Yes, there are more comprehensive analyses of the recent Great Financial Meltdown, but it’s unlikely any of them have the page-turning quality of Michael Lewis’ book, The Big Short. His 1989 best seller Liar’s Poker, was an acerbic and irreverent indictment of Salomon Brothers and its bond-trading culture. In his latest book, Lewis follows a handful of eccentric and mostly small-time investors who as early as 2005 foresaw and bet on the collapse of the mortgage market, all the while finding themselves almost universally ignored as they tried to sound the alarm about the unfolding economic disaster.
It’s a financial–and true–“whodunit?” appropriately sprinkled with Lewis’ smart and smart-ass humor (Example–One chapter is titled “How can a guy who can’t speak English lie?”), but he does a masterful job of explaining some of the arcane argot of the mortgage market cognoscenti. Read the book and you’ll almost understand what a “subprime mezzanine floor tranch” is, or what a “synthetic collateralized debt obligation” is and why those “innovative” financial instruments contributed to the cratering of the stock market. It’s much more just another screed on greed and the curious reader can learn a lot.
As they say on the Infomercials, “BUT WAIT–THERE’S MORE!” The intention here is not to write a book review of The Big Short. There are many good ones out there by writers from The Wall Street Journal, Washington Post, and The New York Times. Just Google the phrase “The Big Short reviews.” But I did want to share with Fast Company readers two unexpected takeaways I got from Lewis’ chronicling of this financial train wreck. Those two a-ha’s for me were the power of institutional ignorance and the dark side of innovation.
Institutional Ignorance. People inside the Wall Street firms, mortgage feeder industries and the bond ratings agencies displayed a galling and appalling level of ignorance about the basic facts in the housing market run-up. These were supposedly the best and brightest executives and analysts, after all that’s been the justification for all of those seven and eight figure salaries and bonuses–to get outsized results you have to pay those people outsized compensation packages. Right? But Lewis provides countless examples of a virus of institutional dumbness seems to have struck most of the well paid and–one would think–well informed experts, wizards, and Masters-of-the-Universe.
The 2007 collapse wasn’t a big-bang-out-of-nowhere event. For several years, central assumptions seemingly were never challenged, such as the belief that housing values would continue to rise, perhaps forever. And those key assumptions drove many of the forecasting models and institutional decision making which as we know, ended quite badly for not just the big banks but for homeowners, communities and the country at large.
When confronted with data which did not fit the conventional wisdom, leaders in the organizations did what so many other leaders or authorities have done in the past, they denied the relevance of the information or the existence of it altogether. That tendency reminded me of the central point made in that popular Joel Barker video about paradigms back in the 1980s. On Wall Street and in the mortgage industry there existed a grand illusion of certainty and self-interest and many people at all levels in the food chain–including homeowners who could not afford a mortgage–thought they had at last discovered the free lunch. Optimism is a good thing, of course, but sometimes the head needs to trump the heart. Courage and clear-headed thinking on the part of key decision makers was needed and our institutions served up little of either.
The Dark Side of Innovation. It’s fashionable–almost expected–in the business world to genuflect at the altar of innovation. Fast Company, in fact, provides wide coverage in both on-line and print editions of innovative ideas and people. And it’s true that innovation can be the engine of growth and progress for organization or civilizations. But The Big Short provided a reminder that innovation does not in itself have intrinsic value, but rather is useful only when advancing something else that does have intrinsic value. The most egregious of the mortgage market’s financial instruments and tools which almost brought a halt to the world as we know it were extraordinarily innovative.
In fact, many were so clever and innovative that almost nobody really understood them or their unintended consequences. “No doc” loans for those who might not have assets or even jobs; the slicing of differently rated mortgage bonds to create collateralized debt obligations (CDOs); the creation of credit default swaps on those collateralized debt obligations when there wasn’t enough actual bonds to bundle into CDOs; the creation of processes to “short” (or bet against) CDOs, etc. Remarkably clever and innovative these instruments were, but they were designed to support an agenda that ultimately did great harm to the economy and to many people.
So the learning point is not that we shouldn’t continuously strive for innovative products and services, but that like technology, innovation can be misguided, especially when its advancement is considered beyond reproach. And in the financial markets we have been down this road countless numbers of times in the past and it’s quite likely the next bubble or burp or bump in the global economic system will be the result of some innovative financial practice or instrument that is being devised today/next week/next month. It will look good on paper, will appear to have social utility and will make some people a lot of money, but it will again end badly.
Hopefully, Michael Lewis will write about it.
Mike Hoban is a senior consultant for a global talent management consulting firm and can be contacted at firstname.lastname@example.org