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The Outsiders Who Foresaw The Subprime Crisis

Nearly the whole financial system bought into subprime mortgages and the securities that were backed by them — and amounted to bundles of bad debt.

In his new book, The Big Short, Michael Lewis writes about people who didn't buy in. In fact, they bet against the colossal tower of debt that Wall Street built. They shorted it — and they profited from its eventual collapse.

For Lewis, The Big Short is his return to the scene of the crime. Twenty years ago, he wrote about his experience working as a young bond trader at Salomon Brothers. Liar's Poker was an astonishing tale of kids fresh out of Ivy League schools making huge decisions about other people's money with no qualifications for doing so.

By the time of the financial crisis, the generation he wrote about in Liar's Poker was established Wall Streeters, typically up to their eyeballs in mortgage-backed securities.

The people he writes about in The Big Short are outsiders by virtue of youth or personality.

Wall Street's Heroes And Demons

One of the characters in Lewis' latest Wall Street saga is an unlikely hero, Michael Burry. He's a young hedge fund manager based in San Jose, Calif., who has Asperger's syndrome.

Originally a neurologist, Burry quit being a doctor during his residency at Stanford Hospital because of a stock market blog he wrote in his spare time. One day, Burry posted a message saying that he was sick of medicine and he planned to go into investing. Two major stock market investors tracked him down to stake him to a business investing in the stock market.

Burry's track record over the next few years, Lewis tells NPR's Robert Siegel, was astonishing.

Discovering Disaster

Then Burry began to realize that the futures of several companies he was investing in turned on a weird lending market, the subprime mortgage bond market. So he started reading the prospectuses of subprime mortgage bond offerings. In the structure of the loans, Burry could see the future disaster. So he figured out how to use this knowledge to his advantage, and he became the first investor off Wall Street to make the big bet against them.

You have this body of facts out there in the financial world, and the vast majority of the people in that world are organizing the facts into one kind of picture -- and it's a pretty picture. And a handful of other people take the exact same facts, but they organize it into a different picture.

Burry went in so early that his investors thought he was crazy.

"He ends up feeling more cynical about Wall Street than anybody I've ever met because of his dealings with the Wall Street firms," Lewis says.

Because he didn't have much connection with people, everything Burry did was via e-mail. So Lewis says, in researching his book, he got to benefit from a perfect, real-time record of what was going on in these markets.

"The one guy that I could trust in the middle of this crisis was this fellow with Asperger's and a glass eye," he says "He became the moral center of this market for me because he was the most honest character."

Lewis profiles extreme characters — outsiders — who are the sane people in an insane world.

"You have this body of facts out there in the financial world, and the vast majority of the people in that world are organizing the facts into one kind of picture — and it's a pretty picture," he says. "And a handful of other people take the exact same facts, but they organize it into a different picture."

The people in Lewis's book were able to look at the situation in a different way.

And The Ugly

At the same time, only a handful of people had bad motives when it came to the crisis.

"More often than not, the people at the center of the doomsday machine were deluded themselves," Lewis says. "The problem isn't criminal behavior. ... The story of American capitalism in recent history is not really the story of Bernie Madoff."

Lewis says the story is one of bad incentives causing people to behave in bad — but legal — ways.

"The best thing we can do is focus our energies on how to create the rules that prevent people from enriching themselves while impoverishing the rest of us," Lewis says.

Course Of Action

Economic policymakers have acknowledged the disaster, but many say they're afraid of stifling innovation if they take action.

"In telling this story, I had my opinion of financial innovation changed," Lewis says. When he left Wall Street, Lewis thought that most of the innovation was leading to a smarter distribution of financial risk. But Lewis says since he left, innovation has run amok.

With the exception of a few people on Wall Street, investors would be better off if credit default swaps, for example, were never invented, Lewis says.

"The failure so far in the response to the crisis has not been the failure to lynch a few people," he says. "It's been failure to introduce some pretty obvious reforms."

The reason for that failure, Lewis says, is that financial crises move quickly while the political process moves slowly.

Copyright 2023 NPR. To see more, visit https://www.npr.org.