Bailouts, Arrogance and Corruption in ‘The Big Short’

Sometimes Hollywood hits a homerun.

For example, The Big Short, the movie account of the US financial collapse of 2007-09. Its all-star cast is notable. But we were skeptical from the sound bites used in previews and other promotional blather that this would be another anti-capitalist propaganda flick. We were wrong.

It’s not easy to craft a compelling drama from complex and unsexy subjects like financial markets and public policy, but The Big Short succeeds brilliantly. It uses a series of creative cameos and asides to explain in plain terms many of the complex financial arrangements underlying the mid-2000s housing bubble that contributed greatly to the collapse – while still keeping the narrative light but gripping.

Michael Burry, an insightful hedge fund manager, realizes in 2005 that too many home mortgages are being given to people without the income or credit to support them. Many of those loans had adjustable rates, and he concludes that when those rates begin to rise in 2007, the whole housing market will collapse.

He responds by buying $1 billion in risky mortgage-based “credit default swaps” from large investment banks, essentially betting against their investment positions. Wall Street bankers think Burry is an idiot and they happily sell him these swaps, laughing as he walks out the door.

Burry’s bet is bold, risking his own investors’ assets on his strong beliefs, which the entire financial industry dismisses as preposterous. He especially draws derision when he asks the bankers what assurances he has of getting paid when their banks go bankrupt.

Eventually, word gets around to a small handful of others. They recognize that Wall Streeters generally don’t make 10-figure bets lightly, so they do some research of their own. They conclude Burry is right, and join him in betting against the financial establishment.

As part of that research, one character, Mark Baum, travels from New York to Florida and sees many homes financed by subprime mortgages vacant and falling into disrepair. He interviews an exotic dancer and asks if she’s aware that her mortgage payment could double or triple soon due to the adjustable rates. She says no and asks him if that’s also true for her other houses, explaining that she owns five. The point is the system gave anyone, even a pole dancer, as much mortgage credit as she’d take.

Baum interviews the brokers who arranged the mortgages for her. They smugly explain that they don’t verify borrowers’ income or assets and it doesn’t matter because they get up-front fees for making the loan. Then they sell it within days to government-created agencies. By selling it, they carry no risk for their reckless lending.

The film doesn’t explain that Congress and federal regulators had set up these perverse loan resale arrangements to lend excessively in order to assure mortgages for low- and moderate-income borrowers. Bankers knew they could make an immediate profit and then pass the risks on ultimately to taxpayers. In 2005-07, bankers floated more than $1 trillion in such sub-prime loans.

Back in New York, Burry and Baum’s colleagues worry as the bubble continues to inflate. In real markets, such bubbles tend to spur corrective action. But the banks keep bidding up each other’s assets even as many subprime loans become delinquent.

When the crash finally comes, the reason for the bankers’ smugness is revealed. Watching the news, Baum sees Treasury Secretary Hank Paulson and Federal Reserve Chair Ben Bernanke leaving the White House. He guesses correctly that everyone who participated in the often fraudulent collusion between banking and government is about to be bailed out by taxpayers. He realizes the bankers correctly counted on this all along.

The film concludes with Baum’s shock and disgust, even though his bet paid off. But these events later culminated in public outcry that led CNBC’s Rick Santelli to call for a “Chicago Tea Party” on the floor of the Chicago Mercantile Exchange. Traders cheered him and a new political movement was born.

Tea parties sprang up across the country to express disgust for the bipartisan cronyism and corruption in Washington. Eventually, the movement would be co-opted by opportunistic politicians, but that’s a story for another day.

Today, we’re long on The Big Short.

Ron Knecht is Nevada Controller. Geoffrey Lawrence is Assistant Controller.