Was it possible to predict the bursting of the subprime mortgage bubble before it happened, and thus maybe to prevent it or make its effects less drastic?
By the reporting in Michael Lewis' entertaining book "The Big Short" (W. W. Norton), a few capital markets types saw what was coming and took decisive action.
Did they lobby for restraint among the big packagers of mortgages and the ratings agencies that blithely rated them AAA, or for action by lawmakers or regulators?
Of course not. They shorted the market and made tens of millions of dollars before the market collapsed and took the planet's economies to the edge of a worldwide depression into a recession which lingers today and could relapse into a double-dip hit against housing and mortgages.
Lewis, author of "Liar's Poker," the story of a previous round of irrational exuberance on Wall Street, has a lively style and an admirable way of explaining what a tranche or a collateralized debt obligation is to a general reader. He uses the metaphor of a tower to describe how subprime mortgages packaged into asset-backed securities got repackaged into CDOs, with tranches filled by pieces of securities that towered up from lowest-rated to best-rated.
He is good at getting across the head-scratching imponderables of the mortgage bust, such as how CDOs filled with crappy mortgages could somehow be rerated AAA. He is level-headed and clear about the irresponsibility of the ratings agencies, who were paid by the issuers and hence were prone to being pleased by obtaining the highest ratings.
Perhaps part of the current market's hesitancy to loan money is a natural lack of confidence now in ratings. Why hasn't there been a new ratings agency, paid for by investors, rather than issuers, to challenge the tarnished legacy of Moe, Larry and Curly?
What the book lacks, though, is a memorable cast. The guys Lewis tracks through their big short are not memorable or even likable. Colorful is the nicest way to describe them. The only difference between the players going long on subprime mortgages (which was almost all of the market) and those going short is that the shorts were better analysts of the market and could see the flaws in the CDO structures.
There are no Lew Ranieris (hero of "Liar's Poker") in this story, which is too bad for the book and for our economy.
