Why The Big Short Is the Most Important Film in the Oscar Race

[eridani]

http://www.thestranger.com/film/feature/2016/01/20/23448095/why-the-big-short-is-the-most-important-film-in-the-oscar-race

Even though The Big Short is successful in making a really complicated and, as a consequence, mind-numbing topic (derivatives and securities trading) understandable and even funny, it still needs some background for its insights to be better appreciated.

Three groups of experts saw the crash of 2008 coming. There were the Marxists (for example, the writers at the NYC-based Monthly Review), then the heterodox economists (such as the Australian Steve Keen, whose work and ideas are promoted by the locally based website IDEA Economics), and, finally, investment managers who saw that many of the collateralized debt obligations (CDO) sold by investment banks were actually worthless and so bought credit default swaps (CDS) on those CDOs.


<snip>

But here is the funny thing, and here is the core of The Big Short: Why is an insurance policy called a swap? A CDS is not really an insurance policy, because the ownership of a CDO and a CDS is not strictly correlated. You can buy the latter without owning the former. This is like allowing strangers to buy insurance policies on my life.

The result of this absurdity is obvious: All of those strangers will want me dead. Meaning, they would be shorting my life. If people happen to see me smoking a cigarette, they can stop whatever they are doing, rush to AIG, and buy my life-insurance policy. This is what perceptive investment managers did to the US economy. They wanted to make money on its death.

Hollywood has made a very good movie about the years leading up to the crash. But because the filmmakers could never (and probably did not desire to) sell the studios a movie about the Marxists or heterodox economists who predicted the crash (both have motives that are regarded with great suspicion in our society), they picked the investment managers. Also there was a book that approached their point of view (that of the perceptive investment manager) with the narrative force of a novel. The leap from the page to the screen was fairly easy.

[SamKnause]

1. I hope it gives Bernie a big bump.

I hope Michael Moore's new movie 'Where To Invade Next' gives

him a big boost as well.

[longship]

2. About the credit default swap.

You might have missed it.

What the credit default swap does is effectively reproduce the risk of the original mortgage bond. If the bond fails, the CDS pays off 100%. And it only took a small percentage of the mortgages within the bond to fail to bring that about.

As Michael Lewis states clearly, and what people like Steve Eisman (Mark Baum in the movie) understood, was the correlation was 100%. When mortgages start to go into default, all the bonds would fail.

And then there's this. The Wall Street banks couldn't get enough junk mortgages to feed their ravenous bond trading desks. So the CDSs, since they duplicated the risk of the original bond, were wrapped up into new bonds, synthetic CDOs, and sold to the public. That is why when house prices dropped and mortgages failed, the entire economic system collapsed with it. The Wall Street banks had replicated the risk of those shitty mortgages dozens, maybe hundreds, of times over. Steve Eisman was like, "This is allowed?"

Apparently it was.

Read the book. It is an incredible story.

[eridani]

4. Will do. Though after I see the movie. I almost never like movies as much as--

--the books they came from.

[countryjake]

3. kickety

[jmowreader]

5. Everyone overlooks THE question: Why issue the shit in the first place?

Look, kids: These high-rolling financial wizards did NOT roll out of the fart sack one morning and think to themselves, "OMG the tires on the Ferrari are getting a little thin, I think I will trade it in on a Lamborghini...but to do so I must sell a trillion dollars worth of toxic investments and use my commission to get the new car!" Nope...they were issuing all this garbage paper to fund corporate buyouts. There was a Leveraged Buyout, or LBO, boom from 2004 to 2007...which neatly parallels the rise in trading of toxic derivatives.

And here's the fun part of it all: There are two kinds of derivatives, "exchange-traded" and "over-the-counter." An exchange-traded derivative is a standard thing. If I want to sell a "put option" (which will cause me to buy...oh, 100 shares of General Mills for $52 per share if the stock falls below that) I can just go to Scottrade and type in what I want. It is a plain vanilla exchange-traded derivative. All this bizarre shit is OTC. No one even knows how much of it's on the market, much less WHAT is floating around out there.

http://leeds-faculty.colorado.edu/bhagat/StrucuredCredit-LBO-Boom.pdf

Your writer asks, "why is an insurance policy called a swap?" That's because it isn't an insurance policy at all. It fails to meet the two critical requirements of a "real" insurance policy: the party who owns the covered risk doesn't need to own the risk (this is called a naked CDS) and the counterparty that will pay off if the covered risk collapses doesn't need to own the money needed to pay up. In a healthy economy where not much default happens, these guys can probably cover their losses just with premium payments on the CDS that haven't yet defaulted; in reality, the counterparty covers his ass by purchasing derivatives from other people.

The VERY FIRST THING anyone who wants to keep the financial industry from killing the economy again needs to do is to get some control over the kinds of derivatives that are allowed to be issued. The Dodd-Frank bill's biggest problem is that it didn't do that. The day before Dodd-Frank was signed, it would have been totally legal to build a CDO (which uses other derivatives as its underlying securities) out of an Auto Credit Accounts Receivable asset-backed security, a Credit Default Swap on that ABS, a CDS written against a Mortgage Backed Security someone else owns, a weather swap that pays off if it rains on Labor Day (they sell these - most of the people who buy them are running big events that'll lose big money if rain washes them out) a Credit Card Accounts Receivable Asset Backed Security on Tractor Supply Company cards, a Mortgage-Backed Security containing $10 million in subprime notes written in Flint, Michigan, $75,000 in actual money and the car loan on a Rolls-Royce. The day after Dodd-Frank was signed, it was still legal to write that monstrosity...AND to give it the very highest credit rating available! It gets worse: It's also legal to use THIS piece-of-shit derivative as part of the underlying for ANOTHER derivative! (The hydra-headed note is called a "CDO-squared." These can also be used as underlying, and that note will be a CDO-cubed, followed by a CDO-4, a CDO-5 and so on and so forth.)

So...fuck "breaking up the big banks," how about we just keep people from selling Credit Default Swaps against debt they don't own and ban the process of tranching derivatives into new ones?

[eridani]

6. Breaking up the big banks will obviously not be enough

We also need the bans on certain kinds of trading that you have described.

[jmowreader]

8. How would you break them up anyway?

The Sanders Intention to break up the six largest banks doesn't explain what the banks will look like after he's done. Is he planning to break them up into banking, investment, mortgage, and so on units, or does he want to make fifty little versions of the banks we now have? The first one means the people using banks to do all this nefarious securities shit will simply start doing business with a bank that hasn't been broken up; the second means those people will go to the all-new "Wells Fargo Bank of New York" rather than the current "Wells Fargo Bank." No folks, if you're going to break up banks so as to prevent a repeat of the Great Recession, you MUST break ALL banks up and you MUST do it along functional lines.

My trading bans will be a lot more effective anyway. The most effective way to prevent a hazard from damaging people is to eliminate the hazard. You can break up banks all day long but if you don't eliminate the hazard of these kinds of derivatives, the shit will continue.

They should also make the people selling derivatives come to work dressed like this:




...because after all, if these bastards are running casinos - and they are - derivatives desks should LOOK like casinos.

[oberliner]

7. Is there a single non-white person in that movie?

Literally, even one?