Finance in Films
On the depiction of the '08 crisis
The financial crisis of 2008 made drastic changes to the landscape of finance and in the lives of people around the world. This article explores how the crisis unfolded and examines the concepts and instruments in finance that led to this misery. I try to comment on how well these concepts were depicted in arguably two of the best movies in the financial-drama genre: Margin Call (2011) and The Big Short (2015). Each movie will be broken into key scenes, and we will study them individually.
Introduction
The financial crisis of 2008 was a major global economic event that unfolded over the course of several years. It began with the bursting of the housing bubble in the United States, which had been fueled by high levels of mortgage debt and relaxed lending standards. As housing prices fell and defaults on mortgage loans increased, many major banks and financial institutions were left holding large amounts of toxic assets, which caused their balance sheets to deteriorate rapidly. This led to a crisis of confidence in the global financial system, with investors and banks becoming increasingly hesitant to lend money to one another.
As the crisis deepened, a number of major banks and financial institutions, including Lehman Brothers and Bear Stearns, collapsed. This sparked a global panic, with investors and banks alike rushing to withdraw their money from the markets. The resulting credit crunch made it difficult for businesses to obtain the financing they needed to operate, leading to widespread economic slowdown. Governments around the world responded by implementing a variety of measures, including bailouts and stimulus packages, in an attempt to stabilize the global economy.
The consequences of the crisis were severe, with high levels of unemployment and increased poverty in many countries. The crisis also led to a widespread loss of confidence in the financial system, with many people losing their savings and retirement funds. A lot of stringent regulations have also followed in the end.
Let’s look at some important definitions and concepts that led to this crisis. The products which led to the collapse are CDOs, synthetic CDOs, and MBS. On the other hand, the financial instrument that helped people make money from the collapse is called a CDS. The idea behind MBS is that everyone who takes a mortgage will pay their loans eventually.
1. Mortgage-backed security (MBS):
MBS is similar to collateralized bonds, with each of them consisting of a bundle of home loans and other real estate debt bought from the banks that issued them. So, the bank will become an intermediary between the homebuyers (loan takers) and the investment industry. The bank handles the loans and then sells them at a discount to be packaged as an MBS to investors.
2. Collateralized Debt Obligation (CDO):
A CDO is a synthetic investment product that represents a complex pool of loans that is sold to institutional investors. It can be seen as a derivative because its value depends on the underlying asset and these assets become the collateral if the loan defaults.
3. Credit Default Swap (CDS):
A CDS is also a derivative product which acts like insurance against the default of an underlying debt instrument (like CDO). CDSs are maintained with ongoing premiums.
Lewis Ranieri, a trader, and a bank executive came up with the idea of making a product out of the logic mentioned before. MBS has become a very lucrative product, and everyone started buying into them, inflating the values, and banks in order to provide these products, have started giving out loans without any proper due diligence. Even the rating agencies have acted unscrupulously by rating bad loans very high, essentially letting banks buy the ratings they want.
As time progressed, the loan defaults increased, and people started to realize that the seemingly AAA-rated MBS were not really that sound. Then everyone started taking out money of these products eventually leading to a crash. Although the films had incredibly good screenplays, with very well-crafted dialogues and sequences, this article won’t be commenting on the depiction of the culture of the firms and people. This article also doesn’t comment on human nature or how middle-class people and taxpayers suffered the most from this crisis. We will be mainly looking at how accurate the depiction of the financial concepts was.
The primary focus for this article will be the following two films. The first one is Margin Call a 2011 film directed and written by J.C. Chandor. The second is The Big Short, a 2015 film directed by Adam Mckay building on the book The Big Short: Inside the Doomsday Machine by Michael Lewis.
Margin Call depicts the events that took place within a fictional investment bank, around the time of 2008. The movie has an excellent screenplay and can be easily understood by anyone. It throws light on how financial institutions operate, how they are too big to fail, and how it impacts the lives of everyone in the economy.
The Big Short tells the story of 3 groups who made money from the insanity and “stupidity” of the investment banks and financial institutions by shorting the housing market (betting against the American economy)
Margin Call
Key characters in the Movie:
Peter Sullivan – Junior Analyst, Risk Management Department
Eric Dale - Head, Risk Management Department
Sam Rogers- Floor Head
Jared Cohen- Divisional Head
Sarah Robertson- Chief Risk Management Officer
John Tuld – CEO of the Bank
There is a hierarchy between these characters. The junior analysts: Peter Sullivan and Seth Bregman work under Eric Dale, who works under Will Emerson, who works under Sam Rogers, who works under Jared Cohen, who reports to John Tuld (is the CEO of the bank and the one who makes the final call on any decision).
The film starts with the company laying off 80% of the firm to cut its costs. Eric Dale, one of them, gives a pen drive to one of the analysts (Peter) who works under him. Peter will finish the model in the pen drive and finds out the firm is over-leveraged. If the assets on the books of the firm drop by 25%, the losses would be greater than the entire value of the firm. He then asks Will Emerson to look at the findings of his model. An emergency meeting will be set up at 4 am in the morning, with all the senior members including John Tuld. After an intense debate, John orders his team to sell all of those toxic assets before the market could react. This decision wasn’t favored by most of the senior executives since they knew that it would destroy the firm and the member’s relationship with all it’s clients. The next day, a major sale would happen. Despite taking huge losses, they will still achieve their target. Post the sale, another round of layoffs starts, with hefty bonuses.
Now let’s look at some of the key scenes in the film.
Opening scene:
The firm lays off 80% of the people. They are rude at times in doing this. They log them out of their devices and shut their email service. Layoffs are very common during distressed periods. We have seen similar heavy layoffs in the tech industry in the end of 2022 and early 2023.
Night at work scene:
When peter finishes the model started by Eric Dale, he finds that the company is over leveraged and that is has crossed its historical volatility levels multiple times in the past week. Even though this is rare, this has happened with a couple of firms during 2008, which were reckless and didn’t have any margin for a Black Swan event.
Conference Room Scene:
At 4:AM, all the senior executives of the firm meet to discuss regarding the scary findings of Peter. John lands in a chopper and joins the meeting. Peter starts the meeting by saying
“Well as you probably know over the last 36-40 months the firm has begun packaging new MBS products that combine several different tranches of rating classification in one tradable security. This has been very profitable as I imagine you noticed.”
“Well the firm is currently doing a considerable amount of this business every
day. The problem, which is I guess why we are here tonight, is that it takes us... the firm... almost a month to layer these products correctly thereby posing a challenge from a risk management standpoint. We have to hold these assets on our books longer than we might ideally like to. But the key factor is these are essentially just mortgages, so that has allowed us to push the leverage considerably beyond what you might be willing, or allowed to do in any other circumstance, thereby pushing the risk profile without raising any red flags.”
Peter has clearly explained how bad the situation was and then looks at John for his call. John then says one of the most famous lines:
“There are three ways to make a living in this business... Be first, be smarter, or cheat.”
And then he decides to be first and to sell everything they have, which has a very bad
value, knowingly. The next morning they start a “Fire Sale”, selling everything they have, even at losses to rescue the firm.
The Big Short
The Big short is a story of the outliers who saw the storm coming and made billions out of it. They essentially “shorted” the market. Michael Burry who runs Scion Capital realized that many subprime loans were at a heavy risk of defaulting and bets against the market with 1.5 Billion $ of credit default swaps. Banker Jared and asset manager Mark Baum, and two recent college graduates, also make successful bets and profit from the decline.
Scion Capital scene:
Michael explains what subprime is to his lawyer on a phone call, “Mortgage bonds were amazingly profitable for the big banks. They made billions and billions off of their 2% fee on each of these bonds they sold. But then they started running out of mortgages to put in them. After all, there are only so many homes and so many people with good enough jobs to buy them. So the banks started doing something different. Instead of creating mortgage bonds that were guaranteed by the US government, they started creating their own private mortgage bonds. No government, no pesky standards like good credit or minimum income. And then the big banks were able to fill the bonds with riskier and riskier mortgages and keep the profit machine churning.”
Jared Meets Mark scene:
Jared sets up a meeting with mark to explain what’s going on with the housing market and how they can profit from it. He explains CDS like this, “Basically I'm standing in front of a burning house and offering you fire insurance on it.” This fire insurance he claims is the credit default swap for the MBS. Mark sums it up by saying “so the mortgage bonds are dog sh**, but the CDOs are dog sh** wrapped
in cat sh**?”
Standard & Poor’s scene:
Rating agencies are also crooked. Mark goes to the Standard and poor’s office and talk with Georgia and start questioning the legitimacy of ratings they give to the products (like MBS and CDOs) designed by the banks by asking for paperwork. Then she hesitates for some time and confesses, “If we deny them the rating, they'll go to Moody's (their competitor).”
Some of the banks are super crooked. Initially, they didn't change the price of the swaps, even when the default rates are increasing. People like Michael and Mark owned swaps at this time and were saddened by the stability of the price. This was shown in one of the scenes. But then, eventually, those banks themselves get into a net short position on those CDOs they made themselves and then price them accurately.
Bailouts:
The firms which were on the verge of collapse were rescued by the government with bailouts using the taxpayer’s money. Mark looking at all of this says
“The whole time we were wondering how the big banks could be so stupid... They didn’t care. They knew the tax payers had to bail them out.”
Final Thoughts
In the aftermath of the crisis, 5 trillion dollars in pension money, real estate value, 401k, savings, and bonds had disappeared. 8 million people lost their jobs, and 6 million lost their homes. And that was just in the USA. Margin Call can be easily understood and enjoyed even by non-finance audiences. The Big Short can be a little hard to grasp on the first watch. Overall, both films have done an excellent job of
depicting the concepts and financial instruments which lead to the demise, using short yet witty dialogues and visual elements like the Jenga, explainers from special characters like Margot Robbie, Richard Thaler, and Selena Gomez. The timing of this article couldn't be more relevant, as the economy is experiencing a tumultuous period reminiscent of the 2008 crisis. Similar events can be seen now, with SVB and Signature bank. These are really tragic events and are warnings to the whole world, and these have been happening at regular intervals throughout history. Movies like The Big Short and Margin Call played an important role in educating the public about the potential risks and consequences of certain financial practices. They shed light on the complexities of the financial system and the potential consequences of unchecked greed and recklessness. Ultimately, it is important that individuals and organizations make prudent decisions about their investments and policies.
Thanks for reading.
References
https://imsdb.com/scripts/margin-call.html
https://www.simtrade.fr/blog_simtrade/analysis-margin-call-movie/
https://www.simtrade.fr/blog_simtrade/film-analysis-the-big-short/
https://www.investopedia.com/terms/