The Big Short – Capitalism in Crisis

Once again I watched a movie that when I started writing a review on IMDB I realised that there was a lot more that I could say about the film than I could easily fit in one of its posts (and even then those post are more for reviews of the film than actually deeply exploring the ideas that come out of the film, not that I actually don’t do that since it is better for me to jump over to my blog to explore the themes). Anyway, The Big Short is based upon a book of the same name and is about some Wall Street traders who predict the coming collapse of the housing market in the United States and decided to bets against this with the purpose of making a profiting (which is what Wall Street traders do). The movie follows these four people from when fund manager Michael Burry first identifies a problem within the market to when the US government bails out the banks.
However, before I continue here is the trailer:

One Pretty Cool Film

As I have indicated above, I have already written a review of this film on IMDB, however I should probably say a few things about it here. In a way the film is crafted in a style known as a docu-drama, where the director is exploring a real situation, and explaining what happened and what went wrong (in the tradition of a documentary) while doing so in the form of a story, as opposed to simply dumping facts upon the audience. While I suspect that there are a number of others similar films out there, the one that a couple of others have pointed out is The Wolf of Wall Street (though that is more an autobiography). The interesting thing about the docu-drama is that the characters regularly break the fourth wall (that is speak directly to the audience). Sure, narrators have done that for a long time, and the narrator may even take the role of a character in the film, but we also have the character turning to the audience simply to flag who he is (personally I wouldn’t have known otherwise).

As for the performances I have to say that they were absolutely outstanding. It was Steve Carrol, playing Mark Baum (who actually doesn’t exist – the character is based on Steve Eisman), the cynical Wall Street trader who was not afraid to call a spade a spade, who stole the show. In many ways Baum is used as the mouthpiece that brings attention to all of the shady practices that had occurred, and are still occurring, within the financial system. Sure, the narrator Jarred Bennett is also bringing that to our attention, however it was Baum’s character that actually saw the rubbish that was being peddled, and the underhanded practices that were occurring all around him. While Bennett and Burry were aware of what was going on, these two simply wanted to cash in on the crash (though I will speak more about it below).

As I have mentioned, the film is about a group of people, who aren’t necessarily interconnected, discovering the discrepancies in the financial system and making a bet upon its collapse. Burry is the one who initially discovers the problem, and then goes out to make a bet that the market is going to collapse. However since there wasn’t any financial instrument at the time to allow him to do it, he ends up creating his own (the credit default swap, or CDS). He then goes and visits a number of large investment banks to request that they sell them to him, which they are more than willing to do since they think the idea of a collapse in the housing market is ludicrous simply see it as easy money.

Once he had done the word gets around: first to Jarred Bennett, who decides that there might be an opportunity in selling these products, who then dials a wrong number which brings them to the attention of Mark Baum. Finally, after being rejected by one of the banks, he ends up leaving the prospectus on the table in the lobby, which is picked up by a couple of others (Charlie Geller and Jamie Shipley) who happen to be outsiders, but enlist the help of retired investment banker Ben Rickett (who is brilliantly portrayed by Brad Pitt) to help them make the bet. Mind you, as they say, they didn’t discover these products the way the film portrays it, but it does add a bit more of a flavour to the story (and at least the film is being honest – most of them don’t actually say anything when they are playing loose with the truth).

Anyway, while we all know what is going to happen in the end – the financial system collapses and these guys make an absolute packet because of it – much of the tension arises due to the fact that these guys are betting against the trend. The thing with being in the financial industry is that you are playing with other people’s money, and other people want to see growth, not losses. As such these people need to convince the other people (in Burry’s case his investors, and in Baum’s case Morgan Stanley) that the bet that they have made is the correct one. The problem with Baum is that he is betting against is own employer (whom we discover has made a $15 billon bet that the housing market will continue to grow). Anyway, it is probably a good time to explain some background.

A Short History of Banking

Actually, if you want a pretty detailed history of the modern financial markets you simply cannot go past The Ascent of Money by Niall Fergusson. However, I will give you a brief run down of what I know (and I am writing this from memory).

The modern financial system began in Renaissance Florence with the Medici family. To enable them to raise money to be able to fight their wars they came up with this ingenious idea of the bond. Basically what they did is that they grabbed some paper and basically wrote ‘IOU $1000’ on them, with the promise to pay $100.00 every year that they don’t pay it back. They then sold these pieces of paper for, well, $1000.00 each. What these pieces of paper said was that it was worth, at face value $1000.00, and that the person who held the piece of paper was entitled to receive $100.00 per year. The thing with these pieces of paper was that the holder could sell it to another person, and that person could then approach the Medici’s and claim that $100.00, or the $1000.00 when the Medici’s chose to redeem them.

An example of a paper bond (actually it is a stock, but they look the same)

However, while the face value of these pieces of paper were $1000.00, the actual value could rise, and fall, based upon the ability of the debtor to be able to pay. The concept then spread across Europe, and as we moved into the 18th century, we see the development of what is known as the joint stock company. Initially such companies were created by the government but they would raise money by selling stock – which is basically an interest in the company. This stock, like the bond, was a piece of paper that basically said that you had a financial interest in the company and thus were not only entitled to a share of the profits, but also a say in the way the company was run.

One of the major differences between a bond and stock (or a share as they have come to be known) is that the share does not have a face value. While the share would be issued for a certain amount, that did not necessarily mean that it would remain at that value. As such the share could increase, and decrease, in value based upon the perceived profitability of the company. This eventually led to some disastrous events, such as the South Sea Bubble, where people were paying huge amounts of money for a company that was in effect worthless.

An example of a share certificate

Trading Paper

Well, from what you can see above, the entire stock market is made up of pieces of paper, and the market makes money by selling these pieces of paper. To be more precise these pieces of paper are actually contracts between the company and the holder of the bond or the certificate. For many years (as far as I am aware) the financial markets simply consisted of these two pieces of paper – shares and bonds. Many of the crashes in the past simply came about because these pieces of paper were way overvalued. For instance, shares were being sold at a value that did not actually represent the profitability of the company, and when that fact came out the holder of the certificate suddenly came to realise that their piece of paper was worthless.

To protect themselves against such falls further instruments were created – options. Now while I am familiar with the financial markets, and understand the concept, I am trying to explain it in a way that the average punter can understand. An option is a piece of paper that derives from an underlying share (from which we get the term derivative). Basically, it is a bet that the value of a share is going to rise (a call option), or fall (a put option). These instruments (the financial term which refers to these pieces of paper) were created as insurance against a rising, or a falling, market.

As the movie suggested, back in the 1970s banking, and insurance, was a boring business. This came about due to the financial collapse of 1929 which resulted in the Glass Stegal Act separating a bank’s commercial business from its investing business. The basic bank would take deposits and then use the money from the deposits to make loans to creditworthy people. However along comes this chap (I can’t remember his name) who came up with this idea of the mortgage backed security. His idea was to package all of these loans and sell them as pieces of paper that promised a decent return. What this meant was that the banks could then free up their capital (money) by selling the loans onto a third party.


Now, the movie suggested that a Collateral Debt Obligation (CDO) and a mortgage back security are two different things, however, I am inclined to disagree. As far as I am aware a CDO is a mortgage back security (MBS), basically an MBS is a piece of paper that represents a bunch of mortgages, and you are paid an amount of money based on the current interest rate (though it is generally less because the middle man has to scape a bit of cream off the top). However what the Big Short did say was that a CDO was basically a bunch of really bad loans that they weren’t able to sell on, so that they divide them up and mix them in with good loans so as to make the piece of paper look attractive to potential investors. The movie used the analogy of a chef mixing three-day old meat into a soup so that he would not lose any money by throwing the fish away.


Fraud on an Epic Scale

When most of us think of fraud we generally think of those Nigerian Email Scams, or some dodgy small timer that swindles an old person out of their life savings. Many of us don’t equate it with the big banks or the reputable ratings agencies, but it happens. For instance HCBC was implicated in a money laundering scandal (yet they are still operating – it’s the economy stupid). My argument is that the big banks are just as capable of fraud as that guy down the road running a two bit financial advice service – the difference is that the banks operate within the law namely because they have an army of lobbyists that make the law.

Anyway, this is how the scam worked. Economics works upon a principle of the Law of Diminishing Returns, which basically means that there is only so much money that you can make from an investment. The longer the investment goes the less money you will make from it. The reason for this is that there are only so many resources that are available, and in the case of mortgage-backed securities there are only so many creditworthy people around at a time that one can lend money to and expect to get it back. As such when the banks onsold all of their mortgages they had a heap of money that they had to do something with. The problem with banks (and with me for that matter) is that we cannot simply have money sitting there doing nothing – we have to invest it in something to produce a return, and with banks they are loans.

Okay, the banks make money from other methods – such as fees and charges – but their primary way of making money is from interest payments on loans, so when they had sold off all of their good mortgages they needed to lend the money they had sitting there to more people – namely to those who already had loans. However it went further than that because once they had leant all of that money out they would bundle it up and onsell it which meant that they had more money to lend out, so the quality of the borrower became less and less to the point that they had to resort to what was known as NINJA Loans – no income, no job, and no assets.

During this time arose a profession known as a mortgage broker – somebody who would find the best loan for a prospective customer, and would receive a kickback for writing up this loan. As with the banks, as the creditworthiness of the customer declined, the mortgage brokers would pretty much look for anybody to whom they could possibly lend money. In the movie we are introduced to two such people, one who preys on immigrants, and one who goes even lower to those who literally have no money at all. When Mark Baun discovered that a stripper owned five houses (and a condominium) he knew there was a problem.

Oh, I should also mention the teaser rates – the banks, to encourage people to borrow more, would offer what was known as a teaser rate, that is a really low (or non-existent) rate of interest and then after a period of time would jump to the average, or even higher, rate. People were thus drawn in by these teaser rates (which is why the term teaser was used) only to discover that when the rates jumped that they were in serious financial trouble.

Are These Guys Heroes?

I guess this is the big question, and to be honest there is some debate about this (at least on IMDB). Sure, these guys have pierced the veil of the financial markets, and in a way we see them as bucking the trend, but what do we get out of it – absolutely nothing. These guys make an absolute bucket load of money by shorting what many of their peers saw as an impossibility, but in the end while they walk away with their millions, those who were caught up in the whole fiasco are left to suffer.

In a sense it is what Ben Rickett says when Geller and Shipley are dancing out of the securitisation convention – sure they have made money, but what are they making money off – other people’s suffering. When the unemployment rate goes up so do the number of deaths. What they are betting against is the American economy, and the fact that it is based entirely on a lie. Sure, they might make millions out of their trades, however there are going to be hundreds of thousands of people suffering from this event.

I remember at the height of the financial crisis going up to a couple of friends at church, one of them quite young, one of them quite old. I asked them what they thought about what happened and the young one thought it was hilarious, while the older one was incredibly incensed – it’s those short-sellers. Mind you, he had lost a heap of money when one of his ‘sure-fire’ investments had completely collapsed (though he never lost faith in the financial markets).

That is the thing with short selling – where you borrow shares and then sell them into the market and buy them back at a lower price – it exacerbates the falls. Sure, it is incredibly risky, and can result in you losing a lot of money, but when you do it at the right time it can pay off immensely. However what it does is that it exacerbates the problem. When people sell they sell because they want to maintain their capital, however, short-sellers sell simply to make money, which means that when the market is in free-fall they suddenly come out of the woodwork and make the crash much worse than it really is.

They are not necessarily responsible for people losing their jobs, but their act of exacerbating a falling market means that peoples’ life savings literally vanish. Okay, I entered the market after the crash (and I have to admit that I really don’t have the time, energy, or willingness for risk to do anything other than buy shares that look like they might make me some money), but a stock market crash affects lots and lots of people. In fact one of the reasons that this crash was as bad as it was was because of the existence of the financial instruments – the Credit Default Swap – that Burry created to short the housing market.

The thing with the Credit Default Swap (CDS) was that it was an insurance policy issued against a rock-solid security, which meant that if the price of the security (a piece of paper) went below a certain level, then the bank that wrote the security would pay out the face value of the security. When these were written up (as was portrayed in the movie) it was believed that they would never have to pay out on them, however when Lehman Brothers collapsed it suddenly because evident that the holders of these securities would be making their claims. In fact this is what brought AIG, at one stage the biggest insurance company in the world, to financial ruin – which resulted in the multi-trillion-dollar bailout.

The Other Side of the Story

I remember standing on the front of a boat with some guy I knew (I won’t call him a friend because, well, he wasn’t) talking about the financial crisis. Now he was a die-hard capitalist that believed in the sanctity of the market, while I’m, well, a Democratic Socialist (for want of a better word). At the time people like me were gloating over the fact that capitalism had failed and that a new world order was just around the corner. What did he do – he blamed Clinton.

The theory goes that Clinton enacted a law that forced banks to loan money to people who were not creditworthy and it was that law that laid the foundations of the crisis. However my understanding was that at the time people of a certain colour (namely blacks) were being discriminated against because, well, they were black. Despite the fact that they were creditworthy the banks refused to lend money to them because the perception was that if you were black, and lived in the United States, then you were poor and thus automatically disqualified for a loan.

However the claim that this was the root of the financial crisis is somewhat of a furphy. While it is true that there was a lot of discrimination against certain minorities, the banks would exacerbate this by offering teaser rates – low rates of interest with the expectation that once the real rates kicked in the bank could repossess the property and sell it for a profit (with the expectation that during the time the teaser rates where in effect the value of the property would grow). However it was the repeal of the Glass-Steagall act that was the cause of the crisis. This was an act that basically said that a bank had to separate its normal banking activities (taking deposits and making secured loans) from its investing activities (making risky investments). By removing this layer of security meant that the deposits of the average punter were suddenly at risk.


A Casino Culture

I found it quite interesting that in the movie the securitisation conference was held in Las Vegas, the casino capital of the world. In a way it says a lot about the modern banking industry – it is little more than a sophisticated casino. In many ways, it is, especially when it comes to speculation. The traditional form of investment was to purchase either bonds for steady repayments, term deposits for a similar result, or purchase shares to add some risk to your investment. However as the financial markets developed, investment suddenly turned to speculation, which is a sophisticated form of gambling.

For a while I have suggested that investing in the financial markets is a much safer, and less riskier form of gambling than going to the casino and pouring your money into poker machines. Okay, while the odds are much better, the thing with gambling at the casino is that more likely than not you are going to lose all your money. With the exception of maybe craps (and I really don’t know how to play craps) I can’t think of any game where if you don’t win money you don’t lose the lot. The difference with the financial markets is that if you make a bet (though the proper term is trade) that goes against you then you can at least cut your loses and walk away with some of your initial investment.

However what I am talking about here is the basic buying and selling of ordinary securities (stocks and bonds). Things change when you move into derivatives. I have already spoken about options, which are seen as a form of insurance against your investments moving in the opposite direction (and they really only become useful when you are playing around with huge amounts of money). They aren’t the only forms of derivatives though (the Credit Default Swap – the derivative that was the focus of the movie, is another form of insurance, and while they had been around since 1994, what the players in the story did was create a financial market for them), another is known as a Contract for Difference (CFD).

Basically a CFD is a contract that represents a fraction of the value of the underlying share (say 10%), so if the value of the share moves (you can purchase CFDs in anticipation of a share going up, and a share going down) when you sell it you keep the entire difference. For instance, if you buy a CFD over a share worth $10 (which means you pay $1.00 for the CFD), and the value of the share increases to $12.00, then you have effectively tripled your money. The catch is that if the share decreases to $8.00, then you have to fork out the extra $1.00 to cover the difference. This is the major difference between gambling on the market and gambling at the casino – on the market there is the potential for you to actually lose more than you have invested.

As it turns out, CFDs aren’t actually available in the United States, however that doesn’t stop the casino nature of the stock market from flourishing. With short sellers and day traders, the idea of investing in stocks being long term investments has gone out of the window, and people buy and sell shares with the hope of generating a quick profit. Sure, there are still some funds out there that prefer the Warren Buffet style of investment – looking for a company that is undervalued and then buying into it, and taking the position that when you buy a share you are actually buying a company. However with supercomputers scanning the markets looking for mispriced securities, and buying and selling them at light speed, one wonders if the nature of the market has changed forever.


Government by Wall Street, of Wall Street, and for Wall Street

Many of the right-wing commentators and free market advocates love to fall back on Adam Smith’s famous invisible hand quote and use that as an argument for the government not to regulate the market simply because government regulation has the effect of distorting the market. However many of these same people seem to completely forget this quote which also comes from The Wealth of Nations:

The interest of [businessmen] is always in some respects different
from, and even opposite to, that of the public … The proposal of any
new law or regulation of commerce which comes from this order … ought
never to be adopted, till after having been long and carefully examined
… with the most suspicious attention. It comes from an order of men
… who have generally an interest to deceive and even oppress the

and not to mention what he had to say about taxation:

It is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than that proportion.

Mind you, people have always picked and chosen bits of pieces of philosophers to promote their own agenda, and this is very much true of religion. However, it is always interesting that out of a huge, two-volume book, the only thing that people pay any attention to, and base their entire economic theory on, is a single paragraph.

Yet I believe Smith is correct about the danger of allowing businessmen to enter the government namely because it is very difficult for them not to push their own agenda. In fact there is a scene in the movie where one of the characters approaches an old acquaintance who works at the Securities Exchange Commission, the government regulator of the financial sector, whom he discovers is currently looking for opportunities to enter the private sector. To him, jumping straight from the government over to private industry reeks of corruption – yet it happens because it is allowed to happen. The problem is that these people tend to retain their contacts in the government.

The revolving door between the government and the private sector has been going on for a very long time, and we aren’t necessarily talking about politicians here. However there is a counter-argument to this because the people that are needed to head up the various government departments need the experience to be able to effectively run these departments, and the only way you can find them is in private industry. Mind you this is an element of the American system namely because the department heads are chosen from anywhere except Congress, while in the Westminster system they can only be selected from parliament. One does raise the question of whether is a potential conflict of interest when it comes to many of these appointments.

The end of Capitalism

I have actually already written a substantial piece on this on a couple of book sites that I use to review books I have read (and in this case it was a book by Slajov Zizek about, you guessed it, the global financial crisis) however I will finish off with a few thoughts on this idea. Basically the gist of that piece is that we are in the process of (or already have) moved from a capitalist, free-market economy, to a new form of feudalism where the corporate bosses basically control society and the little guys are subject to their whims and desires. Sure, we still have a lot of small businesses floating around, however the small business paradise is slowly being crushed by competition from the major corporations.

For instance there has been a lot written about the practices of stores like Walmart (and while that is only one link, you can certainly find a lot of others through a simple Google search) on how they destroy local businesses through cutting prices to a point where they can’t compete, and then cutting them further. Sure, such stores are useful in that they offer goods at low, low prices, yet the variety and nature of the small business is destroyed in the process. One of the great things about a small business is, in many cases, their customer service. The owner of a small business has a lot more at stake in the business than your average checkout operator at McDonald’s.

However another thing is the idea that bad businesses go bust while good businesses survive. If a small business owner is rude to his customers and rips them off then word gets around and people stop shopping there. However, what we now have is a system where a business will survive simply due to its sheer size. Further, what the global financial crisis taught us was that if a financial institution makes foolish investments and collapses, then the government will simply run in and bail them out – in effect propping up the economy. This is not how capitalism works, and in the end encourages dependency. When a multi-national corporation is bailed out, or propped up by government handouts (and tax exemptions) then the business becomes reliant upon it, and adjusts its practices as such. The company will become much more wasteful, and speculative, knowing that if anything happens they can simply run to the government, cap in hand, claiming that if they went under then hundreds of people would be out of work.

That, to me, is not capitalism, but then again it isn’t socialism either. Socialism is where the state has power over the corporations (as is the case in China) as opposed to the Corporations having power over the state. This needs a new term – neo-feudalism. Still, whenever something goes wrong, these companies all run to the government, cap in hand, wanting them to bail them out while the same companies dump of the poor who are forced to survive on government handouts and food stamps. To me, there seems something really hypocritical with that.


Creative Commons License
The Big Short – Capitalism in Crisis by David Alfred Sarkies is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License. If you wish to use this work commercially please feel free to contact me. This license only applies to the text and any image that is within the public domain. Any images that are the subject of copyright are not covered by this license. Use of these images are for illustrative purposes only are not intended to assert ownership. If you wish to use the creative commons part for commercial purposes, please contact me directly.


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