To maximize profits, lenders and investment banks exploited flaws in the rating agency models:

• Using "thin-file" FICO scores from borrowers with limited credit history
• Focusing on floating-rate loans the agencies favored vs fixed-rate
• Offsetting high-risk loans with safer ones to game the averages

This allowed them to get high ratings on subprime mortgage bonds and CDOs that were far riskier than they appeared. Wall Street insiders knew the game, but the rating agencies were oblivious.

Section: 1, Chapter: 1

Author: Michael Lewis

By early 2007, the subprime mortgage market was starting to crack, but few wanted to acknowledge it. The maverick investors who had bet against it - Burry, Eisman, Ledley & Mai - were seen as Chicken Littles. But they knew they were onto something big. The trick was finding ways to profit from their insight. They embarked on a mad scramble to load up on credit default swaps, short positions, and other contrarian bets before it was too late. It was a treasure hunt where the treasure was hidden in plain sight.

Section: 1, Chapter: 7

Author: Michael Lewis

After years of ridicule and doubt, Mike Burry shut down his hedge fund in disgust in 2008:

• Subprime shorts had made investors over 400% returns
• But many investors were furious and wanted to pull money
• Burry grew embittered by the industry's recklessness and greed
• Closed fund and retreated from public life, a disillusioned man

Even though he had been proven right, Burry had lost faith in the system. He realized no one wanted to face harsh truths - they just wanted to keep the casino running.

Section: 1, Chapter: 10

Author: Michael Lewis

As the subprime bubble inflated, even the big Wall Street banks couldn't resist the allure of easy profits. They morphed from intermediaries to active speculators, writing huge checks to buy up subprime loans and CDOs. Banks like Merrill Lynch and Citigroup loaded up on the very securities they were peddling to investors, assuming the music would never stop. They had built a doomsday machine, but couldn't bring themselves to turn it off - the short-term rewards were simply too enticing.

Section: 1, Chapter: 5

Author: Michael Lewis

In 2008, the subprime mortgage bubble finally burst, unleashing a chain reaction that brought the global financial system to its knees. The dominoes fell in rapid succession - Bear Stearns, Lehman Brothers, Merrill Lynch, AIG. The carnage exposed the rot at the heart of Wall Street - the excessive leverage, the reckless risk-taking, the corrupt incentives. For the subprime shorts, it was a bittersweet victory. They had been right, but watching the world burn was hardly cause for celebration.

Section: 1, Chapter: 9

Author: Michael Lewis

According to the efficient market hypothesis, stock prices should reflect the discounted value of a firm's future cash flows. This implies prices should only change when new information about cash flows arrives.

But Robert Shiller (1981) found that stock prices are much more volatile than the dividend streams they supposedly reflect. A firm's stock price can double or halve even when its underlying dividends and earnings are stable.

This "excess volatility" puzzle challenges market efficiency. If prices only reflect fundamentals, why do they swing so wildly in the absence of concrete news?

Shiller argued this reflects "fads, fashions, and bubbles" among investors. Prices are driven by sentiment and speculation as much as real information. This explains why prices move more than fundamentals.

Section: 5, Chapter: 24

Author: Richard Thaler

It's easy to envy the returns of great investors. But most people overlook the hardships they endured. For example:

• Warren Buffett has seen his company stock decline 50%+ three times in his career
• Charlie Munger got divorced in the 1950s and calls that decade his "worst decade"
• Many fund managers have lost most of their assets after several bad years

Earning great returns seems exciting and glamorous. But in reality, it comes with immense volatility, drawdowns, and personal hardships. Appreciating the real cost of returns and treating that cost as a fee rather than a fine is crucial.

Section: 1, Chapter: 15

Author: Morgan Housel

he 2008 financial crisis represented a colossal failure of prediction by many of the institutions and individuals entrusted to forecast economic risk. Ratings agencies like Moody's and Standard & Poor's gave their highest AAA rating to mortgage-backed securities that were in reality extremely vulnerable to defaults. When the housing bubble burst, these securities failed at rates as high as 28%, compared to the 0.12% failure rate S&P had predicted for AAA-rated CDOs.

This predictive failure was widespread - from the ratings agencies to the banks issuing the securities to the regulators and economists who failed to sound adequate warnings. Incentive structures were poorly aligned, with entities like S&P being paid by the issuers of the securities they were rating. There was also a collective failure of imagination - an inability to consider that housing prices could decline significantly on a national basis. As a result, risks were severely underestimated, leading to the near-collapse of the global financial system when the housing bubble finally burst.

Section: 1, Chapter: 1

Author: Nate Silver

In early 2007, Cornwall Capital noticed an odd disconnect in the subprime market:

• Housing prices were flatlining, subprime defaults rising
• Yet subprime-backed bonds continued to rally
• Cornwall knew underlying loans were souring but market was slow to react
• They realized this was the lull before the storm and bet bigger

The delayed market response gave them a chance to load up on cheap "disaster insurance" before it was too late. Understanding market psychology let them exploit the gap between perception and reality.

Section: 1, Chapter: 5

Author: Michael Lewis

Looking back over the last few centuries, all major currencies have either been devalued significantly or died altogether. Currencies are devalued when governments print excessive amounts of money, usually to finance budget deficits or service high debt levels. This reduces the purchasing power of money over time. Many currencies have been completely replaced, often after losing a war or during a political revolution. The only major currencies that have survived since 1850 are the U.S. dollar, British pound and Swiss franc - and even they have lost over 90% of their purchasing power due to devaluations.

Section: 1, Chapter: 4

Author: Ray Dalio

Michael Burry was a misfit in the investing world. A medical doctor with little formal finance training, he had a penchant for exhaustive research and a willingness to go against the grain. Burry's unique perspective as an industry outsider allowed him to spot the flaws in subprime mortgage bonds that Wall Street insiders were blind to. His story showcases the value of unconventional backgrounds and contrarian thinking in investing.

Section: 1, Chapter: 2

Author: Michael Lewis

If markets are efficient, stock prices should respond quickly and accurately to new information. But empirical studies find pervasive evidence of both underreaction and overreaction.

Examples of underreaction:

• Post-earnings announcement drift: stocks with surprisingly good (bad) earnings outperform (underperform) for months after the announcement
• Momentum: stocks with strong (weak) returns over the past 3-12 months tend to continue outperforming (underperforming) in the next 3-12 months

Examples of overreaction:

• Long-term reversals: stocks with strong (weak) returns over the past 3-5 years tend to underperform (outperform) over the next 3-5 years
• Value/growth: "value" stocks with low price/earnings ratios outperform "growth" stocks with high P/E ratios, contrary to efficient markets logic

Section: 5, Chapter: 22

Author: Richard Thaler

Treasury bonds are the safest investment for your FI capital, offering:

• Guaranteed return of principal and interest by U.S. government
• Stable, predictable income you can calculate in advance
• Highest level of liquidity - easy to cash in if needed
• No commissions or fees if bought directly from Treasury
• Wide range of maturity dates to create an income "ladder"

The authors advise putting your core FI money in Treasuries before any other investment. You can count on them to deliver a steady income with no surprises.

Section: 1, Chapter: 9

Author: Joe Dominguez, Vicki Robin

Section: 1, Chapter: 8

Author: Michael Lewis

Cornwall Capital, a tiny hedge fund started by Charlie Ledley and Jamie Mai, was an unlikely player in the subprime trade. Operating out of a Berkeley garage with $100k in starting capital, they were the definition of a shoestring operation. But their outsider status and willingness to look where others weren't allowed them to spot the opportunity in subprime mortgage bonds. Cornwall's story shows you don't need an elite pedigree or billions in capital to make it on Wall Street - just original thinking and relentless drive.

Section: 1, Chapter: 3

Author: Michael Lewis

In the early 2000s, Steve Eisman, an equity analyst covering consumer finance companies, started noticing troubling trends in the subprime mortgage industry. Lenders like Household Finance were making increasingly risky loans to lower-income borrowers. With the help of his analyst Vinny Daniel, Eisman dug into the details and realized the entire industry was a house of cards built on unsustainable lending practices. They started shorting the stocks of subprime lenders.

Section: 1, Chapter: 1

Author: Michael Lewis