Movie Recommendation: The Big Short

It isn’t often that a movie aimed at geneal audiences
focuses on economics, so I hope some people will
learn some things about economics from the movie
The Big Short (based on the book by
Michael Lewis). The movie views the
development of the 2008 mortgage crisis through
the eyes of a few investors that could see the
problem that was coming and took “short” positions
to allow them to profit from the collapse of
mortgage-backed securities. Although the exact
details were deliberately made complicated to make
it hard for outsiders to understand what was going
on, the basic idea is simple: because loan originators
sold their loans to someone else they no longer
had to care whether the borrowers would pay back
the loan. With irresponsible lenders becoming reckless
in approving loans, it was hard for responsible lenders
to compete.

Investors taking short positions are often seen as
unappealing vultures, since their profit depends on
something falling or crashing. However, in the case
of a bubble, short investors can help dampen some of
the excess (if there are enough of them). Recommended
reading: Robert Shiller, The Subprime Solution,
page 150).

Although nobody predicted the exact nature of the crisis,
the characters in the movie weren’t the only ones who saw
that a problem was coming and there were warnings that
were published in earlier years (see Freedom, Opportunity,
and Security).

The movie effectively identifies those that are most
to blame for the crisis: the bond rating companies.
If they had accurately rated the risk of mortgage-backed
securities then far fewer people would have been interested
in buying them. In one line of the movie, a person at
Standard and Poor’s said they had to give good ratings to
the securities because if they didn’t they would lose
the business to their competitor Moody’s.

Economist Richard Thaler joins Actress Selena Gomez to
explain collateralized debt obligations (that’s a sentence
I never thought would appear in a review of a popular movie).
More about Thaler later.

The main problem with the movie is what it leaves out.
No mention is made of Fannie Mae and Freddie Mac, as if
these government-sponsored enterprises had no responsibility
for the growth of mortgage-backed securities.
At the end of the movie it implies that nothing has been
done to change regulations, as if the 2010 Dodd-Frank law
had never been passed.
The role of bank risk-based capital standards is not
considered (more on this in the next post).
The movie risks spreading the myth that “deregulation” was
responsible for the crisis, when in reality the financial
system was regulated (badly) in ways that pressured them to
create more mortgage-backed securities.

……………..
–Douglas Downing
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