Financial Crisis of 2007-2008 in ‘The Big Short’ Movie

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Table of Contents

Introduction
Characters’ Actions
Plausibility of the Depicted Events
Conclusion
Works Cited

Introduction

The Big Short is a movie that uncovers one of the causes of the financial crisis of 2007-2008. The film reveals that banks, thirsty for higher profits, began to offer mortgage loans to those who were unlikely to pay off the debt. However, The Big Short does not simply narrate the story. It discloses the unethical behavior of bankers, who could have investigated the state of the housing market and taken action to prevent the catastrophe, but instead, they chose to line their pockets. The plot revolves around several investors who discovered the housing bubble and recognized the opportunity to profit from it. Further, this review will discuss what the characters were doing financially and how this story was possible in real life.

Characters’ Actions

At the beginning of the movie, the voice-over introduces the concept of a mortgage-backed security, which is an investment secured by a bundle of home loans. These securities were profitable and almost not risky because “who the hell doesn’t pay their mortgage?” (The Big Short).

However, it turned out that there were plenty of people not able to pay their mortgage, and Michael Burry was the first to realize it. After looking through the mortgages in the top 20 selling mortgage bonds, he discovered that many borrowers did not make their payments on time. Michael predicted that it would devaluate mortgage bonds and, therefore, decided to short the housing market, that is, to bet on the market crash. The fact that there were “no insurance contracts or options for mortgage bonds” did not stop him (The Big Short). He just went to several banks and spent $1.3 billion on swaps on mortgage bonds that were created on his request.

Meanwhile, Jared Vennett from Deutsche Bank realized the opportunity discovered by Burry and managed to sell swaps on mortgage bonds to Mark Baum, the manager of the FrontPoint hedge fund. Vennett explained that, since there were many borrowers not able to pay off their debts, the default rates would soon rise, and when they reached 8%, the market would crash. He also explained the concept of a collateralized debt obligation (CDO), which is a repackaged bundle of B, BB, and BBB-rated mortgage bonds that received an AAA rating, so that investors did not consider it risky.

Jamie and Charlie are two more characters who decided to make profits on the oncoming housing market crash. Previously, they were making money buying cheap insurance that sometimes brought them large payoffs. The young investors asked their friend, a former trader Ben Rickert, to help them get their membership in the ISDA, which would allow them to make big deals. After they got their ISDA, they bought swaps on mortgage bonds.

In 2007, default rates began to increase, but rating agencies continued to give an AAA rating to CDOs and mortgage bonds, so their value did not go down. This discrepancy confused all the mentioned investors, and Mark Baum decided to find out what was wrong with rating agencies. It turned out that agencies rated bad CDOs and bonds high because, otherwise, banks would go to their rivals and get the required rating there.

Mark Baum and his colleagues, as well as Jamie and Charlie, went to the American Securitization Forum in Las Vegas. There, they found out about subprime losses and the SEC’s unconcern for investigating mortgage bonds. It became clear that the market crash was still ahead, so Jamie and Charlie bought more swaps on the AA tranche. At the same time, Michael Burry, Mark Baum, and Ben Rickert realized that the decline of the US housing market would ruin the economy. Finally, large banks, including Bear Stearns, collapsed, and the investors sold their swaps at much higher prices, thus making large profits.

Plausibility of the Depicted Events

The events depicted in the movie are not just Hollywood fiction because the story is based on a real-life story. In the film, Vennett stated that “mortgage-backed securities are filled with extremely risky subprime adjustable-rate loans” that were going to fail one day (The Big Short). Indeed, before the subprime mortgage crisis, four-fifths of subprime mortgages in the US were adjustable-rate loans with changing interest rates (Thomas 19). In 2006, the housing market started to decline, which made interest rates increase (Thomas 19). It is clear that, since a great number of borrowers were not creditworthy, the increased interest rates made them default on their loans. Since borrowers made no payments, investors who had bought mortgage bonds and CDOs suffered great losses.

As for Michael Burry and other investors who profited from the housing market crash, I think that there could be more people like them who could have predicted the catastrophe. They managed to do it because they took the time to investigate the mortgages that underlay the bonds. Mark Baum and the two young investors even talked to some citizens and found out that bankers approved even the loan, for which “landlord filled out his mortgage application using his dog’s name” (The Big Short). In my opinion, the movie shows the audience how dangerous overconfidence can be and how useful it is to take efforts to investigate the matter at stake.

Conclusion

To sum up, The Big Short aims at explaining to laypeople the reason for the financial crisis of 2007-2008 concerned with subprime mortgages. In the pursuit of quick profits, bankers endangered the entire economic system and did not critically assess the possibility of the future collapse predicted by Michael Burry. This movie warns bankers, regulators, and other powerful officials that neglecting threats and chasing short-term profits may lead to a disaster.

Works Cited

The Big Short. Directed by Adam McKay, performances by Christian Bale, Steve Carell, Ryan Gosling, Brad Pitt, Melissa Leo, Hamish Linklater, John Magaro, Rafe Spall, Jeremy Strong, Finn Wittrock, and Marisa Tomei, Paramount Pictures, 2015.

Thomas, Jason Earl. “Lessons Learned for Management, Marketing, Sales and Finance Incentives a Decade after the Subprime Mortgage Crisis.” International Journal of Business Management, vol. 12, no. 3, 2017, pp. 19-26.

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Financial Crisis of 2007-2008 in ‘The Big Short’ Movie

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