The Big Short

Steve Eisman got into finance in the early 90s, shortly after Lewis got out. He gets his first job through his parents, who work at Oppenheimer securities, one of the last remaining small firms to survive on Wall Street. He starts as an equity analyst, looking at the value of public companies. Eisman finds that many people in equity analysis are hesitant to go against the consensus, but that he has a talent for it.

Early in his career, Eisman has to analyze Aames Financial, a company that extends loans to low-income Americans through a process called subprime mortgage lending. Eisman doesn’t understand the documents about the company at all.

The second company Eisman analyzes is the Lomas Financial Corporation, which has just come out of bankruptcy. Despite pressure to be upbeat, Eisman puts a “sell” rating on the company because it is “a piece of shit.” Shortly after his report, the company goes bankrupt again, and Eisman establishes himself as an analyst whose opinion can move the markets.

Eisman becomes a polarizing figure on Wall Street, beloved by those who “get” him but hated by others, particularly important men who are surprised by Eisman’s seeming lack of deference. At one point, Eisman insults the head of a large brokerage at a lunch meeting, then leaves to use the bathroom and never comes back, bewildering the other meeting attendees. Even Eisman’s wife, Valerie Feigen, admits he has no manners, though she claims he’s “sincerely rude” rather than “tactically rude.” “He knows everyone thinks of him as a character, but he doesn’t think of himself that way,” she says. “Steven lives inside his head.”

Lewis concludes that Eisman was a “curious character” entering Wall Street at the start of a “curious phase.” Much of this strangeness was due to the mortgage bond market. Unlike other bonds, which are based on fixed terms, mortgage bonds introduce uncertainty, since individual borrowers can repay their loans early if they want, or refinance when interest rates are low. This leaves banks less able to predict their revenue from mortgages. To combat this uncertainty, firms like Salomon Brothers devised a system to pool home loans together into groups called “tranches.” Buyers of bonds in the first tranche received the highest interest rate in exchange for the most risk, with subsequent tranches having less risk but lower interest rates.

In the 1980s, the main fear of mortgage bond investors was that home loans would be repaid too fast, not that the loans wouldn’t be repaid at all. This was because the government would guarantee many home loans, promising to pay them if the borrower defaulted (which means failed to pay back a debt). Starting in the 1990s, however, Wall Street began speculating with bonds on loans that didn’t qualify for government guarantees, since the borrowers were less creditworthy.

In the 1990s, Steve Eisman is one of the few people looking into the consequences of these risky loans; one of the others is Sy Jacobs, who went through the same training program at Salomon Brothers as Lewis and who went on to work at a small investment bank. Jacobs recounts to Lewis how the subprime mortgage bond market began with allegedly altruistic intentions: by mass-marketing the bonds, banks would reduce the cost to low-income people who needed to borrow money, since they would be able to replace high-interest credit card debt with lower-interest mortgage debt.

By the mid-1990s, Jacobs and Eisman both believe in the potential of subprime mortgage bonds to help alleviate income inequality, but Jacobs admits that it was a “fast-buck business” that brought in sleazy speculators. Eisman helps take many subprime companies public, partly due to pressure from his employer and partly because he believes the story that these bonds are helping consumers.

Meanwhile, Vincent Daniel grew up in Queens without the same advantages that Eisman had. After learning that the real money is in Manhattan, he gets a job at a junior accountant and is assigned to audit Salomon Brothers. There, he is shocked to find how opaque the company’s books are, and how no one can answer any of his questions.

Vinny concludes that Wall Street firms are “black boxes,” and that it’s not even possible for an accountant to tell if they’re making money or not. Frustrated with his job, Vinny applies for a job at Eisman’s company, Oppenheimer. The initial interviews go well, but when Vinny gets a call from Eisman that he assumes is the job offer, Eisman leaves for an emergency call and doesn’t come back on the line. Two months later, Eisman calls back and offers Vinny the job.

Vinny later finds out that Eisman never called back because he’d just learned that his firstborn infant son, Max, had died. His wife, Valerie, was calling because the night nurse fell asleep next to the baby, rolled on top of him, and smothered him. This was the moment when Eisman stopped believing he was safe and started believing bad things could happen to anyone at any time.

Vinny doesn’t know Eisman’s whole story when he starts work—he just knows that Eisman seems different from their previous meetings. Eisman begins to become increasingly negative at work. He wants to write a report that basically condemns the practices of the whole industry. Still, he has to be cautious, because there are consequences in the industry for people who make predictions that are both negative and wrong. Eisman asks Vinny to go into a room and look at a database of mortgage loans until he finds out what’s going on.

Vinny teaches himself about mortgage-backed securities and finds that Eisman’s intuition is right: there’s something rotten in the subprime mortgage industry. Companies are disclosing massive earnings but not being honest about the massive risks they’re incurring.

Vinny first notices that lots of people in the “manufactured housing” (mobile home) sector are prepaying their loans surprisingly quickly. Eventually, Vinny realizes that many of these prepayments are in fact “involuntary” (a euphemism for defaulting on the loan). Money lenders are losing money on these defaulting loans, because the interest rates aren’t nearly high enough to justify the massive risk.

Ultimately, Vinny takes six months to sort through all the data about subprime mortgage loans. He reports to Eisman that the whole thing is basically a Ponzi scheme, with companies making more and more loans to cover the losses of their previous loans. Eisman uses this as evidence in a report that harshly criticizes all the subprime mortgage companies.

Eisman’s report creates a “shitstorm,” according to Vinny, and this is exactly what Eisman wants. His report comes in 1997, during an economic boom—but less than a year later, many subprime lenders are forced into bankruptcy.

Eisman emerges as a leading skeptic on Wall Street. He leaves his job for a new one at the hedge fund Chilton Investment, where he continues to analyze companies. By 2002, there are no public subprime lending companies left in the U.S. There is, however, a large consumer lender called the Household Finance Corporation, which is perpetrating a related type of loan fraud. The company is telling borrowers that interest rates will be 7 percent, when in fact they end up being closer to 12.5 percent.

Eisman finds hundreds of complaints from borrowers who discover that they have been lied to by the Household Finance Corporation about their interest rates. He begins a crusade against the company, alerting reporters and regulators to the fraud. The federal government fails to respond. At the end of 2002, Household settles a class action lawsuit for a $484 million fine, but just a year later, the company is sold to the British finance company HSBC Group for $15.5 billion.

Eisman is shocked by the scale of Household’s fraud. He starts becoming more political and notices how the regulatory system seems designed to protect people at the top. A lover of comic books, particularly fractured fairy tales, Eisman sees the subprime mortgage loan as its own sort of fairy tale. Borrowers are told they’ll be able to pay off all their other loans with one new loan at a low rate, but the rate isn’t real—it’s just a teaser to get new people to sign up. As Eisman learns more, he realizes that big financial institutions are out there to make a profit at any cost, even if it means taking advantage of the poor.

Eisman started as a Republican, but his experiences in finance, such as watching the CEO of the fraudulent Household collect $100 million, lead him to become a socialist. Frustrated that his current job doesn’t let him manage money, he sets up his own hedge fund at FrontPoint Partners, which is owned by Morgan Stanley (although Morgan Stanley doesn’t provide investment money). Eisman tries to raise money, but at first, he can’t.

In spring of 2004, Eisman begins to despair that he’ll never raise any money. He takes an unconventional type of therapy, but he causes problems in the meetings—so much so that the therapist eventually begins calling Eisman’s wife, Valerie. Valerie gives Eisman an ultimatum: if his new project on Wall Street doesn’t work out, they’re leaving New York to start a bed and breakfast. This motivates Eisman to work hard enough to get his first investment: $50 million from an insurance company.

Eisman’s unusual style attracts a certain type of person. Vinny comes to FrontPoint Partners right away. Porter Collins, a former Olympic oarsman who previously worked with Eisman, also comes. Finally, there’s Danny Moses, who worked with Eisman at Oppenhiemer and was impressed with his style.

By 2005, Eisman and his employees begin to feel that Wall Street doesn’t understand what’s going on—the subprime mortgage industry is roaring back, bigger than it ever was. Instead of learning a simple lesson (not to lend money to people who can’t pay it back), Wall Street firms simply learned how to get better at hiding the risks of subprime loans in their books. Eventually, all the big Wall Street investment banks want a piece of the subprime game, including Bear Stearns, Merrill Lynch, Goldman Sachs, and Morgan Stanley.

Eisman, who already has a lot of experience with subprime mortgage markets, realizes the whole market is going to blow up at some point, and that it’s possible to make a fortune on shorting it (betting that the value will go down). Eisman has an epiphany: he realizes that instead of focusing on stock picks, he needs to do something with bonds.