Nowadays, it is rare to encounter a really good investment book that manages to tell an inspiring story and enlighten you on the flaws of the financial industry. I just finished reading “The Big Short” by Michael Lewis and I definitively recommend it so anyone who is even remotely interested in a career in the investment world.
Here are some of my favorite passages in the book:
On bank stocks’ book value:
He concluded that there was effectively no way for an accountant assigned to audit a giant Wall Street firm to figure out whether it was making money or losing money. They were giant black boxes, whose hidden gears were in constant motion.
Regarding the value added by sell-side analysts:
You can be positive and wrong on the sell side. But if you are negative and wrong, you get fired
On Manipulation of the masses:
How do you make poor people feel wealthy when wages are stagnant? You give them cheap loans
On Recognizing when a credit driven bubble is about to burst:
What you want to watch are the lenders, no the borrowers. The borrowers will always be willing to take a great deal for themselves. It’s up to the lenders to show restraint, and when they lose it, watch out. By 2003 he knew that the borrowers had already lost it. By early 2005 he saw that lenders had, too.
Real Risk is not Volatility:
He gave a talk in which he argued that the way they measured risk was completely idiotic. They measured risk by volatility: how much a stock or bond happened to have jumped around in the past few years. Real risk was not volatility; real risk was stupid investment decisions.
On being contrarian and the mispricing of potential outliers:
Charley Ledley was odd in his belief that the best way to make money on Wall Street was to seek out whatever it was that Wall street believed was least likely to happen, and bet on its happening. Charlie and his partners had done this often enough, and had had enough success, to know that the markets were predisposed to underestimating the likelihood of dramatic change.
Financial options were systematically mispriced. The market often underestimated the likelihood of extreme moves in prices. The options market also tended to presuppose that the distant future would look more like the present than it usually did. Finally, the price of an option was a function of the volatility of the underlying stock or currency or commodity, and the options market tended to rely on the recent past to determine how volatile a stock or currency or commodity might be.
On how to recognize salesmen on Investment conferences:
Everyone who was trying to sell something was wearing a tie
About the rating agencies:
The ratings agency people were all like government employees. Collectively they had more power than anyone in the bond markets, but individually they were nobodies. They’re underpaid. The smartest ones leave for Wall Street firms so they can help manipulate the companies they used to work for. There should be no greater thing you can do as an analyst than to be the Moody’s analyst. It should be – I can’t go higher as an analyst – instead it is the bottom. No one give a fuck if Goldman likes General Electric paper. If Moody’s downgrades GE paper, it is a big deal. So why does the guy at Moody’s want to work at Goldman Sachs?
Regarding credit quality:
Credit quality always gets better in March and April. And the reason it always gets better then, is that people get their tax refunds
On being misunderstood by your investors:
The definition of an intelligent manager in the hedge fund world is someone who has the right idea, and sees his investors abandon him just before the idea pays off. When he was making them huge sums of money, he had barely heard from them; the moment he started actually to lose a little, they peppered him with their doubts and suspicions.
On the huge importance of proper functioning credit markets:
The banking system was insolvent, he assumed and that implied some grave upheaval. When banking stops, credit stops, and when credit stops, trade stops, and when trade stops – well, the city of Chicago had only eight days of chlorine on hand for its water supply. Hospitals ran out of medicine. The entire modern world was premised on the ability to buy now and pay later.
On the dramatic selloff in the fall of 2008:
There were no bids in the market for anything. There was no market. It was really only then that I realized there was a bigger issue than just our portfolio. Fundamentals didn’t matter. Stocks were going to move up or down on pure emotion and speculation of what the government would do.