The Big Short

This is a great movie. Based on true events and well portrayed. It details the housing/ financial crises of 2008 and the insane gamble a few players on Wall Street took shorting the financial markets.

This is long (covers 2004-2009), but explains the movie and events related to the move.There were some things in the movie that were not accurate (maybe for dramatic effect), but overall events are fairly accurate regarding Credit Default Swaps ("CDS").A CDS is like taking out an insurance policy that says, if someone owes you money, and they can't pay; the insurance company pays you. What if the insurance company can't pay you either? Welcome to the movie!Comparing this movie with related historical events: Many 2007-2009ish mortgage defaults occurred because:(1) FED Gov created the Community Reinvestment Act of 1977 (Carter); expanded in 1999 (Clinton), and further encouraged under GW Bush & Obama Admins. All Admins under CRA forced banks to provide loans to people who basically could not afford them.(2) Permitted "stated income" (no proof of income or proof of job for home loans).(3) The Federal Reserve Bank moved interest rates from 1% to 5.25% from 2004 to 2006 to "fight inflation." (Sound familiar 2022-2023?)Those cheap adjustable-rate mortgages got super expensive when interest rates reset. A 3% adjustable mortgage could have gone 3% + prime (5.25%) plus say 3+ points = 11.25% mortgage rate.If one was paying say $3000 year in interest on every $100,000 (mortgage loan) they would now be paying $11,250/ year in just interest (per $100,000 borrowed).If one could barely afford the $3000/ year, think they could afford paying more than 3x that?Higher interest rates also affected everything with adjustable rates (car loans, credit cards, personal, and business loans, etc.).In the movie and true to life, investment banks sought to manage mortgage risk by putting high quality (A+ mortgages with low quality (sub-prime mortgages) in an investment package.With 1,000's -10,000+ mortgages in these packages, some could default, but overall ppl would still pay their mortgage was the thinking.The mistaken belief was that most people thought interest rates would never go up significantly (increased 425% in 2 years per FED Reserve), and home prices could never go down. Both events happened.A few people effectively took the investment risk (as in the movie) and bet that the insurance companies and banks would default on paying interest on these Credit Default Swaps.Nearly 1 out of 4 mortgages were subprime in 2006 - about $600 Billion in 2006 dollars; and began massively defaulting from spring 2007 to 2009ish then collapsed. This bled into higher quality mortgages. These events led to the largest bank failures since the Great Depression (1929-39).As rates went up, home prices tanked, and borrowers were paying more for their homes than they were worth. Then the US / global economy tanked (related to mortgages, home, and credit issues). Then massive job layoffs occurred as companies could not afford to borrow, and consumers were cutting their spending massively, which led to a massive recession.Like in the movie, the banks/ insurance companies that sold the CDS's (insurance guarantees) defaulted. Banks, insurance, and mortgage companies we failing faster than dropping a rock off a building (don't advise). By Oct 2009, some $9.8 Trillion of wealth was lost just in the USA.These few people (in the movie and real life) who bet on the defaults of the mortgage/ credit markets made out like bandits. They took on huge risks and lost money for 1-2 years before they made a huge profit. Completely legal (like short selling). They didn't cause the crisis, just recognized the risks, and made money as the underlines mortgages (CDS's) tanked in value.Guess what is happening in 2022-2023? Movie part 2 in a few years?We had a booming stock-market (Pre-2022) and a booming real estate market (early 2023).Aggressive FED interest rate hikes to "fight inflation" which was caused by cutting U.S. domestic energy policies. Where are things going in 2022-2023? I think a lot like the movie, but it will be a little different. What the FED and Gov does will impact markets.Overall, best movie that captures this economic time period. It also proves that people who think they are so smart were found to be completely wrong.

Wonderful film about a very difficult problem.

The Big Short is one of 3 movies that came out after the 2008 great recession looking for answers as to what happened in the economy. The other two movies are Too Big to Fail and Margin Call. The Big Short movie takes you through the history of three different investor groups that saw the absurdities and abuses related to MBS products (Mortgage Backed Securities) and derivates. These groups strategically invested to gain from the expected collapse of the economy. It is not to say that they were not frustrated and heart broken that the system was broken and corrupt, but any attempts to ring the proverbial alarm bells were ignored. The movie does a great job in stopping the storyline and explaining key concepts in layman terms. A must see if you really want to know what happened in 2008.

The Big ShortI watched The Big Short. Honestly, I should have seen it coming. I was on the CDO desk and watched a purportedly $2b fund lose approximately $90m a month. It is interesting that they brought up Salomon Brothers. One of their employees was the person that created investment banking as it is today. He and his crew (company name Long Term Capital) made a huge investment in the Russian Ruble before the Russians devalued the Ruble. I believe it was actually Bear Stearns and Lehman Brothers who bought them out. Guess what? Long Term Capital Management was right about the investments, they were just too cash thin to handle the margin calls. I’ve dealt with under-capitalized companies my entire career. Thin capitalization is always a concern, especially with debt pushdowns (meaning third party loans that are extended in an acquisition for the purpose on obtaining tax deductions). Tax law indicates that only a certain amount of deductions will be available to the buyer. From an IRS perspective, it would be ill advised to allow corporations to take deductions above a certain level, and indeed they do under IRC 163(j) and the ultra-affiliate rules.Main character: “I’ve been looking at these mortgage backed bonds and if more than 50% fail, they all go under.” Residential mortgage backed securities (“RMBS”) have tranches, as well. RMBSs have tranches like CDOs. They are correct that RMBSs were junk bonds described as AAA investments. I don’t agree with the characterization of the problem being banks and greed. Surely there was some of that, but this is a multifaceted problem. It’s very easy to point to banks, but, in my opinion the government has much more to explain. I think the movie loosely gives an undertone to this point.With regard to the blocks, he is correct. You take BBB rated investments and assume they fail. It collapses the whole investment. Under CDO agreements, tranche A gets everything, including principal payments. So, when BBB rated investments go under, so too does the fund. AAA rated funds are based on the foundational principal that the underlying assets are accurately measured by credit rating agencies (“CRA”), but they were not. Also, the government required the use of CRAs for investments and other purposes. How is it that Arthur Andersen was destroyed, even after posthumously being cleared of any nefarious involvement in Enron? The government destroyed an accounting firm. So, when I take a cynical view of bureaucrats (people who don’t understand the issues they are dealing with), it leaves me jaded and annoyed. Just because you have some measure of power does not mean you understand the economy or the investments you presume to be regulating.As I alluded to there was a lack of due diligence among RMBS and CDO managers. As long as the market held up, they’d be ok. The housing market, however, did not hold up. So, they ended up with a pool of worthless RMBSs and the funds failed. That is what they were trying to convey in a cinematic way.They also speak about credit default swaps. I’ve explained the logistics of basic swaps in a prior email. Credit default swaps are to protect against… defaults. This is what brought AIG to its knees.CDOs are spoken about continuously, which is one of my specialties. I think they provide a good explanation of how they work; through diversification, a fund could achieve a AAA rating. Like the blocks, however, when the blocks start sliding, everything crumbles. What you must remember with CDOs is that they are based on the premise of full repayment of mortgages. When that doesn’t happen, we have 2008.Standars & Poors, could not answer simple questions in the movie, and that is the exact experience I had with them. As I’ve explained before, credit rating agencies were working for companies and were exercising professional bias. I understand why people do it, but it makes no sense to me; Happiness should not be derived from material goods, it should come from family and friends.When the two brothers are talking about AAA rated tranches actually being more like BBB rated tranches, they were correct. To be more accurate, I’d say those tranches were CCC. I have a Powerpoint file and excel spreadsheets to show this. So, shorting those investments means you sell the investment with borrowed funds (or as they say, on margin). The idea is that you’ve locked in your potential gain and are betting that the value of the investment decreases. So, when you repay with the securities, you have a real gain. Now, there are tax implications regarding timing and the treatment of such gains, but I won’t bore you with the details. You have to understand that shorting a tranche that presumably is AAA rated, would seem nuts prior to 2008. It was a brilliant maneuver.In his meeting with the Asian CDO manager, they are describing a concept that I have written about in my piece on the 2008 crash. CDOs invested in other CDOs. They also created CDOs that invested in credit default swaps, which are synthetic CDOs. I didn’t like how they explained synthetic CDOs in the movie. I think a short cameo from one of the actors would have sufficed.There is also an underlying theme that I alluded to before, the ignorance and consistent belief that residential real estate prices always go up. Franklin Raines in 2005 during Congressional hearings sought for cover under that exact argument. He was the CEO of Fannie May. Of course the Congressional black caucus, including Maxine Waters and people like Barney Frank called it a lynching. Barney Frank in conjunction with Dodd created one of the most onerous and destructive bills, the Dodd/Frank act. Barney said that housing goals were paramount and that everyone in society should own a house. I think it was in 2009 that he then said that not every person should own a house. Hypocrisy be thy name.In the movie, they reference the Bear Stearns buy-out. Bear Stearns had to be bought out by JP Morgan. Lehman Brothers was not so lucky. I postulated in a paper on banking regulations in law school that Lehman was a litmus test for bail outs. The government and other banks let Lehman fail. I’ve done cleanup work on a Lehman subsidiary that included three partners, a manager, a senior associate, and two associates. We wrote a series of five should level opinions. In tax, a should level opinion can protects a client from interest and penalties. So, we don’t take those opinions lightly. A should level opinion means there is over a 75-85% chance that we’re right. The taxpayer can depend on these opinions from a legal and administrative perspective.Finally, I assume the Cuban place the brothers are referring to is Sophia’s. It has great food; it’s on Fulton Street in the financial district. There’s also one in Midtown and the upper east side.This piece is not exactly coherent, but it conveys my thoughts on the movie.

This movie explained so much! Just wow.

The Big Short is an insightful and entertaining film that successfully demystifies the 2008 financial crisis while keeping audiences engaged. While its stylized approach may not appeal to everyone, and it doesn’t fully explore every facet of the crisis, it remains one of the most compelling financial dramas in modern cinema. I've have watched it close to a dozen times and I just decided to purchase it so I can continue to remind myself of how the system is broken and flawed on a core level.

Great movie