 * 20 = 526,000). They didn’t actually buy the stock at $40 then simultaneously sell at $60 or something like that.

      Reply
        Martin Lee says 12 years ago

        Dear Mike, I can’t remember the numbers from the book but the trade could be something like buy the options at $1 and sold all at $21.

        Reply
Fook Soon says 12 years ago

Before the financial crisis in early-mid 2008 CFA magazine already carried an article on subprime implosion. The descriptions in the article was almost unbelievable in terms of how Americans borrowed money. My stock broker was a bit slower to show me the same article. The US market has a depth that is unparalled anywhere in the world.

Reply
    Martin Lee says 12 years ago

    Yes, the subprime actually started to unravel in 2007. There was one last bear trap before everything exploded in 2008.

    Reply
James says 12 years ago

Good reading is just that, occupies your time & feeds your mind, but does nothing else, if you can’t translate it to fish profitably for yourself in the financial market. Don’t you agree ?

Reply
    Martin Lee says 12 years ago

    Hi James, all the knowledge in the world will not help if it is not translated to action. I feel that a lot is dependent on the reader.

    Reply
uknowo says 12 years ago

Read his continuing series on the European financial implosion on Vanity Fair’s website.

Reply
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