Summary - The Big Short PDF

Preview

Summary

Download Summary - The Big Short PDF

Description

Book: The Big Short Author: Michael Lewis Subject: Financial Reporting and Analysis Submitted on: December, 10, 2019

SUMMARY: THE BIG SHORT

1|Page

Summary The big short is narrated by Michael Lewis. This book explains the series of events that led to the 2007-2008 financial crises. There are three main characters named Steve Eisman from FrontPoint Partners, Greg Lippmann, a bond trader from Deutsche Bank and Michael Burry, hedge fund manager. Lewis explains his story that he worked for Salomon Brothers as a salesman in the 1980’s. He uncovered the fraudulent practices that led to the 1990’s crisis. Following this purpose to expose such practices, Lewis wrote his first book named as Liar’s Poker in which he tried to make people oblivious about such corruption. The aftermath of this action was that people learned more new ways to continue such activities. After writing this book, the second one was The Big Short, in which Lewis pondered on the 2007-2008 financial crises. Further, Lewis explains the Eisman and Michael Burry as bold and strange men because of their challenging character/quality. When Eisman came to know that Wall Street (financial and investment community) is tricking the poor, so with the assistance of his new employee Vincent Daniel, he investigated the subprime lending industry. Then he was contacted by Greg Lippmann who discovered that buying Credit Default Swaps on subprime mortgage bonds would be beneficial. Eisman grasped this opportunity as he already wanted to bet against Wall Street. Lewis tells that Michael Burry had his own hedge fund, Scion capital and progressing at a faster pace. But when Eisman started to bet against the subprime mortgage bond market, he faced resistance from his investors. However, he stood determined with his goal. Additionally, the author tells that the intention to create the lending industry was to make the system more productive, but it didn’t fulfill its purpose rather this industry started deceiving the poor by hiding actual risk. Further, Lewis tells about the founders of Cornwall Capital i.e. Charlie Ledley and Jamie Mai. Both men used to think for the long term and their ability always pay them off. For example, they bet against A-rated bonds, which no one ever did. They believe that this bet would be beneficial for them in the long run. And hence, it proved right later and in addition, they also got a hint for the upcoming crisis. Now, 2007-2008 actually occurred and effected the majority of Wall Street but these four were safer Eisman, Michael Burry, Lippmann and Cornwall Capital. They were not only safer but they also made a profit out of the crash. Later, it was proved that their opinion regarding Wall Street was right but still Wall Street didn’t change their practices.

2|Page

The Big Short and Financial Reporting & Analysis

The Big Short, the book is purely related to FRA (Financial Reporting & Analysis), this book tells how these 3people Eisman, Greg Lippmann and Michael Burry at Wallstreet predicted the housing market collapse. These people had a strong background of the stock market and had very strong analytical skills. They did not rely on the system and thought to analyze the market, policies and accounting systems on a global level. Their analysis was so strong and deep and their direction was right. They connected dots and found loose ends in systems. Working on the bet against Wall Street they found that the system is corrupt and its fooling middle-class Americans by showing attractive investments in order to make a profit for themselves. For example, they used to fool poor Americans by showing them the interest rate for15 years fixedrate loan but in actual they were taking interest on fixed-term loan of 30 years, the borrower was told he had an effective interest rate of 7percent when he was, in fact, paying something like 12.5 percent. Take another example of a Ponzi scheme which was common in this market. This scheme is basically a fraud in which the companies show the new investors that whatever they are earning are from sales but in actual the earnings are from the old investors. But unfortunately, there was no regulatory body to inspect these practices. They analyzed that it cannot go for long and it might collapse in the future. No one dug out what they discovered.

3|Page

Financial Terms to Understand Mortgage Bond A mortgage bond is secured by a mortgage or pool of mortgages that are typically backed by real estate holdings and real property, such as equipment. In the event of default, mortgage bondholders could sell off the underlying property to compensate for the default and secure payment of dividends. Subprime Mortgage Bond A subprime mortgage is one that's normally issued to borrowers with low credit ratings. A prime conventional mortgage isn't offered because the lender views the borrower as having a greaterthan-average risk of defaulting on the loan. Bond Rating A bond rating is a letter grade assigned to bonds that indicates their credit quality. Private independent rating services such as Standard & Poor's, Moody’s Investors Service, and Fitch Ratings Inc. evaluate a bond issuer's financial strength, or its ability to pay a bond's principal and interest, in a timely fashion. Investment grade bonds contain “AAA” to “BBB-“ratings from Standard and Poor's FICO Score A FICO score is a type of credit score created by the Fair Isaac Corporation. Lenders use borrowers' FICO scores along with other details on borrowers' credit reports to assess credit risk and determine whether to extend credit. FICO scores take into account various factors in five areas to determine creditworthiness: payment history, current level of indebtedness, types of credit used, length of credit history, and new credit accounts.

4|Page

Collateralized debt obligation A collateralized debt obligation (CDO) is a complex structured finance product that is backed by a pool of loans and other assets and sold to institutional investors. These assets become the collateral if the loan defaults. To create a CDO, investment banks gather cash flow-generating assets—such as mortgages, bonds, and other types of debt—and repackage them into discrete classes, or tranches based on the level of credit risk assumed by the investor. Mortgage-Backed Security (MBS) A mortgage-backed security (MBS) is an investment similar to a bond that is made up of a bundle of home loans bought from the banks that issued them. Investors in MBS receive periodic payments similar to bond coupon payments. Credit Default Swap (CDS) A credit default swap (CDS) is a financial derivative or contract that allows an investor to "swap" or offset his or her credit risk with that of another investor. For example, if a lender is worried that a borrower is going to default on a loan, the lender could use a CDS to offset or swap that risk. To swap the risk of default, the lender buys a CDS from another investor who agrees to reimburse the lender in the case the borrower defaults. Most CDS will require an ongoing premium payment to maintain the contract, which is like an insurance policy.

Reference: https://www.investopedia.com/

5|Page...