The Big Short first premiered in the U.K. in 2016, to great critical acclaim. The film won an Academy Award for Best Writing Adapted Screenplay, along with various other major honours. However, unless you’re an expert in the operations of a hedge fund (which you should be after reading our article on them here), you’d be forgiven for finding the film rather complicated. Therefore, sit back and enjoy our book review on The Big Short, and hopefully, once you’ve read it, you’ll be able to re-watch the film with greater clarity.
The movie boasts some of Hollywood’s biggest names; Steve Carrell, Brad Pitt, and Ryan Gosling. Based on a book with the same name, the Big Short documents the build-up to, and the effect of the 2008 global financial crisis. The movie centres around three different hedge funds of vastly different sizes, all of which manage to foresee and exploit the huge global crash in the American housing market.
A History Lesson…
The financial crash is also referred to as the sub-prime mortgage crisis. Why? Well, in the late 1970s, Lewis Ranieri created the concept of mortgage backed securities (MBS). These are bundles of mortgages packaged up and sold by the bank that issued them. In return, the investors who buy into trusts made up of these MBS’ receive the cash that these mortgage owners pay.
If the above seemed slightly confusing, here’s another way of looking at it:
Investors are lending money to homeowners, and homeowners are then returning the money with interest, with the bank acting as the middleman.
Mortgages are valued based on their holder’s ability to pay, and are consequently categorised by risk. Investors can decide their risk level by choosing between more secure trusts with AAA ratings (with lower returns), or riskier ratings of BBB (to chase higher returns). In the United States, however, banks were selling so many MBS’ that they began running out of secure mortgages to use. With increasing demand, greed kicked in, and the banks began offering riskier mortgages, with much greater chance of default. This led to collateralised debt obligations (CDOs). CDOs are similar to MBS’, only they are more diverse. Instead of just mortgages, banks were now selling auto loans, credit card and corporate debt.
Why did banks create and sell mortgage backed securities and CDOs?
Simply put, they allowed the banks to receive money upfront from investors instead of waiting for people to pay off their long mortgages. This created more liquidity (cash) for the bank, as well as moving the default risk to investors.
When the interest rates in the U.S. began to rise, huge defaults on mortgages and other loans left investors distraught and banks with failing CDOs and MBS’ that they hadn’t sold yet. The result? Devastating losses.
So, what did the film’s main stars do in order to beat the market and profit from the financial crisis?
They all used credit default swaps in order to bet against these CDOs. In return for a small fee, CDOs allowed hedge fund managers to pay banks to protect against losses, in the seemingly unlikely event that these CDOs should fail due to defaults. In the film, Dr Burry, Mark Baum and Cornwall Capital bought these credit default swaps without owning the CDOs, and banks were more than happy to offer them these as they deemed CDOs to be solid.
Think of it like taking out insurance on a yacht that’s not yours. The thing is, Dr Burry, Mark Baum and Cornwall Capital all knew what others didn’t - that the loans that made up these CDOs and MBS’ were worthless. They knew what the boat was made of, and knew that it was going to sink pretty fast.
Whilst the film may lack some of the glamour, danger and comedy of The Wolf of Wall Street, it is still fast paced and full of drama. It’s a great film to watch regardless of your interests and I would recommend it to anyone. Hopefully this review, coupled with some star-studded explanatory scenes within the film itself, will allow you to enjoy and understand the film even more. Also, as a fan of The Office (U.S. version) television series, it’s nice to see Steve Carrell (notable for playing Michael Scott) making a much bigger difference in the world of business.