‘Big Short’ hits some marks about housing bubble
‘Big Short’ hits some marks about housing bubble
Christian Bale plays Michael Burry in “The Big Short.” The movie does an impressive job of conveying arcane financial concepts. JAAP BUITENDIJK , PARAMOUNT PICTURES
“The Big Short,” the movie version of the Michael Lewis book about a bunch of misfits who foresaw the housing and mortgage bubble a decade ago and profited handsomely from its popping, is now in theaters.
It is the strongest film explanation of the global financial crisis.
Spoiler alert: In the end, the global economy collapses.
The movie does an impressive job of conveying arcane financial concepts that are very hard for a general audience to grasp. (Turns out, the best way to explain synthetic collateralized debt obligations involves a blackjack table and the singer Selena Gomez.) But a different, perhaps unintentional, lesson of the movie stands out to me.
“The Big Short” makes a big deal of its protagonists realizing that there was a giant housing bubble in the middle of the last decade at a time no one else could see it. But that’s not quite right. When no-money-down home loans were commonplace and home prices were soaring, there was widespread discussion of the possibility that the United States was experiencing a housing bubble.
It was in August 2005 that the number of Google searches for that term hit its peak, according to Google Trends, fully two years before the crisis began. That year alone, there were 1,628 articles in major world publications included in the Nexis database that used the term “housing bubble.”
It’s true that plenty of those articles quoted economists and real estate industry representatives arguing there was no bubble and nothing to fear, but there also are clips discussing the possibility it could end with tears.
“The worldwide rise in house prices is the biggest bubble in history,” The Economist said in a 2005 article. “Prepare for the economic pain when it pops.” The New York Times published an article in August of that year citing economist Robert Shiller: “He is arguing that the housing craze is another bubble destined to end badly, just as every other real-estate boom on record has,” said the article, by some guy named David Leonhardt.
So plenty of people were at least discussing the possibility of a dangerous bubble. But there’s a big difference between identifying at the macro level that something is going on and understanding the financial plumbing that would allow a person to profit from that insight.
What the characters portrayed in “The Big Short” figured out that people writing housing bubble stories didn’t was how the rot from bad mortgage loans that helped fuel the housing bubble had come to permeate supposedly safe securities. There were billions of dollars of highly rated bonds floating around that were in fact worthless, or at least worth far less than advertised.
The key transmission mechanism that turned a simple correction in the housing market into a global financial crisis were those bonds.
Global banks had loaded up on these supposedly safe securities and were at risk of becoming insolvent when their true value became known.
Some banks blew up, others were bailed out. Either way the global credit system froze and the global economy tanked.
But even if you were clever enough in 2005 to see all of this coming, you wouldn’t necessarily have been able to cash in as successfully as the characters in “The Big Short.” Figuring out exactly what securities to bet against, and how, and when mattered as much as the basic insight.
The movie captures this well, as the characters face a crisis of confidence when foreclosures begin to rise yet their big bets against mortgage-backed securities aren’t yet paying off. (“I may have been early, but I’m not wrong,” says one character, the hedge fund manager Michael Burry as portrayed by Christian Bale. “It’s the same thing,” a skeptical investor retorts.)
Indeed, the movie has a glancing reference to how hard it is to translate the basic insight about mortgage securities into profits. We hear of a Morgan Stanley trader who had the insight that B-rated mortgage securities were at major risk, but believed that AA-rated securities would be fine and so offset his bet against the former with a bet for the latter. It cost the firm billions.
One simple lesson of this is kind of obvious: It is hard to make a boatload of money trading financial assets, even if you are brilliant. But there’s a broader one that explains why most everyone, including regulators (and journalists) were caught by surprise by the ferocity of the financial crisis.
A lot of people thought a decade ago that there might be a housing bubble. Few of them understood the connections between housing prices and poor lending practices, and the connection from poor lending practices to complex, highly rated securities, the connection between those securities to the balance sheets of major banks, and the peril to the economy if just a few of them faltered.
At each link in that chain, there were people aware that something was wrong, but lacked the ability to put those pieces together and connect bad lending in Florida suburbs with the existential risk being taken by companies like Bear Stearns and Lehman Bros.
The impossible job for the regulators (and journalists, and credit rating agencies) of the future is to better understand how the pieces within the infinitely complex economy and financial system connect.
“The Big Short” is a powerful reminder of how hard that will be.