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In review: The Big Short

The New York Times Best Seller “The Big Short: Inside the Doomsday Machine” by Michael Lewis hit theaters last month with much anticipation and populist acclaim from Hollywood.  GFC would like to provide a subjective review of the film for our readers who, have most likely either read the book or, are at least intimately familiar with the storyline of the financial crisis of 2008.

Let us start by saying this is easily the best financial film since Margin Call starring Kevin Spacey debuted in 2011. (For those of you wondering where Wolf of Wall Street ranks in our hierarchy of financial flicks, just know we regard that movie as a sad and debauched production with very little substantive content to qualify itself as a legitimate Wall Street Classic)  With that being said, The Big Short is a very captivating story which  provides great insight to the real stories of the people who not only saw the crisis coming, but had the wisdom and the fortitude to bet against the U.S. housing market and profit handsomely by doing so.

The story primarily revolves around 3 people, Greg Lippmann, a CDO trader at Deutsche Bank who was intimately familiar with the toxic mortgage backed securities his desk was packaging and selling, Steve Eisman, a outspoken hedge fund manager, around Dr. Michael Burry, a former neurology specialist turned Portfolio Manager at Scion Investments Inc.  The story tracks how these people were among the first to recognized serious trouble on the horizon and details their creative and heroic trading exploits as they were able to capitalize on the greatest financial crisis since the Great Depression.

For the average American, who is still grappling with understanding how the housing crisis nearly bankrupted the entire U.S. financial system, The Big Short should be required viewing in order to gain a basic understanding.  The movie does a great job explaining the origin and evolution of complex financial instruments such as Mortgage Backed Securities (MBS) Collateralized Debt Obligations (CDO) and Credit Default Swaps (CDS).  The movie dumbs these concepts down as much as possible and even provided cameo roles to random celebrities who explained these synthetic financial instruments with creative abstractions in order to hold the attention of the financially illiterate.

Despite showcasing an all-star Hollywood cast consisting of Brad Pitt, Ryan Gosling Christian Bale, and Steve Carrell, the true populist attraction of this film emanates from America’s feelings of antipathy towards Wall Street bankers in the wake of the financial crisis.  It’s easy to envision many young females buying tickets to this movie because of the Hollywood heartthrob cast, and then watching the screen as the entire plot flies over their head.  Only an intellectual audience is fully capable of appreciating this movie.

As a financial professional, one of the key takeaways for me was recognizing how complex the trades these guys were putting on actually were.  It’s important to know that up until 2005, the market for mortgage backed securities was a one way market.  Long only.  Dr. Michael Burry had learned about the fledging credit default swap market and literally had to petition the big banks to allow him to buy credit default swaps on specific mortgage bonds he knew were likely to default.  They reluctantly agreed to create a new CDS market for him and at first were happy to sell him default insurance and initially charged him basis point premiums which were essentially the cost equivalent of insuring AAA rated bonds.   He was one smart cookie to not only recognize that the MBS market was going to fail spectacularly, but he got into the trade so early, that the banks were willing to make an entirely new CDS market for shorting subprime mortgage bonds, which they only agreed to because in their minds he was buying insurance for the end of the world.

Another aspect of the storyline that could have been emphasized a bit more, was that after throughout 2006 and 2007 as adjustable rate mortgages were being reset higher and mortgage delinquencies began to rise dramatically, the banks were not properly adjusting the value of the speculative positions in their CDS markets.  Consequently, people like Michael Burry and Steve Eisman were being forced to pay additional insurance premiums on their CDS positions because the banks were not marking the value of their MBS bonds to market. The large Wall Street banks had assigned artificially high values that their optimistic MBS pricing models were projecting irregardless of the actual economic performance of those bonds.  The movie could have done a better job highlighting the key importance as well as the key legal battles that were waged over the importance of mark-to-market accounting during and after the crisis.  Nevertheless, the movie revealed how the tension stemming from bank reluctancy to mark down the value of their CDO & MBS securities directly led to undue financial stress for the people who got it right and correctly bet against such instruments.  One can only imagine the agony of being 110% correct and having to fork over another monthly CDS insurance premium in the tens of millions of dollars each month, knowing #1) that the banks are defrauding you, #2) that you have to pacify investors who are going to wonder why your fund experienced another monthly drawdown, #3) that you have been 110% correct on the crisis and are losing money. Personal Note: During the Crisis, I was short many different banks stocks until the SEC banned the shorting of financial equities on Sept 19th 2008. On that day there was a massive artificially induced short covering rally with the  Dow Futures up over 600pts before the markets opened and I was subsequently forced to cover my positions at steep loss despite being 100% right about the solvency of the U.S. banking system.  My account was relatively small at the time as I was fresh out of college and only 22, however, the disgust and loathing the hedgefund managers in the film must have felt toward the big banks when they literally billions of dollars in the game can only be imagined.  

The final takeaway from this film that needs to be addressed fully is Hollywood’s exploitative demonization of Wall Street as well as the subtle narrative of class warfare this movie promotes.  Michael Lewis’s book was a great expose into how a small group of men who thought outside the box were able to identify and profit from a speculative mania. The main intention of the book was not to be a damning indictment of  banker corruption that contributed to the crisis, and even if it were, corruption within the banking system itself would be wholly inadequate.   Unfortunately for America, Wall Street, and audiences everywhere, the main takeaway from the The Big Short is a theme of banker corruption.

 

SPOILER ALERT:  The last scene of the movie offers a satirical ending with bankers being walked away in handcuffs as the narrator says:  “In the years that followed, 100’s of bankers and rating’s agency executives went to jail. The SEC was completely overhauled.  And Congress had no choice but to break up the big banks and regulate the mortgage and derivatives industries.  Just Kidding.”  For anyone who wasn’t asleep under a rock during and after the financial crisis, you know that’s not how the story ended at all, and therefore these satirical statements are more than a stupid joke, they are subtle exploitation of ignorance directed toward the type of people who know how their fantasy football team performed but couldn’t tell you what a bond is.  The satirical ending is meant to influence ignorant people into believing that banks going to jail is what should have happened and there is a deep wrong that injustice has been served Basically, the end of movie could instantly be transmuted into a Bernie Sanders class-warfare campaign video.   Deeper contemplation is needed to truly understand how the crisis happened.  The Big Short ultimately comes up drastically short of offering a comprehensive explanation of how and why the financial crisis occurred.

Prudent observers should ask themselves: “Why weren’t Wall Street bankers greedy and corrupt before the mid 2000s?  Why did the financial crisis happen when it did?   Mortgage Backed Securities have been around since the 1970s, why did it all blow up in 2008?”   To answer those questions one has to understand that the actions of bankers is largely dictated by monetary and regulatory incentives emanating from the Federal Reserve Bank, the U.S. Treasury, and Congress.  President Bill Clinton signing legislation which repealed the 1933 Glass-Steagal banking regulations was left out of the film entirely.  Additionally, a historical recap of the Federal Reserve’s interest rate policy decisions made by Alan Greenspan which lowered interest rates to 1% and incentivized loose lending practices by bankers after the dot-com bubble was conveniently omitted.  Also completely omitted were the roles played by Federal agencies such as Fannie Mae, Freddie Mac, and the Department of Housing and Urban Development (HUD) in which not only originated vast quantities of shitty mortgages but guaranteed them with a subtle tax-payer guarantee which eventually occurred to the tune of more than a trillion tax-payer dollars.

Was there fraud committed by bankers on Wall Street leading up to the financial crisis?  Undoubtedly there was, but it pales in comparison when compared to asinine legislative policy decisions propagated by the Federal government itself.  Ultimately the elected representatives of the American people voted to bail out the bankers with Secretary of the Treasury Hank Paulson and the Chairman of the Federal Reserve System Ben Bernanke imploring congress to bailout the financial system.  The satirical ending of this film insultingly assumes the American populous is just as dumb and ignorant after the crisis as there were before.    With all that being said, it worth remembering that Hollywood’s true motive is to sell movie tickets and entertain, not truly educate people.

Overall Rating: 5.5/10