Study Guide

The Big Short: Inside the Doomsday Machine Analysis

  • What's Up With the Title?

    This one isn't too complicated. In financial terminology, to "short" something is to make a bet that it's going to fall in value. And that's what our heroes do in The Big Short: they bet that the U.S. home market, which underpins the entire economy, will fail. Fun stuff. And the big part? Well, let's just say they're betting a lot more money than you would in your average hand of poker.

  • What's Up With the Ending?

    We have two endings to look at with this one, so buckle in, Shmoopers.

    The first ending is the culmination of the subprime mortgage crisis in 2008, when the stock market crashes. Our heroes have made a bunch of money—and the baddies have lost theirs (sort of)—but this still isn't necessarily a happy ending. After all, the banks and financial firms are bailed out by the government—a luxury certainly not extended to millions of American now in massive debt. Lesson: if you're too big to fail, you won't get punished. No matter what you do.

    With that in mind, we close out the novel with the dudes from FrontPoint Partners sitting on the steps of St. Patrick's Cathedral in New York City, wondering when the people walking the streets will understand how this invisible crisis affects them.

    After this, The Big Short closes with a shout epilogue in which author Michael Lewis has lunch with his former boss from Salomon Brothers, John Gutfreund. Lewis argues that the subprime crisis was made possible by Gutfreund, whose decision to make Salomon Brothers the first publicly traded Wall Street firm detached investment companies from the needs of their investors for the first time. This brings the book full circle, helping us understand the complex series of events, starting in the '80s, that led to the 2008 stock market crash.

  • Setting

    Wall Street

    Oh, boy. You know it's gonna get real when the setting of anything is Wall freakin' Street.

    Now, The Big Short is much more concerned with the economic factors underpinning the 2008 financial crisis than painting pictures for the reader, so there's not much to say as far as physical settings go. Most of the action takes place in nondescript offices littered about Manhattan, though we spend a spell in California and enjoy a quick jaunt to jolly old England.

    Still, there are a few moments when the book uses setting to great effect. For example, during the subprime mortgage conference in Vegas, we receive a series of scene description that symbolically relate Wall Street to gambling (which we helpfully analyze over in our "Symbolism" section). This helps solidify the foolishness at the heart of the subprime mortgage market.

    Similarly, Vinny and Danny take a trip to Florida to take a look at neighborhoods built by subprime loans, and the sight of so many empty houses makes them realize the extent of the crisis. Although we don't spend too much time in either one of these locations, they help paint a picture of how Wall Street's shenanigans are affecting the world at large.

  • What's Up With the Epigraph?

    The most difficult subjects can be explained to the most slow-witted man if he has not formed any idea of them already; but the simplest thing cannot be made clear to the most intelligent man if he is firmly persuaded that he knows already, without a shadow of doubt, what is laid before him.
    —Lev Tolstoy, 1897

    What's up with the epigraph?

    Was Tolstoy predicting the 2007 housing market crash way back in 1897? Possibly, because this quote is the perfect encapsulation of the subprime crisis.

    Throughout The Big Short, we see incredibly smart people make incredibly stupid decisions based on shortsighted assumptions. That's why everyone ignores Eisman's warnings: they can't fathom that the subprime mortgage market will collapse, because they've already convinced themselves that it could never happen. Based on what evidence? None, really.


    If nothing else, you should walk away from the book will some healthy skepticism about your own beliefs, as well as some willingness to adapt to changing circumstances.

  • Tough-o-Meter

    (7) Snow Line

    We're of two minds on this one. On the one hand, this is by far the easiest possible book to read on the subprime crisis, as author Michael Lewis explains things without the use of jargon and focuses first and foremost on human stories.

    That being said, this is still economics we're talking about (and an especially complex subset of economics, at that) so it may take a while to understand what Lewis is saying when he talks about "CDOs" and "subprime mortgage bond tranches." Give it time, though, and it'll all click into place.

  • CDOs

    If you're like us, then you still had some questions about the nature of a CDO, or collateralized debt obligation, after finishing The Big Short. That's no accident. These things were expressly designed to confuse the person looking at them, so we're going to have to take a deeper look to understand what's going on under the surface.

    CDO 101

    In its simplest terms, a CDO is a bond. When you buy a bond from someone, you're lending that person a specific amount of money, which he or she agrees to pay back over an agreed-upon period of time, with interest. Pretty easy so far, right?

    Originally, CDOs contained a variety of different types of debts, from student loans to home mortgages to business leases. This is important, as having a variety of income sources means that the bond is insulated should one of those sources go bad. Housing market going south? No sweat—those student loans are still chugging along just fine.

    Between the 1980s and 2000s, however, CDOs begin to be exclusively filled with home mortgages. For example, by 2004, "the 'consumer loan' piles that Wall Street firms, led by Goldman Sachs, asked AIG FP to insure went from being 2 percent subprime mortgages to being 95 percent subprime mortgages" (3.25). Whoa.

    That's a bad thing for the reason listed above: if the housing market takes a downturn, the entire bond will be affected, rather than just a portion of it. But when you consider the fact that these mortgages are primarily subprime (translation: really bad) the chance that those CDOs will lose their value rises exponentially.

    Postmodern Finance

    But we're not done, not by a long shot. Over the course of the 2000s, the banks manipulated CDOs even further, misguiding the ratings agencies into rating low-quality mortgages as if they were top-of-the-line. What's more, the actual content of those CDOs turned into a twisty labyrinth, with many mortgages being represented in multiple CDOs. That means you could buy five CDOs that contained 90% of the same mortgages. That's legit nuts.

    Nothing compares to the synthetic CDO, however. Every time someone bet against a CDO using a credit default swap, the bond trader simply took that bet, packaged it together with a bunch of other bets, and created a brand new CDO. Really. To the outside viewer, these synthetic CDOs were indistinguishable from normal ones.

    In practical terms, however, this process ballooned the amount of debt associated with the subprime market: "to make a billion-dollar bet, you no longer needed to accumulate a billion dollars' worth of actual mortgage loans" (3.39).

    Causing a Crisis

    Are you starting to understand what caused the 2008 stock market crash? Let's go step-by-step:

    • In the 1980s, CDOs become popular in the financial market.
    • In the early 2000s, CDOs start containing primarily subprime home mortgages.
    • In order to produce more CDOs, banks give out low-quality, subprime loans.
    • To pad their numbers further, individual subprime mortgages are placed in multiple CDOs, which means that a single bad mortgage can cause more debt than its actual value.
    • Once people start betting against CDOs, bond traders turn those bets into synthetic CDOs, which they buy and sell as normal ones.
    • In 2007, subprime mortgages start going bad, which starts off a domino chain of debt that collapses the economy.

    Making more sense? Basically, the CDO system is an elaborate scheme of misdirection that obscures the fact that trillions of dollars' worth of CDOs are all pointing back to a handful of subprime mortgages. It's like building the Empire State Building out of Styrofoam and bubbles. If those mortgages go bad—or those bubbles pop—the whole building goes crumbling down with it.

  • The Venetian

    Although it doesn't involve any Hangover-style hijinks, our heroes' trip to Las Vegas for the big subprime mortgage conference teaches them a lot about this hellish industry—and provides us readers with some tasty symbols to nibble on.

    Right off the bat, we enter the Venetian to a wild scene: "a jangle of seemingly random effects designed to [...] to alter your perception of your chances and your money" (6.32). This is fairly easy to connect to the subprime mortgage bond market, as subprime bonds were explicitly designed to disorient outsiders into thinking that they're more valuable than they actually are.

    In addition, Lewis notes that craps is the game of choice for bond traders. This is interesting, he says, because craps only "offered the illusion of control [...] and a surface complexity that masked its deeper idiocy" (6.32). Does that remind you of anything else? Hm? If you just said "CDOs," then you're completely right. As we see in the case of Howie Hubler, who tries to bet against the subprime market and accidentally bets for it, the subprime market is all about creating illusions.

    Related to this is the screen in the casino which lists "the wheel's most recent spins" in order "to help gamblers [...] delude themselves" (6.24). This, as it happens, is an example of "recency bias," which is the mistaken belief that whatever is happening now will continue happening in the future. Again, this relates quite easily to the subprime market: banks thought that home prices would never fall, simply because they hadn't in recent memory.

    Huh—looks like Las Vegas and Wall Street aren't so different after all.

  • Deviled Eggs

    Our final course in The Big Short is a deviled egg, which author Michael Lewis enjoys while grabbing lunch with John Gutfreund, his former boss at Salomon Brothers. Take a look:

    Now I see he'd ordered the best thing in the house, this gorgeous, frothy confection of an earlier age. Who ever dreamed up the deviled egg? Who knew that a simple egg could be made so complicated, so appealing? I reached over and took one. Something for nothing. It never loses its charm. (e.29)

    This, if you can't tell, is a sly reference to the rise of the mortgage bond. Just as a simple egg can be dressed up in this fancy "deviled" fashion, a simple mortgage can be packaged, repackaged, sold, bought, renamed, and, ultimately, made to sink the world's economy. It's not the most complex symbol in the world, but it sure is a clever one.

    Plus, we all just need to admit it, people—deviled eggs are gross. Grosser than gross. Shiver.

      • Allusions

        Literary and Philosophical References

        Historical References

        • Warren Buffet (1.3, referenced throughout)
        • Benjamin Graham (2.19, referenced throughout)
        • John Greenblatt (2.36, referenced throughout)
        • Alan Greenspan (2.71, referenced throughout)
        • Bill Clinton (5.7)
        • Richard Posner (6.49)
        • Ben Bernanke (7.16)
        • Henry Paulson (8.60)

        Pop Culture References

        • Gordon Gekko from Wall Street (1987) (3.4)
        • Jay Leno (6.29)