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Investopedia/James Garret Baldwin: 'The Big Short' Explained

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'The Big Short' explained
By James Garrett Baldwin | Updated November 7, 2017 — 9:50 AM EST
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The Big Short is a 2015 Oscar-nominated film adaptation of author Michael Lewis’s best-selling book of the same name. The movie, directed by Adam McKay, focuses on the lives of several American financial professionals who predicted and profited from the build-up and subsequent collapse of the housing and credit bubble in 2007 and 2008.

Published in 2010, The Big Short: Inside the Doomsday Machine was a loose sequel to Lewis' best-selling book Liar's Poker, a chronicle of his work experiences at Solomon Brothers in the 1980s. Both non-fiction works offer a deep dive into the lives, workplaces and psychology of several Wall Street professionals and the financial world.

This article explores The Big Short, its main characters, and the stylistic tools used by McKay to explain complex financial instruments engineered by the banks during the run-up to the subprime mortgage meltdown.
The Big Short

The Big Short was not the first film adaptation of a successful non-fiction book covering the financial crisis. In 2011, HBO adapted Andrew Ross Sorkin’s crisis tell-all Too Big To Fail, which also had a star-studded cast. That story centered more on the few weeks leading up to the collapse of Lehman Brothers and the Congressional response to bailout the nation’s largest banks (For more, read Top 6 U.S. Government Financial Bailouts.)

The Big Short, however, is a character-driven piece that focuses not just on the events leading up to the financial crisis but also the conflicted morality of several men who foresaw the crisis well in advance. The film adaptation stars Christian Bale, Steve Carell, Ryan Gosling, and Brad Pitt.

The story chronicles the work of hedge fund manager Michael Burry (portrayed by Christian Bale), who recognizes that the U.S. housing market of the early 21st century is virtually an asset bubble inflated by high-risk loans. In 2005, Burry – the manager of Scion Capital — creates a credit default swap that would allow him to short the housing market. However, his clients grow angry. When banks and creditors argue that housing is stable, and the market in fact does keep on surging, his clients grow angry and fearful as Burry continues his short plays. When they demand their money back, he places a moratorium on withdrawals.

Meanwhile, Jared Vennett (Ryan Gosling) inadvertently discovers Burry’s goal to establish the credit default swap. Hedge fund manager Mark Baum (Steve Carrell) joins Burry in investing in the credit default swap market and recognizes that poorly structured loan packages known as collateralized debt obligations (CDOs) have received AAA ratings and are exacerbating the mortgage crisis. After discovering that questionable innovation in the CDO market has fueled massive risk in the markets, Baum concludes that the housing bubble will ultimately lead to the collapse of the U.S. economy and bets big – shorting the financial sector. (Baum was based on real-life hedge fund manager Steve Eisman. Vennett was based on Greg Lippmann, a former bond salesman at Deutsche Bank.)

Finally, two investors – Charlie Geller (John Magaro) and Jamie Shipley (Finn Wittrock) – seek the investment advice of retired banker Ben Rickert (Brad Pitt) after they discover a paper written by Vennett. After Shipley and Geller make a series of successful bets against the housing market, Rickert grows angry that they have profited off the downfall of the U.S. economy and Middle America’s financial doom. Geller was based on Cornwell Capital founder Charlie Ledley, while Jamie Shipley was based on Cornwell partner Jamie Mai. Rickert was based on Ben Hockett, a former trader at Deutsche Bank.

Though they make a fortune on their trades, the duo is left highly dejected about the amount of risk taken and the moral hazard that ultimately would fuel the bailouts of several banks. Shipley and Geller would later try – and fail – to sue the ratings agencies for their misleading rankings of mortgage-backed securities and mortgages.

Burry, meanwhile, ends up producing nearly 500% returns for investors who stay with him through the duration of the housing market's collapse.
Stylistic Approaches

Financial terminology and the chronology of the financial crisis is highly complex and difficult for a traditional audience to comprehend in a two-hour movie. The film production team employs a simple, yet stylistic approach to defining the tools, from collateralized debt obligations (CDOs) and tranches to credit-default swaps and mortgage-backed securities, that helped sink the global economy. (For more, read The 2007-2008 Financial Crisis in Review.)

For example, the film explains the origination and complexity of a synthetic CDO in a scene where actress Selena Gomez plays blackjack. Joined by economist Richard Thaler, they explain how increasingly larger side bets on Gomez’s hand of blackjack are great when she is winning – a metaphor for a rising housing market. However, when Gomez loses the hand – or the housing market falls – those increasingly larger side bets set off a domino effect that create larger losses at the table and the economy, respectively.

Next, audiences receive a visual aid when learning the definition of a tranche. In one scene, Ryan Gosling pulls blocks from a Jenga tower to display how tranches work in mortgage-backed securities (MBS) such as collateralized mortgage obligations (CMO). By pulling out blocks in the lower part of the tower, Gosling explains that the top-rated securities at the top end of the tower can not stand when the lower-rated securities fail and are removed from its base.

Other examples of visual cuts and props explain the complexity of financial innovation. One cutaway features actress Margot Robbie in a bubble bath drinking champagne and explaining the frailty of mortgage-backed securities. Meanwhile, TV food personality Anthony Bourdain explains how tossing a two-day-old fish into a stew is similar to the subprime mortgages tossed into CDOs to hide their risky nature from unsuspecting customers.
The Bottom Line

The Big Short received several Academy Award nominations – including "Best Picture" – and won for "Best Adapted Screenplay." Some critics, including Nobel Memorial Prize in Economics Laureate Paul Krugman, have said that the film fails to acknowledge that several people, outside of the characters profiled in the movie, also flagged the issues with subprime mortgages. Others noted that the film failed to fully acknowledge the role that the Federal Reserve played in allowing the crisis to flourish.

That said, The Big Short offers a highly engaging exploration into the years preceding the collapse of Lehman Brothers and the housing market, which led to the Great Recession. In the end, it concludes, Wall Street greed sank the global economy for years.
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