Two recent books by former bond trader Michael Lewis, The Big Short and Boomerang, set out to explain the financial crisis of the 2000s. In the 2010 book The Big Short, he traces the experience of a few select hedge fund managers who identified the real estate bubble and made a killing when the mortgage market tanked and the pillars of Wall Street collapsed. For his 2011 book Boomerang, Lewis took his show on the road, looking at financial bubbles in Iceland, Ireland, and Greece, then turning his laser eye back home to the mountain of debt created in California.
The macroeconomic issue of "what's wrong with the system" has been discussed and dissected by many experts and academics. Here are five important lessons that individual investors can take from the insights of this delightfully acerbic financial writer.
1. Contrary to what a lot of people believe, the U.S. stock market is not rigged. The equity markets have been democratized by discount brokers like Fidelity and Schwab, the explosion of the financial press from Bloomberg to CNBC, and especially by the Internet. The stock market is relatively open and transparent, particularly when compared to debt markets, which do not enjoy the same level of public scrutiny. It's not so easy to get the price of most bonds or collections of bonds that are bought and sold every day. But anyone can go on Yahoo! or Google in a minute and instantly find out what a stock is selling for.
2. Wall Street insiders purposely complicate financial products, even labeling them with misleading names, in order to confuse the public as well as other financial professionals. As Lewis points out, "A credit default swap was confusing mainly because it wasn't really a swap at all. It was an insurance policy." Insiders end up making a lot of money when customers don't really understand what they are buying. This underscores the old adages that you shouldn't invest in something you don't understand, and if it's too good to be true, it probably is.
3. Your stock broker or mutual fund manager is probably not one of the smartest guys on the Street. Two of Lewis's heroes from The Big Short showed up on Wall Street with $10 million. They went from bank to bank, trying to get someone to take them seriously, but no one gave them the time of day because $10 million isn't considered that much money by the real insiders. The best and brightest of the financial world work for big institutions and deal in hundreds of millions of dollars. The people who work for you, and your measly million, are the ones who couldn't get a job where the real money is made.
4. For the most part, people on Wall Street are not looking out for your best interests, they're looking out for their own. But as Lewis makes clear in Boomerang, self-interest and sheer hubris are not exclusive to Wall Street. The bankers in Iceland and Ireland were no better. The public sector in Greece is just as self-interested and short-sighted. And so are the voters of California who elect representatives who provide them with all kinds of benefits and services for free, because they don't raise taxes, they just issue more debt.
5. Some of Lewis's financial protagonists were very smart. They employed sophisticated statistical methods and financial models. But even they had plenty of anxious moments, when things in the real world weren't working the way their analysis said it would. Or, as one manager agonized, "It feels like my insides are digesting themselves." They ultimately were proved right, and they got rich, but they had their moments of doubt and trepidation. So, as you go about your own investing, keep in mind what one of these professionals admitted in a weak moment: "It's really hard to know when you're lucky, and when you're smart."
Tom Sightings is a former publishing executive who was eased into early retirement in his mid-50s. He lives in the New York area and blogs at Sightings at 60, where he covers health, finance, retirement, and other concerns of baby boomers who realize that somehow they have grown up.