"The Big Short" Is Long on Wall Street Wisdom

August 12, 2010
Jeff Brown, MD

For a plausible explanation of how the nation's economy melted down in 2008, read "The Big Short" by Michael Lewis. The book not only boasts solid writing, but it's peppered with wisdom and insight into the workings of Wall Street.

Physicians have so many things clamoring for our 16 hours (we hope) of consciousness each day that we have all learned to triage information, as well as its sources.

For example, if you would like a short, reasonably understandable explanation of how the nation's economy melted down in 2008, read "The Big Short" by Michael Lewis (Norton 2010). What fascinated me about the book was not the plausible explanation offered by the author, or the solid writing, but how it was peppered with wisdom and insight. I took notes to share some of these thoughts with you, time pressed as you are.

In his book, Lewis writes: "Investing is something that you have to learn how to do on your own," underscored the fact that we get no training in this vital area. For each of us, it’s like reinventing the wheel. No wonder most of us aren't very good at it. Specifically, the research firm Dalbar Inc. has found that in the last two decades when the Standard & Poor’s 500-stock index earned 8.2 percent, the average stock mutual fund investor earned just 3.2 percent. (So roughly half of us did worse than that.)

It may not shock you to learn from Lewis that "private investors are second-class citizens in the market...and by the time that you read or hear about a change in the market, it is too late." Our primary hope is to find experts who can act as "jungle guides," and Lewis says that involves "knowing the right people to call." (He doesn't mean your brother-in-law, the one with the hot stock tip.)

"Success in anything is noticing the little things, the details,” Lewis writes. “That's your job, recognizing patterns that no one else sees." That’s true in medicine as well as money matters, it's just that we spend hundreds of multiples of more time on the former than on the latter.

Lewis does offer a cautionary note: "Beware when you encounter someone whose livelihood depends on speaking jargon." He's talking about Wall Street financiers with their "credit default swaps" and the like, but how often have you heard the same charge levied against doctors who refuse to speak plain English to their patients?

More to the point of why and how our financial system is in trouble: "Wall Street's essential function is to allocate capital; to decide who gets some and who doesn't…Financial markets are at base a collection of arguments...that often become a popularity contest....emotion usually overcomes logic and facts. And the closer you are to the market, the harder it is to see the inherent folly." Cynically, we might agree, but it is hard to accept as fact.

On the subject of risk, Lewis says: "There is no limit to risk. And it's not volatility that is risky but stupid decisions.... the main effect of (financial houses) selling themselves to the public was (not just to take a quick, liquid profit but) the transfer of (the huge) financial risk (away from the partners) to the shareholders." The professionals realized that "the line between gambling and investing is artificially thin." In life, it's always dangerous to not know the difference between being smart and being lucky.

Apparently, the biggest folly shared by everyone -- Wall Streeter and Main Streeter alike -- is to believe that a really bad outcome is unlikely to occur simply because it is too terrible to consider. So you plunge ahead with your critically unexamined current track of investing while the "Black Swan" event — referring to its previously unsuspected existence -- begins to arise. "Protective" tunnel vision can lead into the abyss, Lewis writes. Hello October 1929, September 2008, and...next?

Humbly, I have no answer or rejoinder, so as an appendix, I will simply reprise a few other interesting observations that Lewis wove into his tale.

  • “Every new business is inherently implausible."
  • "Just changing names can launder a (bad) business' taint."
  • "One man's liability is another man's asset. It's a zero sum game."
  • "The historic ratio of home cost to income has traditionally been 3:1. By 2008, in some locales, it had reached 10:1."
  • "Rule of Thumb: There is a ratio of annual rental to home cost. Buy at 10X and sell at 20X."
  • "Self awareness reduces madness" -- who knew that Freud was also a financial guru?