The Big Short
The Big Short is a biographical comedy-drama film about the real-life events surrounding the financial crisis. It is based on Michael Lewis' 2010 book, The Big Short: Inside the Doomsday Machine, and focuses on how the housing bubble caused the financial crisis. The movie also offers insight into the role of credit default swaps and securitization.
Michael Burry's background could have detracted from his story arc in "The Big Short." However, Burry's transformation from medical doctor to financial guru is so compelling that it almost merits a movie. Plus, at 44 years old, he has time to make even more career changes. "The Big Short" is up for five Academy Awards at the 88th Academy Awards.
The film follows the events leading up to the subprime meltdown and the cynical men who profited from the crisis. The plot centers on Michael Burry, an eccentric ex-physician turned hedge fund manager at Scion Capital. He believes that the booming U.S. housing market is a major asset bubble.
The process of securitisation entails a lot of risk, which is why it's important to have high standards and good common sense when investing in securitisations. Overconfidence, greed, and misalignment of interest can lead to overleveraging. The recent financial crisis is an example of how securitisations can go terribly wrong. As a result, there are few advocates for radical changes in this market.
As risk was transferred to the end investor through securitisation notes, standards for loans dropped dramatically. The NINJA loan, which stands for "No Income, No Job, No Assets," is a prime example. The securitisation notes backed by these loans were rated high, but many investors never checked to make sure that the loans were quality loans.
Collateralized Debt Obligations
Collateralized debt obligations are pools of debts that are traded on the capital markets. The idea is that they can create price discovery and liquidity for investors. This makes them attractive to a broader group of investors. There are some concerns about CDOs, though. First, it is important to understand that they are not the same as mortgages. Instead, they use corporate debts as collateral. Despite the risks, CDOs performed well during the Great Recession and remain a thriving market today.
CDOs are not risk-free investments. Many investors have suffered big losses in this market, and there is no way to predict when they will recover from these investments. The problem with CDOs is that they're a risky way to invest in mortgages. A CDO contains a large amount of debt, but it can't pay off a single mortgage. Investors buy into the CDO in the hopes that the repayments will increase over time. But they've been burned time and again.
Credit Default Swaps
When Michael Burry realized that the housing market was full of subprime mortgages, he decided to make a profit by short selling them. To do this, he convinced investment banking firms to sell him credit default swaps. He then sold these positions with the assumption that housing prices would fall. This gamble paid off and Burry earned over one hundred million dollars.
In early 2007, mortgage default rates start rising while bond ratings remain unchanged. Despite this, professional investors such as Mark Baum and Jared Vennett make fortunes by holding credit default swaps and buying them when the market is at its most expensive. But Mark Baum is skeptical, believing that this entire system is riddled with dishonest people.
"Morgan Stanley and the big short" by Michael Lewis explores the "inside" forces that led to the 2008 real estate bubble and near-collapse of Wall Street. It also tells the story of how one bond trader managed to make $16 billion in the wrong way, risking the bank's capital. The story begins with Howie Hubler, the head of Morgan Stanley's subprime mortgages division. Hubler's team had purchased credit default swaps on mortgage bonds prior to the collapse of the market in 2003.
Morgan Stanley was heavily invested in the housing market before the 2008 financial crisis, which resulted in a massive crash. The firm sold subprime mortgage bonds to investors, and then bet on these bonds to make money. This strategy made Morgan Stanley a "bank within a bank." By April 2006, Hubler and his team were responsible for 20 percent of Morgan Stanley's profits.