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updated 10/3/2011 6:55:40 AM ET 2011-10-03T10:55:40

In navigating the sobering reality of what he calls the "New Third World" in "Boomerang," bestselling author Michael Lewis examines some of the financial players and those who were financially played in the worldwide financial meltdown. Here's an excerpt.


This book began accidentally, while I was at work on another book, about Wall Street and the 2008 U.S. financial disaster. I’d become interested in a tiny handful of investors who had made their fortunes from the collapse of the subprime mortgage market. Back in 2004, the biggest Wall Street investment banks had created the instrument of their own destruction, the credit default swap on the subprime mortgage bond. The credit default swap enabled investors to bet against the price of any given bond—to “short” it. It was an insurance policy, but with a twist: the buyer didn’t need to own the insured asset. No insurance company can legally sell you fire protection on another person’s house, but the financial markets can and will sell you default insurance on another person’s investments. Hundreds of investors had dabbled in the credit default swap market—a lot of people had thought, at least in passing, that the debt-fueled U.S. housing boom was unsustainable—but only fifteen or so had gone all in, and placed enormous bets that vast tracts of American finance would go up in flames. Most of these people ran hedge funds in London or New York; most, usually, avoided journalists. But on this topic, at this moment, they were surprisingly open. All had experienced the strange and isolating sensation of being the sane man in an insane world and, when they talked about their experience, sounded as a person might if he had sat alone and in silence in a small boat and watched the Titanic steam into the iceberg.

Author Michael Lewis: 'We're all too well read'

A few of these people were temperamentally ill-suited to solitude and silence. Among this subset was the manager of a hedge fund called Hayman Capital, in Dallas, Texas. His name was Kyle Bass. Bass was a native Texan in his late thirties who had spent the first years of his career, seven of them at Bear Stearns, selling bonds for Wall Street firms. In late 2006 he’d taken half of the $10 million he had saved from his Wall Street career, raised another $500 million from other people, created his hedge fund, and made a massive wager against the subprime mortgage bond market. Then he’d flown to New York to warn his old friends that they were on the wrong side of a lot of stupid bets. The traders at Bear Stearns had no interest in what he had to say. “You worry about your risk management. I’ll worry about ours,” one of them had told him. By the end of 2008, when I went to Dallas to see Bass, the subprime mortgage bond market had collapsed, taking Bear Stearns with it. He was now rich and even, in investment circles, a little famous. But his mind had moved on from the subprime mortgage bond debacle: having taken his profits, he had a new all-consuming interest, governments. The United States government was just then busy taking on to its own books the subprime loans made by Bear Stearns and other Wall Street banks. The Federal Reserve would wind up absorbing the risk, in one form or another, associated with nearly $2 trillion in dodgy securities. Its actions were of a piece with those of other governments in the rich, developed world: the bad loans made by highly paid financiers working in the private sector were being eaten by national treasuries and central banks everywhere.

In Kyle Bass’s opinion, the financial crisis wasn’t over. It was simply being smothered by the full faith and credit of rich Western governments. I spent a day listening to him and his colleagues discuss, almost giddily, where this might lead. They were no longer talking about the collapse of a few bonds. They were talking about the collapse of entire countries.

Click to hear Dylan Baker read an excerpt from Michael Lewis' 'Boomerang'

And they had a shiny new investment thesis. It ran, roughly, as follows. From 2002 there had been something like a false boom in much of the rich, developed world. What appeared to be economic growth was activity fueled by people borrowing money they probably couldn’t afford to repay: by their rough count, worldwide debts, public and private, had more than doubled since 2002, from $84 trillion to $195 trillion. “We’ve never had this kind of accumulation of debt in world history,” said Bass. Critically, the big banks that had extended much of this credit were no longer treated as private enterprises but as extensions of their local governments, sure to be bailed out in a crisis. The public debt of rich countries already stood at what appeared to be dangerously high levels and, in response to the crisis, was rapidly growing. But the public debt of these countries was no longer the official public debt. As a practical matter it included the debts inside each country’s banking system, which, in another crisis, would be transferred to the government. “The first thing we tried to figure out,” said Bass, “was how big these banking systems were, especially in relation to government revenues. We took about four months to gather the data. No one had it.”

The numbers added up to astonishing totals: Ireland, for instance, with its large and growing annual deficits, had amassed debts of more than twenty-five times its annual tax revenues. Spain and France had accumulated debts of more than ten times their annual revenues. Historically, such levels of government indebtedness had led to government default. “Here’s the only way I think things can work out for these countries,” Bass said. “If they start running real budget surpluses. Yeah, and that will happen right after monkeys fly out of your ass.”

Still, he wondered if perhaps he was missing something. “I went looking for someone, anyone, who knew something about the history of sovereign defaults,” he said. He found the leading expert on the subject, a professor at Harvard named Kenneth Rogoff, who, as it happened, was preparing a book on the history of national financial collapse, "This Time Is Different: Eight Centuries of Financial Folly," with fellow scholar Carmen Reinhart. “We walked Rogoff through the numbers,” said Bass, “and he just looked at them, then sat back in his chair, and said, ‘I can hardly believe it is this bad.’ And I said, ‘Wait a minute. You’re the world’s foremost expert on sovereign balance sheets. You are the go-to guy for sovereign trouble. You taught at Princeton with Ben Bernanke. You introduced Larry Summers to his second wife. If you don’t know this, who does?’ I thought, Holy sh_t, who is paying attention?”

Thus his new investment thesis: the subprime mortgage crisis was more symptom than cause. The deeper social and economic problems that gave rise to it remained. The moment that investors woke up to this reality, they would cease to think of big Western governments as essentially risk-free and demand higher rates of interest to lend to them. When the interest rates on their borrowing rose, these governments would plunge further into debt, leading to further rises in the interest rates they were charged to borrow. In a few especially alarming cases—Greece, Ireland, Japan—it wouldn’t take much of a rise in interest rates for budgets to be consumed entirely by interest payments on debt. “For example,” said Bass, “if Japan had to borrow at France’s rates, the interest burden alone would bankrupt the government.” The moment the financial markets realized this, investor sentiment would shift. The moment investor sentiment shifted, these governments would default. (“Once you lose confidence, you don’t get it back. You just don’t.”) And then what? The financial crisis of 2008 was suspended only because investors believed that governments could borrow whatever they needed to rescue their banks. What happened when the governments themselves ceased to be credible?

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There was another, bigger financial crisis waiting to happen—the only question in Kyle Bass’s mind was when. At the end of 2008, he thought Greece would probably be the first to go, perhaps triggering a collapse of the euro. He thought it might happen within two years, but he didn’t have a lot of conviction about his timing. “Let’s say it takes five years and not two,” he said. “Let’s say it takes seven years. Should I wait until I see the whites of their eyes before I position myself, or should I position myself now? The answer is now. Because the moment people think it [national default] is a possibility, it’s expensive. If you wait, you have to pay up for the risk.”

When we met, he had just bought his first credit default swaps on the countries he and his team of analysts viewed as the most likely to be unable to pay off their debts: Greece, Ireland, Italy, Switzerland, Portugal, and Spain. He made these bets directly with the few big Wall Street firms that he felt were least likely to be allowed to fail—Goldman Sachs, J.P. Morgan, and Morgan Stanley—but, doubting their capacity to withstand a more serious crisis, he demanded that they post collateral on the trades every day. The prices he paid for default insurance, in retrospect, look absurdly cheap. Greek government default insurance cost him 11 basis points, for instance. That is, to insure $1 million of Greek government bonds against default, Hayman Capital paid a premium of $1,100 dollars a year. Bass guessed that when Greece defaulted, as it inevitably would, the country would be forced to pay down its debt by roughly 70 percent—which is to say that every $1,100 bet would return $700,000. “There’s a disbelief that a developed country can default, because we have never seen it in our lifetime,” said Bass. “And it’s not in anyone’s interest to pay attention to this. Even our own investors. They look at us and say, ‘Yeah, you got subprime right. But you’re always out there looking for these extremely rare events and so you think they happen more often than they do.’ But I didn’t go looking for this position. I was trying to understand the way the world was working, and this came to me.” Now that he understood the way the world was working, he continued, he couldn’t see how any sane person could do anything but prepare for another, bigger financial catastrophe. “It may not be the end of the world,” he said. “But a lot of people are going to lose a lot of money. Our goal is not to be one of them.”

He was totally persuasive. He was also totally incredible. A guy sitting in an office in Dallas, Texas, making sweeping claims about the future of countries he’d hardly set foot in: how on earth could he know how a bunch of people he’d never met might behave? As he laid out his ideas I had an experience I’ve often had, while listening to people who seem perfectly certain about uncertain events. One part of me was swept away by his argument and began to worry the world was about to collapse; the other part suspected he might be nuts. “That’s great,” I said, but I was already thinking about the flight I needed to catch. “But even if you’re right, what can any normal person do about it?”

He stared at me as if he’d just seen an interesting sight: the world’s stupidest man.

“What do you tell your mother when she asks you where to put her money?” I asked.

“Guns and gold,” he said simply.

“Guns and gold,” I said. So he was nuts.

“But not gold futures,” he said, paying no attention to my thoughts. “You need physical gold.” He explained that when the next crisis struck, the gold futures market was likely to seize up, as there were more outstanding futures contracts than available gold. People who thought they owned gold would find they owned pieces of paper instead. He opened his desk drawer, hauled out a giant gold brick, and dropped it on the desk. “We’ve bought a lot of this stuff.”

At this point, I was giggling nervously and glancing toward the door. The future is a lot harder to predict than people on Wall Street would have you believe. A man who has been as dramatically right about the future as Kyle Bass had been about the subprime mortgage bond market collapse might easily fool himself into thinking he had a talent for being dramatically right about all sorts of other complicated things. At any rate, I was too interested in trying to figure out what had just happened in America to worry much about what was going to happen in the rest of the world, which seemed, at the time, a trivial matter. And Bass had more or less lost interest in what had just happened in America, because he thought what was about to happen all around the world was so much more important. I made my excuses, and took my leave of Dallas, and more or less dismissed him. When I wrote the book, I left Kyle Bass on the cutting-room floor.

Then the financial world began to change again—and very much as Kyle Bass had imagined it might. Entire countries started to go bust. What appeared at first to be a story chiefly about Wall Street became a story that involved every country that came into meaningful contact with Wall Street. I wrote the book about the U.S. subprime mortgage crisis and the people who had made a fortune from it, but began to travel to these other places, just to see what was up. But I traveled with a nagging question: how did a hedge fund manager in Dallas even think to imagine these strange events?

Two and a half years later, in the summer of 2011, I returned to Dallas to ask Kyle Bass that question. Greek credit default swaps were up from 11 basis points to 2300; Greece was just about to default on its national debt. Ireland and Portugal had required massive bailouts; and Spain and Italy had gone from being viewed as essentially riskless to nations on the brink of financial collapse. On top of it all, the Japanese Ministry of Finance was about to send a delegation to the United States to tour the big bond investment funds such as Pimco and BlackRock—to see if they could find someone, anyone, willing to buy half a trillion dollars’ worth of ten-year Japanese government bonds. “This is a scenario in which no one alive has ever invested before,” Bass said. “Our biggest positions now are Japan and France. If and when the dominoes fall, the worst, by far, is France. I just hope the U.S. doesn’t collapse first. All my money is bet that it won’t. That’s my biggest fear. That I’m wrong about the chronology of events. But I’m convinced what the ultimate outcome is.”

He still owned stacks of gold and platinum bars that had roughly doubled in value, but he remained on the lookout for hard stores of wealth as a hedge against what he assumed was the coming debasement of fiat currency. Nickels, for instance.

“The value of the metal in a nickel is worth six point eight cents,” he said. “Did you know that?”

I didn’t.

“I just bought a million dollars’ worth of them,” he said, and then, perhaps sensing I couldn’t do the math: “twenty million nickels.”

“You bought twenty million nickels?”


“How do you buy twenty million nickels?”

“Actually, it’s very difficult,” he said, and then explained that he had to call his bank and talk them into ordering him twenty million nickels. The bank had finally done it, but the Federal Reserve had its own questions. “The Fed apparently called my guy at the bank,” he says. “They asked him, ‘Why do you want all these nickels?’ So he called me and asked, ‘Why do you want all these nickels?’ And I said, ‘I just like nickels.’”

He pulled out a photograph of his nickels and handed it to me. There they were, piled up on giant wooden pallets in a Brink’s vault in downtown Dallas.

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“I’m telling you, in the next two years they’ll change the content of the nickel,” he said. “You really ought to call your bank and buy some now.”

I doubt Kyle Bass was ever the sort of person who enjoyed sitting around an office and staring at a computer screen. He enjoys the unsettled life. We hopped into his Hummer, decorated with bumper stickers (God Bless Our Troops, Especially Our Snipers) and customized to maximize the amount of fun its owner could have in it: for instance, he could press a button and, James Bond–like, coat the road behind him in giant tacks. We roared out into the Texas hill country, where, with the fortune he’d made off the subprime crisis, Kyle Bass had purchased what amounted to a fort: a forty-thousand-square-foot ranch house on thousands of acres in the middle of nowhere, with its own water supply, and an arsenal of automatic weapons and sniper rifles and small explosives to equip a battalion. That night we tore around his property in the back of his U.S. Army jeep, firing the very latest-issue U.S. Army sniper rifles, equipped with infrared scopes, at the beavers that he felt were a menace to his waterways. “There are these explosives you can buy on the Internet,” he said, as we bounded over the yellow hills. “It’s a molecular reaction. FedEx will deliver hundreds of pounds of these things.” The few beavers that survived the initial night rifle assault would wake up to watch their dams being more or less vaporized.

“It doesn’t exactly sound like a fair fight,” I said.

“Beavers are rodents,” he said.

Whatever else he was doing, he was clearly having fun. He’d spent two and a half years watching the global financial system, and the people who ran it, confirm his dark view of them. It didn’t get him down. It thrilled him to have gotten his mind around seemingly incomprehensible events. “I’m not someone who is hell-bent on being negative his whole life,” he said. “I think this is something we need to go through. It’s atonement. It’s atonement for the sins of the past.”

Once again a hedge fund manager had been more or less right, and the world had been more or less wrong. Now seemed as good a time as any to pose the question that had nagged at me for more than two years. Here you are, I said, in so many words, an essentially provincial hedge fund manager in Dallas, Texas, whose entire adult life has been lived within a few miles of this place. You speak no foreign languages. You seldom travel abroad. You are deeply patriotic: your biggest philanthropic cause is wounded veterans. You hardly know anyone who isn’t American. How did it even occur to you to start spinning theories about the financial future of these distant countries?

“It was Iceland that got me going,” he said. “I’ve always been interested in Iceland.”

“But why?”

“Did you ever play Risk as a kid?” he asked. “I loved playing Risk. And I would always put all of my armies on Iceland. Because you could attack anybody from there.”

The belief that he could attack anyone from Iceland had led Kyle Bass to learn whatever he could about Iceland, and to pay special attention when something happened in Iceland. He found out, for instance, that Iceland was held up by geographers as an example of a country with a special talent for survival against long environmental odds. “We kept saying, ‘These banks are out of business.’ But the government kept saving the banks,” he said. “And right in the midst of this Iceland went broke. And I thought, Wow, that’s interesting. How, after a thousand years of getting things right and overcoming all these natural obstacles, did they get it so wrong?”

I had my answer. His interest had started with a board game. It was ending with another kind of board game. And Iceland was, once again, a good place to start.

Reprinted from "Boomerang: Travels in the New Third World" by Michael Lewis © 2011 by Michael Lewis. Used with permission of the publisher, W.W. Norton & Company, Inc.

© 2012 MSNBC Interactive

Video: ‘Blind Side’ author trades sports for subprimes

  1. Closed captioning of: ‘Blind Side’ author trades sports for subprimes

    >>> we are back now at 8:43. sandra bullock won the oscar for her role in "the blindside" written by michael lewis . now the best-selling author is tackling the latest economic meltdown. can you find an excerpt in this month's " vanity fair ." thanks for coming back. how are you doing?

    >> i'm doing well. thanks for having me back.

    >> some go as far to say this is the book you need to read about the economic meltdown. but a lot has been written about it. it's been dissected and looked at under the micro -- or magnifying glass . why did you decide to tackle it?

    >> oddly, because you're right so much has been written about it, but -- two reasons. one is i had come in at the beginning of this story with "liar's poker," about me working on wall street in the '80s and a lot of what happened, the seeds of the ka tas trocatastrophe were plante d then.

    >> most of the books that you read about economic meltdown go into september and october of '08. your story starts and ends kind of before that.

    >> that was the other thing. i felt like there was this great untold story with these wonderful characters that just hadn't been told and it was this period from kind of the early '05 to the end of '07 when, in effect, the bombs were built and laid and the fuses were lit and by the end of '07, the story is basically over in the sense that the bad things are going to happen. it's just a question of when.

    >> you hear people say all the time about this economic meltdown, no one saw this collapse coming. well, no, there were a lot of people who saw it coming and found a way to sell short on some of these awful mortgages and cash in when things really got bad. explain it to me.

    >> well, you can almost think of the financial system leading up to the crisis as having gathered itself around a giant bet. most of the financial system was betting on the subprime mortgages and actual ly only a relative handful of investors saw what was happening and made big bets against them. they shorted them, betted on the price of mortgage bonds falling. the thing that was so curious to me is that there were so few of them. maybe the greatest bet in modern financial history to be made and it was sort of like, why did those people figure it out? what was it about them that led them to figure it out?

    >> you tackle some of these people and kind of delve into their character and their personalities. some reading it or listening to this might say, michael , these are bad people because they're as bad as the other guys because they profited off the misery of people. do you see it that way?

    >> no. when you put it that way, it sounds pretty horrible, but i don't see it that way. for a start, if more people had seen the world the way they saw the world, none of this would have happened and they were screaming to high heaven that this stuff shouldn't be -- these loans shouldn't be being made. in one case, they go to the scc, "the new york times," " wall street journal " to try to get people to pay attention . this whole question of the role of people who short things in the marketplace has been badly distorted, especially by big wall street firms.

    >> because they're made out to be cashing in. in some ways, they are a check and balance.

    >> they are the check and balance. they are the way the information gets into the marketplace. someone has to have the incentive to dig out the bad information as well as the good. and the ability to sell short something create that is incentive.

    >> you tackle a couple of these guys, michael bury who was studying to become a neurologist.

    >> he was a neurologist.

    >> didn't love medicine before he got into finance. why did he stand out for you?

    >> he was the first person to really see -- to see that the smartest thing he could do -- he was a stock market investor, an ordinary stock market investor. he couldn't invest in stocks in good conscience, because he saw what was happening in subprime mortgage market and knew it was going to affect everything. he actually starts, sets out to make a bet against the subprime mortgages. the thing that was so interesting about him, there were some deep character logical quality that is led these people to do what they did. he has aspberger's syndrome but didn't know it. but in retrospect he said only someone with aspberger's syndrome would bother to read subprime mortgages. he spent a lot of time alone in a room looking at data. and that set him up to see it, because he wasn't -- he was sort of outside the fog machine that wall street had created to disguise what was actually going on and he was looking at just the raw numbers . when you looked at just the raw numbers , they told you that, my god, there's a catastrophe in the making.

    >> a fascinating study. before i let you go, sandra bullock wins best actress oscar for her role in "the blindside." did you ever dream when you sat down to tell that story years ago that it would result in something like that?

    >> you know, i thought it was a wonderful story that i could only screw up. and when i was done with it, i thought some great actress could really do something with it, but she did. what she did was a miracle. i mean, it was a miracle. and she took a risk to do it. and you know, i was very proud of her.

    >> good for you as well. michael , nice to see you, as always.

    >> thanks for having me.

    >> the book is called "the big short."


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