Just devoured the Michael Lewis book: flipping marvellous it was, too.
Baruch has 3 major takeaways.
Takeaway One: I wrote not so long ago that “investing should be a solitary activity” — in a (-nother overlong) post which was nicely taken up and expanded upon by Tadas at Abnormal Returns. What I meant was that you shouldn’t be dependent on Baruch and others for your investing results. The Big Short is a reminder of something else: that the independence of mind working alone creates is a huge asset. All the guys in the book were “out of the flow”; Mike Burry because of his Asperger’s, Cornwall Capital because it was just too small for anyone to want to service it, and Steve Eisman, well, because he was on a mission to punish evil-doers. And being out of the flow allowed them to see the unclothed nature of the Emperor. Baruch has lived through bubbles; he knows the attractions of being well-connected, getting “first call” on the hottest new trend or IPO. But its mostly bullshit; an invitation to join the current groupthink.
Takeaway Two: out of the three investors in the book, Baruch identifies most with the Cornwall Capital guys. He largely shares their epistemology, as described by Lewis. They and Baruch are Talebian investors, people who know the opportunity is that they live in Extremistan, but many things are priced like it’s Mediocristan instead. Betting on mispriced, assymetric outcomes is what Baruch tries to do too, and tech investing is great place to find opportunities like that. It’s odd though that Taleb isn’t mentioned by Lewis in the sections relating to Cornwall, as he is sort of the intellectual father (OK, maybe uncle) of investment strategies such as Cornwall’s — but never mind.
Shorting subprime debt via buying credit default swaps, which weirdly amounted to, as Lewis makes clear, something akin to writing subprime CDOs, was the classic Talebian strategy: a small outlay for an outsized payoff in the case of an outcome wrongly judged by the crowd to be highly improbable. Situations like that can be excessively profitable for the smart punter on the right side of the trade, yet the other side is correspondingly highly dangerous. In the case of subprime, the other side was the financial system. If we ever do somehow “fix” everything, remove the leverage, create redundancy and robustness in the system, it struck Baruch, might we not also partially remove from the system the ability to make big bucks? I hope not. After all, that’s how I put food on my children, as George Bush used to say.
Takeaway 3. I’m not sure how to feel about Lewis’ conclusion about overall financial system. He thinks that when the big old Wall Street partnerships went public it removed all restraint and socialized all the risks; the managers of partnerships with unlimited liability, Lewis thinks, tend to be more careful with the money, which after all belongs to them, than when the capital belongs to faceless shareholders. This is a good insight, and should not be controversial.
However, could the old partnership structure sustain the massive expansion of financial services in the past 30 years? Many would say that is exactly the point, that our current financial system is far too dynamic, too big. But really, can we be sure there aren’t positive aspects to this as well? The past 30 years also happen to be the period where, despite the odd systemic crisis, more people around the world have been brought out of hopeless poverty into the global economy than ever before, and while we have created some undeserving super rich, I suspect that when you consider the relative change in real incomes in BRIC markets, wealth inequality on a global basis might have actually fallen. It may only be a coincidence that the two phenomena occured at the same time. Then again, it may not. If an economy gets bigger and more complex, might it not need an increase in the size and complexity of its circulatory system?
Anyway, let’s see. Roll on the next crisis if it means another book as good as this one.
