The Big Short: The Financial Collapse as Traumedy

By Bill Barclay

The behavior of our money people is still treated as a subject for specialists. This is a huge cultural mistake. High finance touches – ruins – the lives of ordinary people in a way that, say, baseball does not, unless you are a Cubs fan. And yet, ordinary people, even those who have been most violated, are never left with a clear sense of how they’ve been touched or by whom. Wall Street, like a clever pervert, is often suspected but seldom understood and never convicted. It is my hope that Adam McKay’s The Big Short might actually help change this situation.

Michael Lewis, Vanity Fair, 12/31/2015

 And he may just be right.

Michael Lewis is at again. Lewis, who spent a few years at (the now defunct) Salomon Brothers in the late 1980s, and resigned to write Liars’ Poker about the financial excess of that decade, has never lost either his fascination or his disgust with finance and Wall Street. In 2010 he wrote The Big Short: Inside the Doomsday Machine, a book that described how the financial sector created, and in turn was almost destroyed by, the U.S. housing market bubble and collapse.

The book tried – and actually did a pretty good job – to explain such esoterica as securitization, collateralized debt obligations, synthetic CDOs, etc. But it didn’t seem like a good candidate for a movie. Any cinematic possibility seemed even less likely as time passed and the clarity of our actual experience faded in our collective memory. Blurring and fading our memories, was, of course, aided and abetted by financial elites and right-wing think tanks that have worked diligently to recast our memory of the 2007-08 financial crisis into one of a spendthrift public sector and misguided governmental policies designed to help low-income families buy houses by compelling mortgage lenders to make loans that would never be repaid.

The Big Short, the movie version, brings everything back into focus and strips away the lies and the obfuscation. In this film, one of the two best that I’ve seen about the events that threatened the world financial system (the other being Inside Job), we meet again the actors and actions of the institutions at the core of the U.S. financial sector. And we see clearly the perversity of the IGB/YBG[2] culture that ruled the lending, the packaging, the rating and the selling of that most boring of bank lending products, the home mortgage.

But, unlike other accounts, we see this mostly from the perspective of a few people who decided that the whole structure was rotten and who figured out a way to take a short position, betting the whole mortgage market would collapse. The film actually uses a tower of building blocks to represent the securitized mortgages, with the foundation being the ones rated BB or worse, propping up the AA and AAA portions (“tranches” in finance speak). The film may overplay a bit the scene where the smart guys meet with an employee of S&P, an agency that insures against risk, whose opaque glasses protect her eyes against light. But you do get the point. Most of the people we meet are not particularly nice, partly because of their cynicism but also for a larger reason: if they’re right, a very large number of people are going to be hurt. Their success is predicated on the destruction of the dreams of millions of families.

Mortgage lending was boring. It was the epitome of the old 3-6-3 description of banking: borrow at 3%, lend at 6%, on the golf course at 3:00. In the new world depicted brilliantly in the film, mortgage lending is all about short-term profit making, lending to anybody who walked in the door (we meet a stripper who “owns” 5 houses) and selling to your and my pension fund the resulting packages of loans, suitably blessed by the holy water of a AAA rating by S&P, Moody’s or Fitch. And to a surprising number of bank traders who should have known better.

The film takes us into the “sand states” (Florida, California, Arizona and Nevada) that were at the heart of the housing price bubble as one of the protagonists discovers empty housing developments as well as the suites of firms such as Morgan Stanley and the Las Vegas convention of mortgage brokers. In the latter locale one of our unlikely heroes tries to tell an unreceptive audience that doom is nigh.

But he was too early. Part of the drama of the film is that those taking on a short position were early in the game. And, as one established fund manager says in anger, “Being early and being wrong are the same thing.” The short positions seem stuck, mortgage defaults are escalating and foreclosures are rising but the shorts are still losing money.

How is that possible? 

In an opaque market where prices are set by a small number of very large entities, those setting the prices were also those holding long positions. In Lewis’ account, the short positions began to gain in value only after firms such as Goldman Sachs and Morgan Stanley were able to unload more of the toxic junk and acquire their own short positions.

And then Bear Stearns collapses and the money starts flowing into the short accounts.

See the film. You’ll come away with a renewed commitment to reducing the power and role of finance in the U.S. political economy. Perhaps by your choice of who to vote for president??