Finance Professors at the Movies: Reflections on “The Big Short”

For Isenberg finance professors, a Friday night expedition to The Big Short, Adam McKay’s movie about the lead-up to the 2008 financial crisis, proved both compelling and troubling. As a group, the professors—all dedicated cinephiles—regularly take in movies where financial and public policy issues meet. Afterwards, they meet for animated discussions that would no doubt energize their students.

The Big Short, the professors agreed, was at its best in chronicling the activities of its vivid characters. First and foremost, it followed the improbable pathways to investment success of several maverick investors (memorably played by Christian Bale, Steve Carell, Brad Pitt, and others) and their funds, who—independent of one another—had discovered growing instability and potentially inflated values in the U.S. home real estate market. Taking short positions on the market, they placed bets with incredulous, clueless players at the major investment houses.

In their market research, the mavericks paid due diligence visits along the entire food chain of the mortgage-generation machine. They visited the nonbank banks that fueled the mortgage free-for-all by conspiring with investment houses to create risky and potentially overpriced securitized mortgage investment funds. They interviewed unscrupulous realtors, home owners, and renters of properties who would face prohibitively higher interest rates earmarked for 2007. And they visited a ratings agency that, like its competitors, looked the other way in the face of multiplying red flags.

Professorial Insights

 "The movie artfully explained complex financial concepts like securitized mortgage funds and collateralized debt obligations."

“The movie’s many strands did ultimately come together,” observed senior faculty member Ben Branch. “I didn’t find any obvious errors in the narrative and the movie artfully explained complex financial concepts like securitized mortgage funds and collateralized debt obligations.

“The Big Short failed to reveal that the banks got off scot free and that almost nobody went to jail,” Branch continued. “Ultimately, they did pay back the money, including the interest. And they also faced large fines, government regulation, and private law suits.”

In its abrupt ending, the movie remained faithful to the Michael Lewis book on which it was based, noted the professors. Both the book and the movie conclude with the crisis still in full swing but before lawmakers and regulators responded with unprecedented regulatory teeth. Dropping the curtain at that juncture, the professors agreed, left viewers in a disturbing limbo mirroring the unresolved crisis.

“The new regulations, based on Dodd-Frank legislation and executive orders, now require large banks and other financial players to measure and report the risks that their activities might impose on the greater financial system,” observed finance professor Mila Getmansky Sherman. “They must now, for example, regularly conduct prescribed financial stress tests. The new system-wide vigilance is a sea change from the fragmented behavior that was so well depicted in the movie.”

The Trouble with Real Estate

“Real estate as a vehicle for speculation on Wall Street—that was dangerous, remarked Ginnie Gardiner, a lecturer in finance. “Wall Street was too far removed from the underlying market; too high above the ground.” “Few on the Street and in the nation itself believed that real estate prices could go down,” added Getmansky Sherman. “The high-tech bubble of the late 1990s focused on stocks and technology investors,” she continued. “This time the damage was more mainstream: real estate and home ownership—what could be more central to average Americans?”

"Without question, lack of common sense regulations played a key role in the creation of exploitive derivative structures like CDOs."

The damage, the professors agreed, was hugely compounded because pension and other funds had incorporated the securitized real estate funds into their portfolios. Like home ownership as an investment, securitized real estate funds were wrongly viewed as bullet proof.

Common Sense and Ethics

“Without question, lack of common sense regulations played a key role in the creation of exploitive derivative structures like CDOs,” notes finance department chair Sanjay Nawalkha. “Eight years before the blow-up, removal of all regulations on OTC derivatives by the CFMA act of 2000 –supported by Alan Greenspan, Robert Rubin, and others—turned even basic derivatives like the credit default swap into what drugs would be like without regulatory authority from the FDA. In the absence of margin requirements, capital requirements, or disclosure requirements, banks overdosed on those derivatives. “As if that wasn’t enough, the problem was compounded by the relaxation of the net capital rule by the SEC in 2004. It allowed banks to join the party in overdosing on financial leverage.

“As a department, we have special strengths in alternative investments, including derivatives. An understanding of those practices does benefit our students, but that value is marginal compared with a solid grounding in finance fundamentals coupled with discussions that provide a moral compass.”

“I make a point of integrating newsworthy stories about illegal, unethical activities into my classes,” observed Professor Branch. “When conflicts of interest, insider trading, and other deceptive practices emerge through the news, we have discussions. Over the years, my message to my students has remained constant: Your most valuable asset, I emphasize, is your good name!”