Recommended: The Big Short

After watching Comrade Aaron Clarey's 3-star'ish video review of the new movie, The Big Short, I felt comfortable enough to go see it.  My lowered expectations going in may be influencing this review.  My history in the mortgage industry may be an influence too. 

I think it was a rare 5-star production.

The Big Short is the true story about the men who first saw the cracks in the US mortgage business that led to the SubPrime disaster of late 2007 and the banking crisis of 2008. 

It is entertaining.  Top acting by Brad Pitt, Steve Carell, Christian Bale and others.  It presents the events and causes of those crises.  And it does so in a way that educates the audience and demystifies the mortgage banking industry.

The end credits summarize America's losses: 8 million jobs, 5 million homes, and $5T in wealth.

Comrade Aaron and I are two of those 8 million jobs lost.  We're both unemployed by choice, and are both employable now, but we have pursued other ventures since walking away from the this man-made disaster.  Others have not been as fortunate.

Aaron was on the front lines reviewing loan applications for a credit union.  You can read his stories in his book, Behind the Housing Crisis.

My story:

I don't care to reveal the details of my experience, but you'll see my former employer in the movie.

I was in a senior, non-mortgage specific, role at a leading player in the mortgage business in 2007.  My timeline is slightly different, although in parallel with, what is presented in The Big Short.  I think you'll enjoy the movie more if you know my experience:

Late 2004

I'm hired.

From day #1 to my last day

The discussion at lunch with my co-workers was the same:

These loan programs from Fannie/Freddie are ridiculous.  Who buys a house with no money down?  It is only a matter of time before this scheme blows up.

April 2007

My company reaches its highest valuation ever.

Shortly thereafter

A wall street analyst warns of a coming mortgage crash.  My CEO and other major players pounce on the analyst and his employer.  The analyst is fired for his warning, including the 'outrageous' prediction that my company will go bankrupt.  This was hard to reconcile in the optimistic environment where I worked, but I had a little secret at the time - I was fully divested in my company and had been since I was hired. 

I didn't own a share of the company stock.  When the company matched 401k deposits with their own shares, I'd go into my account and sell those shares the next day.  In good times and bad.  I didn't understand the business and I knew there was a bubble going on.   I had been burned in the dot-com bubble and I wasn't interested in re-living that experience.  I didn't have access to the data that you'll see in The Big Short, nor would I have recognized the coming disaster if I had.  Of the 401k choices, my company's shares just looked less exciting than others.

So imagine my objectivity as things went South.  I had no skin in the game other than my job, and by that time I had already made plans to leave the company.  I watched it all - business news and management responses, with no zero bias but rapt fascination.

July 2007

SubPrime defaults go from 7% to 15%.  My company's stock tanks.  A major subprime lender shuts its doors overnight.  My company loses a key funding source that makes up 20-25% of its available funds.  Subprime is "toxic."

I remember thinking it wasn't too bad.  15% default rate?  To people who have a history of not paying their debts?  That means 85% of these people are making their payments.  Good for them!  Why the surprise? Why the 'sky is falling' panic?  The Big Short does a great job answering these questions.

August 2007

The CEO of a major bank is quoted, "I don't know why my bank's stock is falling.  We don't do SubPrime."  My company's CEO, whose biggest failure was to not hire crisis management experts back in July, came out the next day: "I don't know why my stock is falling.  We only do 13% SubPrime."  I remember sitting at my desk with my head in my hands thinking, 'Ya, and I'm only 13% pregnant."  Others saw this epic fumble too.  The stock drops more.

 I read the Wall Street Journal every morning - religiously - and noticed a very bad trend.  Either "Mortgage Backed Securities" (MBS) or my company's name was on the front page EVERY day in August 2007. This violated MBA rule #1: You never want your company name on the front page of the Wall Street Journal.  I'd then go to management meetings and hear something different than what I had read that morning.  Disconnect.  Big time.

October 2007 -

Layoff rumors abound.  The company starts layoffs in the periphery.  While not one of the 'mortgage gods' that I worked with, I was in a key role, senior and essential enough to know my job was safe.  Assuming the company survives. 

I discover from a co-worker that my company is still selling SubPrime loans.  It wasn't a secret - I had just assumed we stopped selling "toxic" products.  In the movie you'll learn just how lucrative the SubPrime loans are compared to traditional loans.  The greed was strong in my company as the groupthink took hold from board to CEO to senior managers:

We've survived these downturns before.  We'll emerge stronger as we take on the business that our failed competitors have left us.

December 2007

Layoffs are heavy and brutal, and are now rumored for headquarters staff (me).  The company starts using a tactic to avoid state laws and employment contracts regarding severance payments.  They limit all severance payments to two-weeks of salary regardless of time served.  Loyalty goes out the window as the company throws veterans and new employees alike out on their asses.  We hear that the CEO has dumped most of his shares despite a promise earlier in the year not to.  I decide to enjoy an extended Christmas vacation, away from this stress.  I tell my boss on a Monday morning that Friday is my last day.

January 2008

Two weeks after I leave, management is finally shocked out of its groupthink, but too late to do anything about it other than take the first only offer for a buyout - at 6% of its April valuation - just 7 months earlier.  Probably just days away from going out of business.

---

I never saw anything unethical.  And the one time a mortgage broker tried to steer an applicant to a SubPrime loan instead of a standard loan that they qualified for, I saw a lightening bolt go from the CEO's office to that broker and read about it on the front page the next day.  My boss might have been an ass and the CEO clearly failed to grasp the gravity of the situation, but I otherwise worked with extremely smart and honest people.

The CEO took some heat and had to pay some guilt money over his stock sales, but I don't judge him for the broken promise to Wall Street.  He made the promise in one environment and was faced with a new environment later that year.  You'll see this paradigm shift in The Big Short.  And, those were his shares to sell.  If you don't like executives getting rich on stock grants, outlaw stock grants or close the stock markets.  For more on this, see Marx. Or Obama.

What could we have done differently?  The company's business model was to offer EVERY new loan program from Fannie/Freddie.  There was zero consideration for default probabilities.  In other words, we had no management that reviewed loan programs with an ethical eye.  And I'd argue that it wasn't their job to do so.  But the industry's assumption that the ratings agencies, or congress, or Fannie/Freddie were policing the ethics, in hindsight, was the stupidest and most costly assumption in banking history.

One aspect that The Big Short did not cover was the churn at the mortgage companies.  Most mortgage lenders are dead if they do not recover the loaned funds within THREE DAYS.  This occurs in their Secondary Marketing divisions.  This means they must package the new loans into Mortgage Backed Securities and sell those securities - all in three days.  The more competitive firms, like mine,  would actually pre-sell securities that were promised to have a certain mix of loans, by loan type, lender FICO scores, or some other measure that the investors preferred.  Understand this for a better movie-going experience: [most] mortgage lenders do not hold/own the loans they process.  It isn't the defaults or the collapse of MBSs that bring a mortgage lender down.  They die when either they are separated from their funding sources, their funding sources charge too much, or when they cannot make their 3-day churn.

My criticisms of The Big Short: 

You'll see a family lose their home in this movie, and that happened.  But more often, people stayed in defaulted properties for one or more years at the expense of you, the taxpayer.  The rule of law was suspended - living rent free and trashing properties was allowed with no recourse. The term "Private Property" has a new definition now.

While mentioned in the movie, another factor could have received more attention: the bailout and the forgiveness of risk.  When you lend to someone who has a history of default, you accept a higher risk.  Similarly, if you buy MBS's with these crap loans in them, you accept a higher risk.  The only criticism you'll hear from me Re: President Bush is this: he should have let the banks who took excessive risks fail.  He should have let capitalism run its course.  In his defense, this was his initial impulse, but his loyalty to his cabinet, specifically the ethically-challenged former GoldmanSachs chief, Secretary Paulson, was a horrible mistake.  It not only forgave faulty risk assessment by bankers and encouraged this to continue ("Too big to fail"), but TARP opened the door for Obama to pseudo-nationalize the banks.

The movie also plays to the 'mean banks' theme of hurting the 'little guy.'  I noticed a few people in the audience succumbed to this theme as they were visibly agitated.  Don't fall for this anti-capitalist bullshit - it was nothing personal.  This gets to the blame question.

The movie doesn't place blame, and they show all but one factor.  Was it the home-buyer who didn't understand the contract that they signed?  Was it the broker who matched the buyer to a loan program?  Was is the mortgage-lender who maximized profits with customized Mortgage Backed Securities?  Was it the ratings agencies (the movie does a great job exposing these agencies and their true motivations)?  Was it the pension funds who clammored for MBS, thus enabling this entire market?  Was it fraud (yes, some at the broker level) or was it layer upon layer of stupidity and groupthink (bingo)? 

The factor missing from The Big Short.  The biggest reason for the mortgage and banking crises.  The reason we are still suffering from the events of 2007 and 2008: Democrats. 

It was Democrats who demanded SubPrime following the LA Riots, which were triggered by a lack of 'dignity' in that oppressed, SubPrime market.  It was Democrats Barney Frank and Chris Dodd who rewrote banking law and, with their fellow Democrats, allowed encouraged the semi-private/semi-public Government Sponsored Enterprises (GSEs - Fannie Mae, etc.) to guarantee stupid loan programs that required no income, no down payments, etc.

Last:

I suspect the next bubble will be defaults in municipal bonds.  Specifically cities that have been run by Democrats for decades.  I thought of this as I watched the S&P scene in this movie.  When you see this part of the movie ask yourself as I did: Has Chicago earned its current BBB+ rating?

If you like The Big Short, consider watching Margin Call.