Wall Street
Introduction
Recently, I’ve become quite interested in the mysterious Wall Street, so I’ve set out to learn more about the financial market through reading a series of books. The first book among which is The Big Short by Michael Lewis. Prior to reading the book, I’ve also watched the movie adaptation, but the book definitely provided much more details that I was looking for.
Lewis explained the 2008 Financial Crisis from the short side - through the lenses of hedge fund managers and investment bankers that shorted the housing market, which made the story much more interesting for me. After reading the book, I felt that I’ve gained a basic understanding of the causes and impact of the 2008 Crisis, as well as how Wall Street functions. In particular, I now understand the roles of mortgage-backed securities, CDOs, investment banks, and credit rating agencies during the crisis.
Major Players in the 2008 Financial Crisis
Mortgage-backed securities (MBS)
- MBS is an investment product similar to bonds, where investors receive monthly payments
- Each MBS consists of a collection of home loans
- Essentially, MBS investors lend their money to homebuyers, where banks act as an intermediary between them
- MBS is designed to diversify the pool of loans, thus, reducing risks
Collateralized debt obligations (CDOs)
- A complicated financial derivative that repackages mortgages/bonds into a single product divided into different levels based on the risks
- A CDO is like a skyscraper, with each floor being mortgages/bonds. The lower the floor, the higher the risks of the bonds that it contains
- Mostly for institutional traders
Investment banks
- A big investment bank does a little bit of everything
- Financial/banking services
- Provides advice (consulting)
- Market making
- Examples: Goldman Sachs, JP Morgan, Morgan Stanley, CitiGroup
- Foreign investment banks like UBS (Switzerland), Credit Suisse (Switzerland), Deutsche (Germany) also played a major role in the 2008 Financial Crisis
Rating Agencies
- Financial institutions that provide ratings (triple-A, triple-B etc.) to assets
- During the 2008 Financial Crisis, ratings of garbage CDOs remained high
- Examples: S&P, Moody’s, Fitch Group
Next Up
Next, I will read Liar’s Poker, another book by Lewis, which focuses on his experience working for the Salomon Brothers.