The book: ‘The Big Short’ by Michael Lewis, financial journalist and nonfiction author…
The movie: ‘The Big Short’ directed by Adam McKay, ‘Funny or Die’ website co-founder.
The book: One of the ‘shorts’ was Mike Burry @ Scion Capital.
The movie: Christian Bale plays Dr. Michael Burry, an eccentric ex-physician turned one-eyed Scion Capital hedge fund manager, who has traded traditional office attire for shorts, bare feet and a Supercuts haircut. He believes that the US housing market is built on a bubble that will burst within the next few years. Autonomy within the company allows Burry to do as he pleases, so Burry proceeds to bet large against the housing market by first asking Goldman Sachs, and then other banks, to create a derivative known as a credit default swap, or CDS, which is a custom-made insurance policy, on specific subprime debt, hand-picked by Burry. This newly-written policy, this derivative contract, effectively creates an underlying, mirror-image, ‘synthetic’ duplicate of that chosen subprime debt with as much devastating loss potential as those subprime securities that they are insuring, or guaranteeing to cover in the event of default. These CDS would pay off for Burry if the housing market crashes and the subprime debt his policies are ‘derived’ from, become worthless. The banks are more than happy to accept his proposal for something that has never happened in American history, believe that Burry is a crackpot, and therefore are confident in taking the other side of his bet.
The book: One of the ‘shorts’ was Steve Eisman @ Greenwich, Connecticut-based FrontPoint Partners LLC, under Morgan Stanley.
The movie: An errant telephone call to FrontPoint Partners gets information about subprime CDS that are betting against the housing market into the hands of Steve Carell playing “Mark Baum”, an idealist who is fed up with the corruption in the financial industry. “Mark Baum” and his associates @ FrontPoint Partners, an arm’s length under Morgan Stanley, invite “Jared Vennett” from Deutsche bank to explain and possibly solicit these CDS, despite not totally trusting him. In addition, “Mark Baum” further believes that most of the mortgage securities are overrated by the bond agencies, especially now with this new information from “Jared Vennett” that banks are dangerously blending an alarmingly increasing amount of subprime mortgages together with AAA-rated mortgages into bundled debt securities known as collateralized debt obligations, or CDOs.
The book: One of the ‘shorts’ was Charlie Ledley & Jamie Mai @ Cornwall Capital.
The movie: Charlie “Geller” and Jamie “Shipley”, who are minor players in a $30 million start-up garage company called “Brownfield”, also get wind of “Jared Vennett’s” subprime CDS prospectus on the matter. Wanting in on the action but not having the official clout to play, they decide to call an old friend, retired investment banker Brad Pitt playing “Ben Rickert” – actually based on Ben Hockett, a banker who had previously worked at Deutsche Bank – is also pessimistic about the banking industry, and joins forces with his erstwhile neighbors Charlie and Jamie to help out establishing “Brownfield”. These three groups, these three ‘big shorts’, Scion Capital, FrontPoint Partners, and “Brownfield”, work on the premise that the banks are stupid and don’t know what’s going on, while for them to win, the general economy has to lose, which means the suffering of the general investor who trusts the financial institutions.
The book: One of the ‘shorts’ was John Paulson.
The movie: John Paulson, the most notorious ‘big short’, wasn’t in the movie.
The book: One of the ‘longs’ was American International Group (AIG).
The movie: There was no significant mention of AIG.
The book: One of the ‘longs’ were the proprietary traders @ Bear Stearns & Lehman Brothers.
The movie: There was no significant mention of Bear or Lehman’s duplicity in manipulating subprime debt prices, only scenes that described their demise.
The book: One of the ‘longs’ were the German institutional funds in Dusseldorf that were buyers of subprime securities that didn’t beware.
The movie: There was no significant mention of German fund managers that bought these toxic mortgage assets in the movie, except that they too took heavy losses.
The book: Morgan Stanley was also one of the ‘longs’. Firmly believing that wagers on the housing market were safe bets, Morgan Stanley’s Howie Holden was heavily long AAA-rated tranches of CDOs (the slices that were backed by solid mortgages), along with other proprietary traders at the firm, but at the same time, in…
The movie: “Mark Baum” at Morgan Stanley’s hedge fund FrontPoint Partners buys CDS that bet against all mortgage debt, from low-rated subprime debt to AAA-rated mortgage debt from Deutsche bank’s “Jared Vennett”. Meaning “Mark Baum” is betting against his own firm’s long positions in mortgage debt, so his desk’s gains will not only come from the financial carnage of the American people, but his own fellow employees. A scene in the movie depicts him finding out from his previous assistant, now working for Morgan Stanley’s risk department, the extent of the mortgage CDO losses, 10x more than he imagined, of the other traders at his firm. Coming from a family with a history of suffering from depression, this devastates “Mark Baum” psychologically, and even when eventually proven right, he instead sulks, and out of guilt delays taking profits, nor ever says ‘I told you so’.
The book: One of the ‘longs’ was Greg Lipman @ Deutsche Bank. Deutsche Bank’s proprietary trader Greg Lipmann was at first long subprime tainted CDOs along with other desks at Deutsche to initially get involved in the subprime market. Lipmann then, in….
The movie: …goes rogue, unwinds his personal long positions, and starts soliciting Deutsche Bank mortgage CDS soon after getting wind of what Dr. Michael Burry is doing at Goldman. As a savvy proprietary trader at Deutsche Bank, Ryan Gosling playing “Jared Vennett” believes he too can cash in on Burry’s beliefs, and sells “Mark Baum” mortgage debt CDS, despite being bets against Deutsche’s own long positions in subprime tainted CDOs. Furthermore, unlike the CDS that Goldman sold to Dr. Burry, the CDS that “Jared Vennett” sells to FrontPoint Partners was his trading idea, and because the expected windfall will be so large, he shamelessly explains that Deutsche intends to rake in a huge mark-up for themselves when “Mark Baum” unwinds the position. In the movie, talking directly to the camera while smugly showing off his 8-figure bonus check, the cold-blooded “Jared Vennett” of Deutsche feels no remorse whatsoever that he personally profited off the financial ruin of fellow employees as well as fellow citizens.
The book: While practically everyone was somehow long or short during the housing boom, in a comically-tragic yet impressive display of financial engineering, Goldman Sachs played both sides of the subprime market to perfection. With newly-created, subprime credit default swaps (CDS), not only did Goldman ‘replicate’ the risk exposure of the most toxic of subprime debt by writing contracts insuring it to sell to their clients, the shorts, wanting to bet against it, Goldman then took these CDS contracts that they wrote, that placed Goldman at risk, and fraudulently laundered that risk TO THEIR OWN CLIENTS. By cleverly inserting Goldman’s newly-created subprime CDS inside legitimate, prime AAA-rated collateralized debt obligations (CDOs), so-called ‘Synthetic CDOs’…and immediately turning them around…selling them to their other clients…the longs, wanting to bet on subprime debt…Goldman was profiting from both the buyers and the sellers in the subprime mortgage market…the whole time…without taking any risk! Here’s how that worked: CDS, or financial insurance, is not the same as traditional insurance. You can write and sell a CDS, insure a financial product, to a person who is not the owner of the ‘property’ being insured. On Main Street, you cannot do that, you cannot insure a house against a fire and offer to sell the policy to someone other than the owner of that house, like an unfriendly neighbor, for obvious reasons. By law a home fire insurance policy must have what is known as ‘insurable interest’, but on Wall Street you can write a CDS, insure any bond, any debt instrument, owned by one person, and not only sell that contract to the owner of that bond, but to anyone else, and write as many contracts and sell them to as many people as you want. As a newly-created replication of that original debt, a newly-created ‘synthetic’ risk, these newly-created CDS multiply the loss potential. This is because the buyer, or holder of the original bond that the CDS is derived from (why they call CDS a ‘derivative’), plus all the sellers, or writers of any additional CDS contracts insuring that debt, all of those people lose money, a potentially devastating amount, if just that one, single, underlying bond defaults. Dr. Mike Burry asked Goldman to insure particular subprime debts that he had researched and concluded had the best chances of defaulting, not because he owned that debt, not because he had an ‘insurable interest’ in that debt, not to wisely hedge against that debt, but only because, like a cunning and unfriendly neighbor, he just wanted to bet against that debt. Worse than the guy that yells “Fire” in a crowded movie theater that isn’t on fire, this is like a guy that doesn’t yell “Fire” in a crowded movie theater that IS on fire because he would rather call his broker and make money off the carnage. Burry and Goldman couldn’t care less about the worldwide financial damage those subprime mortgages would inflict after burning down, only how could they multiply the damage, to profit immensely from it. To be fair to Burry and the other ‘big shorts’, at least they were taking a position, they had ‘skin in the game’, they were exposed to losses, the entire principal amount that they invested, if they were wrong about betting against the mortgage market, but Goldman cleverly was not taking any risk at all. Goldman wrote this insurance, this CDS, and sold it to Burry, the CDS holder. As the seller, or the writer of this insurance policy, this CDS contract, Goldman effectively created a replication of that debt, and Goldman was now temporarily exposed, Goldman was at risk, for this ‘synthetic’ debt, as well as, just as much as, the original holder of that subprime debt, that low-rated bond underlying Goldman’s contract. Goldman, instead of carrying this risk, this ‘synthetic’ exposure, that they just created for one client that wants to short subprime debt, then needs to lay it off on another client that wants to go long subprime debt. So the trick for Goldman was to devise a way to get clients to take, to become the writers, of these contracts. No client would ever agree to write a fire insurance policy on a single movie theater that had smoke coming out of it, but a client could be duped into doing just that if that very same contract was buried deep inside a diversified portfolio of randomly-selected high-grade bonds. That is exactly what Goldman did, they took actual AAA-rated mortgage CDOs that were paying bond interest from prime mortgage bond debt, inconspicuously blended in their newly-concocted CDS contracts insuring junk debts specifically picked by a ‘big short’, and unloaded it on another client that thought they were just investing in, going long on, mortgage debt. Previously AAA-rated CDOs, renamed ‘Synthetic CDOs’ because they contained newly-created ‘synthetic’ CDS contracts that were insuring subprime debt, was sold to Goldman clients like American International Group (AIG). That was Goldman’s grift, that was what you could call The Big Con. Instead of buying plain-vanilla CDOs yielding (mortgage bond) interest payments, a Goldman client, the mark, like AIG, were unknowingly buying financial weapons of mass destruction that were actually paying subprime CDS (insurance policy) premiums. Same difference if you were an investor seeking income and you were bullish on subprime debt, right (?) Sure, until the day that investor finds out after it’s too late that the CDOs that they just bought…from Goldman’s traders…contain risk on subprime debts…that were hand-picked by Goldman’s other client, a hedge-fund expert…who was convinced they would default….because those specific debts had the greatest probability to default….so that expert shorted those particular subprime risks… by replicating that dangerous risk…disguising it as an innocent little CDS…created inside Goldman’s laboratory…and because Goldman didn’t want to touch it with a ten-foot pole…quietly slipped that toxic subprime CDS into your CDO. While everyone from the buyers of these securities, to the regulators of these securities, to the credit rating agencies getting paid pretending to know how risky these securities were, Goldman kept profiting, with no skin in the game, as long as everyone kept drinking that housing-boom Kool-Aid…
The movie: Goldman Sachs is portrayed as only a counter-party, as Dr. Michael Burry’s broker, and that the Synthetic CDOs that Goldman later created and sold to lay off their own exposure to subprime debt was just an innocent ‘side bet’, like ‘people standing behind blackjack players making personal wagers.’
The book: Morgan Stanley proprietary traders avoided taking bigger losses on their long CDO positions by using inside foreclosure trend information to front-run the market. Merrill Lynch was able to sidestep losses in their long CDO positions by colluding with other banks to help “bespoke”, or freeze market prices of CDS at grossly inflated levels long enough until they could dump most of their losing positions on their own clients.
The movie: doesn’t specifically finger any bank, just ‘the crooks at the banks’. In separate scenes showing each of three big shorts exasperated and even terrified they were being conned while it took so long for the prices of their CDS positions to reflect actual market conditions.
The book: For the crimes committed that caused the 2008 Credit Crisis, ONLY ONE PERSON went to jail.
The movie: predicts that the blame would go to ‘the immigrants and the poor people’ who caused the housing bubble and shows the only person, Kareem Serageldin, an Egyptian-born trader at Credit Suisse, the only person that went to jail for crimes committed in the 2008 World Financial Credit Crisis.
Meanwhile, over in Staten Island, NY, a black man named Eric Garner died. He choked to death…while resisting arrest…on the charge of selling loose cigarettes…for a dollar each. (Take a knee and ponder that.)
NOTE: This is not an exact description of the events leading up to and causing the 2008 Credit Crisis, only my side-by-side comparison of both the book and the movie, The Big Short, which pushes a narrative that the ‘big shorts’ were geniuses, or even prophets. In reality, many other people also knew that there was a dangerous housing bubble, over-inflated with borrowed money, about to burst, and positioned themselves accordingly (i.e. for every single home buyer during the housing boom that was convinced home prices would go higher, there was a seller that wasn’t). The ‘big shorts’ were just good at their jobs, and were even better at timing their bets…
The movie also veers away from incriminating any of the banks, unlike the book, which puts most of the blame for the nationwide, unbridled greed just on the banks, and especially Goldman. At the end of the day, the actions of the banks may not have been criminal, but they were certainly mistakes, and the banks have been punished for those mistakes…
In April 2016, Goldman agreed to pay a fine of $5.1 billion to the US Department of Justice, part of a January 14, 2016 settlement reached with the US federal gov’t for Goldman’s role in “miss-selling” mortgage securities in the run-up to the financial crisis. As per the Justice Department, the settlement also “preserves the government’s ability to bring criminal charges against Goldman and does not release any individuals from potential criminal or civil liability.”
In October 2016, the US Department of Justice demanded that Deutsche Bank pay an additional $14B fine for “miss-selling” toxic mortgage securities to investors including mortgage giants Fannie Mae and Freddie Mac. According to Bloomberg, since 2008, Deutsche Bank had already paid US authorities more than $9B in fines for foreign-currency rate manipulation, interbank interest rate manipulation, precious metals pricing manipulation, and whether it facilitated transactions that helped investors illegally transfer billions of dollars out of Russia, a US sanctions violation. The threat of this additional $14B fine (an amount almost as much as Deutsche’s entire value) pushed the bank’s shares to record lows. The following month, officials at Deutsche reached a $7.2B settlement, the largest amount ever paid to resolve charges against a single entity for misleading investors in residential mortgage-backed securities, according to the US Department of Justice.
In May 2018, RBS, the biggest casualty of the financial crisis, agreed with the US Department of Justice to pay a $4.9B fine to resolve the investigation into the sale of toxic mortgage-backed securities, resolving RBS’s last outstanding litigation issue which had weighed on its share price, blocked dividend distributions to shareholders and complicated the UK government’s plan to sell down its more than 70% stake. The settlement was only civil in nature (no criminal charges). Once the world’s largest bank by assets, RBS narrowly avoided insolvency in 2008 after the UK gov’t agreed to a 45B pound bailout just six months after the bank tapped 12B of emergency cash from shareholders. In July 2017, RBS agreed to pay $5.5B to resolve a lawsuit by the US Housing Finance Agency on claims that RBS mislead mortgage giants Fannie Mae and Freddie Mac. RBS also previously resolved similar claims by the US National Credit Union Administration on claims RBS mislead credit unions, as well as other settlements by RBS in the hundreds of millions of dollars to the state attorneys general of NY and California.
For breaching a variety of financial regulations that led to the 2007- 2008 global financial crisis, banks across the world have paid well over A QUARTER OF A TRILLION DOLLARS in compensation, according to Reuters (the final figure is close to $326 billion). Aside from “miss-selling” mortgage securities, these banks and other financial institutions were fined “for misdeeds ranging from manipulation of currency and interest rate markets and compensating customers who were wrongly sold mortgages in the US or insurance products in Britain.”
P.S. This is a case study why you can’t give the free market’s ‘Invisible hand’ full control over the sword of capitalism.
Thanks for reading,