May 3, 2016
May 3, 2016
Among the most enjoyable ways to learn about the 2008 financial crisis is to read Fault Lines, a zippy book on global finance which is both short and accessible. Written by a professor since promoted to be head of India’s Reserve Bank, Raghuram Rajan, the book advances a kind of Murder on the Orient Express explanation for the global economy’s killer, positing that there was a long list of perpetrators. Many may hesitate to wade into any 200 pages of finance from a University of Chicago economist, however, and so we also recommend highly the movie, The Big Short, the 2015 adaptation of Michael Lewis’s similarly titled book. It’s now available on video, and it is laugh out loud funny. It’s worth watching at least twice. (Date night spoiler alert: the film’s relentless eye candy is shameless, as Ryan Gosling, Christian Bale, Steve Carell and Brad Pitt all have prominent roles in the film.)
With less encompassing explanatory intent than Ragan’s book, The Big Short primarily fingers the stupidity and avarice of much of the financial services industry as the cause of the crisis. Downright weird but consistently successful hedge fund manager, Dr. Michael Burry, gets the plot rolling with a visit to the offices of Goldman Sachs, where he asks them to create a security he can buy that will go way up in value at such time housing prices go way down in value. The incredulous Goldman employees stifle giggles and note that housing never goes down in value. Undeterred, Burry repeats his request. The Goldman employees smell easy money, relent, and tell him they will sell him such a security. “This is Wall Street, Dr. Burry. If you offer us free money, we are going to take it.” A subsequent scene shows a bar filled with giddy derivative traders, spilling expensive champagne and roaring with laughter about similar trades executed by Dr. Burry’s hedge fund with multiple investment banks. Trading Rule #1: No matter how smart you may be, and no matter how much you know, it’s unwise to assume the person on the other side of your trade, risking his own money, is an idiot. In fairness, even Dr. Burry’s clients think he’s nuts.
As sand state housing prices begin to teeter, a handful of other independent thinkers begin to express similar interest in “shorting” housing related securities. One especially brash money manager, Steve Eisman, can’t understand why securities linked to loans taken out by borrowers with checkered credit histories would be rated as extremely safe, reliable investments. He visits the offices of Moody’s, a company that is paid to evaluate the credit worthiness of the relevant securities. The Moody’s representative, who has had an eye exam that morning and is thus wearing dark glasses which render her all but blind (it’s obvious, but it works) confesses that no one in fact looks carefully at the securities the company is paid to evaluate. If we don’t rate them as safe, she tells Eisman, the companies seeking excellent credit ratings for their dodgy products will simply hire a more cooperative “independent” ratings agency down the street. Eisman is disgusted, but the Moody’s representative is even more upset that her integrity would be questioned. Further, she informs Eisman that Moody’s ratings are nothing more than “opinions” that its consumers are free to disregard. It was Upton Sinclair who wrote, “It is difficult to get a man to understand something when his salary depends upon his not understanding it.” As with other episodes in the movie, the Moody’s visit highlights the problem of agency, in which people paid to give advice may in fact be so conflicted as to be effectively working the other side of the street. Warren Buffett summarized the problem thus: “Never ask the barber if you need a haircut.”
Don’t miss it.