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The Big Short

In 2010, financial journalist Michael Lewis published a book telling the story of investors who made money in the 2007-2010 crash by betting against the mortgages we now know were doomed. He called it The Big Short: Inside the Doomsday Machine.

On 11 December 2015, that book premiered in theaters as The Big Short, with an all-star cast beginning with Christian Bale, Steve Carell, Ryan Gosling, and Brad Pitt. Audiences on the Internet Movie Database (IMDb.com) gave it 8.1/10 stars, and critics on Rotten Tomatoes gave it 87/100. Those are the kind of numbers that put it roughly on par with the recent Star Wars.

Of course, even with one more week of showings, so far The Big Short has grossed about 4.4 percent of Star Wars’ revenue.

Which is a shame, even allowing for PG-13-rated movies making on average about double what R-rated movies pull in. Rotten Tomatoes’ composite review is all praise: “The Big Short approaches a serious, complicated subject with an impressive attention to detail — and manages to deliver a well-acted, scathingly funny indictment of its real-life villains in the bargain.”

This is a financial blog, so this isn’t the place to rave about how impressive it is to see a movie that explains finance in a way that is both insightfully correct and delightfully captivating. This is the place to identify important lessons to be learned from it.

If it has been awhile since you looked into the cause of what is now called the Great Recession, the story goes like this. Pressured by reckless consumers and banks, mortgage lending standards sunk at the same time that credit ratings rose. Encouraged by the free money, consumers and banks behaved even more recklessly, overborrowing to catastrophic levels. When the reckless (variable rate) loans moved beyond their introductory fixed rates, the default rate nearly bankrupted the entire financial system.

Stockpicking is Hard

Rare is the human that learns about the stock market without considering an attempt to make the next brilliant investment that turns into millions of dollars in profit. Even more rare is the viewer of The Big Short who feels no draw to match their success. But after the surge of ambition fades, hopefully we as the audience will recognize that of all the intelligent investors in the world (and the movie), only a very few of them were right.

For most of us, dollar cost averaging into a low-cost mutual fund or balanced collection of index funds is the wisest choice.

Believe in the Business Cycle

As its characters prepare for the 2007 crash they believe to be coming, they discuss other historical crashes. While the movie glosses over history in order to focus on this crash, hopefully audiences who believe that bull markets can grow forever without correction will reconsider.

The inevitability of economic correction is an important lesson for business owners, business professionals, and the rest of us who work for businesses. No boom has ever continued forever. Bull market exuberance should always include reasonable preparation for bear market despair.

Be Cautious with Debt

Debt is an essential piece of the capital stack for both individuals and businesses. Individuals use debt to escape rent, gain education, and secure transportation. Businesses use it to invest in the future without selling equity. Investing power can reasonably increase by an order of magnitude with the help of debt…but too much of a good thing is almost always a bad thing.

In the year before the crash, investment banks had debt ratios of 30 to 1, and Fannie Mae and Freddie Mac has debt ratios closer to 60 to 1. Individuals purchased properties without downpayments, collateral, or even income. Debt of that kind is advantageous in bull markets but disastrous in bear markets. Remembering that a crash is always coming will help us moderate our enthusiasm enough to remain cautious about assuming debt.

Be Wary of Ambiguous Loyalties

The worst villain of the movie is a fund manager who specializes in mortgage-backed securities. He claims to represent shareholders, but he works more closely with the banks and seems complicit in pressuring credit rating agencies to overvalue his fund. As easy as it is to dislike the character, informed viewers will recognize that his situation is not at all unusual: it is the standard. Public securities and public companies are overseen by director boards that theoretically represent the shareholders’ interest but lack sufficient accountability (or contact) to realistically represent anyone but themselves.

The principle is broader than management of public securities. Accountable fiduciary duty is essential because ambiguous loyalty is no loyalty at all.

Honesty

The grand climax is a speech that should make every student of economics want to stand up and cheer. The evangelist of the film gives a speech about the essential nature of honesty, not because it is the right thing to do, but because throughout history it has been essential to economic development.

That principle is as true on a micro level as it is on a macro level. Economies, businesses, and families are limited and potentially doomed when they are dishonest with themselves or the world around them. Good culture needs honesty before it needs anything else.

Next Steps

After you watch The Big Short, come talk to us about it. We have insights that can turn your current money into more money. Whether you need us full-time, part-time, or temporary, we welcome a fiduciary relationship in which we help you with the hard work of investing, navigating the business cycle, balancing debt, and other necessary functions. We handle your books while you handle your business, and we all make money together. That’s not bragging.

That’s just honest.

 

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