This Oscar-nominated movie sure has a lot of things to brag about; my favourite being the way they tried explaining the cause for the 2008 fiscal year recession in the most comical way without major deviations. As a student from a non-financial background or any kind of knowledge on that front, I had a hard time trying to make sense of the events that happened over 2 hours, quite short to explain the major series of events tbh. So here’s all the information I gathered today over the movie.
The movie starts with the description of the banking sector as boring and not where most of the money is made until the 1970s when Lewis Ranieri from Soloman Brothers changed it forever. He introduced Mortgage-backed security bonds to investors. Now let's break down this huge term.
Bond: Whenever an organization requires money, they issue bonds to investors which is basically a contract to pay lump sum along with interest or coupons at a predetermined time in exchange to money now. Bonds, unlike shares, do not depreciate in value based on the company’s valuation.
Mortgages are housing loans given based on an individual’s credit score and security which results in low default (faults in dues). Thus, mortgage-backed security bonds were very attractive to investors as it was the safest one on the block. These mortgages are also rated AAA, AA, BBB till C which refers to the probability of it being paid.
Mortgages are grouped together say, AAA, AA, A, BBB, BB, B and is called a tranche. A tranche issues bond for its value which anyone can buy including banks. Since this was a low-risk market with a high return, this brought in a lot of investors, mostly pension based. Bank employees were interested in their 3% commission for selling bonds and banks bought bonds to obtain profits.
Now as banks grew more greedy, they started issuing more and more mortgages as depicted in the movie where a stripper owns 5 houses. These loans are given on no security and thus default rates are high but banks dint bat an eye with all the profits they were getting. Housing prices, however, kept getting higher as technically it would be paid by the bank if not so by the mortgage holder. So tranches became more of B grade mortgages but people investing in it, more and more, for even less than 550 FICO value tranches only because it has been duped as AAA by unfaithful rating agencies Standard and Poor’s or Moody’s and named CDO. CDO is a Collateralized Debt Obligation which mixes a C rating with other mortgages which makes it diversified to obtain a AAA.
Micheal Burry who runs hedge funds ie limited accredited investors working with a guy smart enough to observe trends in the market to make huge profits. Funds also have a lock-up period of at least a year as this money goes through a turmoil of actions and investors may panic midway. Burry spots these low rated Mortgages being put into bonds on the market and decided to short it.
Short position is the sale of a borrowed security, commodity, currency with an expectation of asset falling in value. A person borrows security, commodity, currency from the bank and sells it to people immediately and keeps the money to himself. Now as predicted when the value falls, he pays for the borrowed commodity at the lower price back to the bank thereby making profits.
The payment for the deal is done with credit default swaps which is a financial tool used to purchase insurance on investment. So, Burry buys CDS from the bank for the mortgage based security bonds. The banks happily agree to this only because the housing market is going strong for 30 years and they had no reason to foresee a bubble there.
Investors were highly doubtful of Burry’s expertise in handling 550M which includes the premium for 6 years. They wanted out on several occasions after which Burry locks the investments, making a lot of investors furious. However, when the market collapsed he made 489% profits ie 2.69B.
Jared Vennett played by Ryan Gosling was a Global asset back security trader at Deutsche bank who heard about Burry’s deal and wanted to get profits from it through commissions by explaining the entire picture to Mark Baum played by Steve Carell connected through a wrong call. Baum runs Frontline another hedge investment firm under Morgan Stanley. Baum refuses to believe the whole scenario until he sees it in his own eyes through the house broker, stripper and finally CDO manager Wing Chau.
Vennett had already shown them the increase in default rates which was at 1% in 2006 which raised to 4% in 2007 and it had to get to only 8% for it to collapse the housing market due to a chain reaction. Wing Chau spoke about synthetic CDO ie bets on CDO more in value than an actual commodity at the ratio of 20:1. So, if the market goes down, it goes down with all of it. This is when Baum realizes the market is going to collapse and buys more swaps. Vennett makes 47M out of all these trades. It all takes a big turn at the end when Baum realizes that he has bet against Morgan Stanley which is his own but goes on to sell swaps and make profits with a heavy heart.
Brownfield investors had also profited from this period. Charlie Geller and Jamie Shipley are shown as small-time investors who made $110,000 into 30M but short of 1B and 470M to get an ISDA license which allows them to trade big. They find out about the housing bubble and take it up to Ben Ricket, a retired banker who helps them buy and sell the swaps for profit. They shorted AA and got most profit out of the three stories as AA have more payout ratio. They made 80M in this deal. Ben Ricket was however sensitive about making money this way as millions were about to lose their livelihood.
Overall the movie was very interesting to watch and had a lot to learn from.