Distressed Debt Book Review - The Big Short

On Friday, I picked up Michael Lewis' new book "The Big Short: Inside the Doomsday Machine" which chronicles the sub-prime short through the eyes of four different characters: Cornwall Capital, Steve Eisman, Michael Burry, and Greg Lippmann. To give you a sense of how much I enjoyed it, and how quick a read it was, I successfully finished the book last night. Despite the somewhat lukewarm review on Amazon and in the press, I really enjoyed this book and recommend it to readers.

For a little background, in early 2007, the fund with which I was working at the time was shorting both vintages of the 2006 ABX as well as a number of single name tranches of sub-prime. I learned how to analyze loan tranches using Bloomberg and Intex, stayed up on all the remittance data, and was greeted daily by email blasts from Greg Lippmann and co. A number of other distressed funds we were friendly with were also buying protection on the ABX and single named sub prime tranches. The fund had great returns but nothing like the likes of Harbinger, Paulson, or Scion.

Reading Lewis' account of the events of 2006-late 2008 for me was absolutely fascinating. I had seen Greg Lippmann present (along with Karen Weaver) but had no idea about the inner workings of Deutsche Bank and his relationship at the time. The story of Cornwall Capital was particularly interesting in that these guys started out with a little over 100k (yes: one-hundred thousand dollars), and somehow turned that into many and many of millions of dollars by betting with the fat tails (i.e. Black Scholes is wrong in assuming a normal distribution of stock prices...the better assumption may be that the tails are a lot fatter) or when the market was laying them a 100x payout for a chance they perceived at 1 out of 10.

The story of Steve Eisman is also spectacular. It is comical at times of how aggressive this guy and his analysts/traders were. On speaking about a meeting with Ray McDaniel, the CEO of Moody's:

..."But we're sitting there," recalls Vinny, "and he says to us, like he actually means it, 'I truly believe that our ratings will prove accurate.'" And Steve shoots up in his chair and asks, 'What did you just say?' - as if the guy had just uttered the most preposterous statement in the history of finance. He repeated it. And Eisman just laughed at him. "With all due respect, sir," said Vinny deferentially, as they left, "you're delusional."

I love it.

The book chronicles from the very beginning: When Mike Burry was one of the first people to short sub prime (according to the book, Morgan Stanley was doing it before Burry but on a bespoke basis", through AIGFP being the counterparty to the short, through the CDO machine and the creation of AAA out of BBB- mezz tranches, through Lippmann pitching the trade to anyone who would listen, and through the inevitable decline in the prices of everything sub prime or CDO or bank which in my mind first began with the filing of New Century.

My favorite quote in the book came from Dr. Michael Burry when it seemed like the whole world was against him (including - which I did not know - Joel Greenblatt):

I have always believed that a single talented analyst, working very hard, can cover an amazing amount of investment landscape, and this belief remains unchallenged in my mind.

This quote resonated with me and it makes perfect sense. The example of Monish Pabrai or a young Warren Buffett come to mind. I know of two or three young managers pursuing the same strategy with mind boggling successes.

Nonetheless, you will not be disappointed purchasing this book. I definitely would say its the most enjoyable book I have read on financial markets in some time. Hope you enjoy.

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Distressed Debt Book Review - The Predictioneer's Game

As many of you know, I have written about how important it is to look at incentives when predicting what may happen, or what the probability something may happen, in certain distressed debt and high yield investing situations. It is my belief, that generally speaking, people act in their own best interest. Whether it be a management team that sides with a certain creditor plan because their upside will be greater, or a group of creditors that may block a debt exchange to trigger the default provision in a credit default swap, it is vitally important to look who is getting what spoil when deciding how to allocate your own capital. Few books discuss the implication for motivated self interests and how one can use those same self interests to make decisions about the future. I just finished reading one...and frankly...It was fascinating...

The Predictioneer's Game by Bruce Bueno de Mesquita talks about the use of game theory to predict the future course of events. If you have not heard of the Bueno de Mesquita, there have been a number of articles written about him in the past. He run's a consulting business (who's number one client apparently is the CIA) which predicts the unfolding of future evens using game theory. From the Book Description:

Bruce Bueno de Mesquita is a master of game theory, which is a fancy label for a simple idea: People compete, and they always do what they think is in their own best interest. Bueno de Mesquita uses game theory and its insights into human behavior to predict and even engineer political, financial, and personal events. His forecasts, which have been employed by everyone from the CIA to major business firms, have an amazing 90 percent accuracy rate, and in this dazzling and revelatory book he shares his startling methods and lets you play along in a range of high-stakes negotiations and conflicts.

For me, the political discussion in the book was interesting. But as noted above, I care more about how rational (maybe sometimes irrational) actors act in the finance world and how I can profit from these opportunities. Many of us have read about Game Theory, or learned about it in our Econ classes far too long ago - this bring a real world, tangible discussion to the mix which merits everyone's attention.

After reading this book will you be able to lay claim on a 90% hit ratio on prediction on which company is getting acquired or which company is next going to file...No. Definitely not. But it will begin to show you, that when you break things down, predicting how certain situations or cases will play out can become blindingly obvious.

The book is a fast, quick read. There is some promotional aspect to the book (he runs a consulting business and hence wants to show off his predicting abilities). Nonetheless, I think this text is an essential addition to the enterprising investor's library.

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