Anchorman auteur Adam McKay's new film The Big Short based on Michael Lewis's book about a handful of Wall Street sharps who made billions betting on the housing crisis, is filled with explanation. (The movie opens in limited release on Friday, Dec. 11 and goes wide on Dec. 23.)
We're not talking about the kind of incidental explanation that gets tucked into the story via implausibly encyclopedic dialogue á la Aaron Sorkin. Instead, The Big Short breaks the fourth wall; the plot is paused; and various unexpected celebrities (who aren't even in the rest of the movie) address the camera to literally explain financial jargon and concepts essential to the story.
These interludes, though mildly amusing, are a bit disruptive to the story's dramatic effect. But let's face it, most of us didn't understand the financial crisis as it was going on, and many of us are still a little fuzzy about the specific mechanisms that nearly brought down the world economy. What's more, it's pretty clear that a lot of Wall Street's coma-inducing jargon and endless abbreviations—which have been known to flummox judges and put jurors to sleep—is actually part of an intentional strategy to separate otherwise reasonable people from their hard-earned cash.
So the explanations pay off, and you can understand and enjoy "The Big Short" on their strength alone. But the movie is definitely enhanced by a little background information. Here's a list of five things you should know before buying a ticket.
1. A brief summary of the financial crisis
In a very, very small nutshell, the meltdown happened because banks were irresponsibly giving mortgages to people who couldn't afford them (and, in truth, probably shouldn't have taken them on). The banks then bundled all those mortgage IOUs into bonds and other more exotic securities and sold them to big-time investors, including pension and hedge funds, under the pretext that they were extremely safe investments.
Unfortunately, they were not safe at all. Many of the underlying IOUs turned out to be pretty worthless because someone making $30,000 a year often can't pay a fat mortgage. As a result, the bundles of mortgages (and bundles of bundles of mortgages) soon lost much of their value, too. Because so many investors had been gorging on these "mortgage-backed securities," their drop in value generating huge investment losses for major financial institutions, some of which went under, while those that survived all but stopped lending money. The financial system ground to a halt, and the economy went into a tailspin as the reverberations cascaded through the system: More homeowners lost jobs and stopped paying their mortgages, which caused more investment losses, and so on in a vicious cycle.
2. What it means to "short" something
Most people, correctly, think of successful investing as buying stocks or bonds when prices are low (because you believe their value will go up) and later selling high. Investors who "short" also hope to buy low and sell high—but they sell first (believing the value will go down) hoping to later buy low. Essentially, a short is a bet that a security will decrease in value.
The mechanics are a little complicated. After all, how do you sell something you don't yet own? You do it by first borrowing the security with a promise to return it at a later date. If you were wrong and the value goes up in the meantime, you have to buy it back at a higher price in order to return it—meaning you lost money on your bet.
The Big Short protagonists couldn't use this fairly straightforward shorting approach to bet against the American housing market. So much of the film deals with their efforts to structure a series of insurance deals that would have the same effect. In essence, the deal they created involved paying an insurance premium every month that the housing market remained healthy, with the knowledge that they'd get a huge insurance payout if and when it got sick. And as we know, it got very sick.
3. A few key definitions
We've come this far without much jargon. But these things have names and it'll help to know them.
- Mortgage A loan that the borrower uses to buy real estate.
- Sub-prime mortgage A risky mortgage loan made to someone with a relatively low credit score and insufficient income to get a conventional mortgage. Sub-prime borrowers are more likely to default (or be unable to make payments on) their mortgages.
- Mortgage-backed security (or MBS) A bundle of mortgages that's sold and traded like a bond. When you bundle a lot of mortgages, even sub-prime ones, it's unlikely that all of them will default at the same time, so the risk associated with the bundle is thought to be relatively low. The relative risk of these bundles get graded by ratings agencies like Standard and Poor's and Moody's.
- Collateralized debt obligation (CDO) A bundle of mortgage-backed securities. Yes, a bundle of bundles of mortgages. There were also "CDO Squared," which were bundles of bundles of bundles of mortgages. As you would imagine, these got so complicated that nobody really understood what the underlying value of these were. Yet in many cases they were still rated as very safe investments. Oops.
- Credit default swap An insurance policy that pays off if a CDO defaults. This is how The Big Short guys bet against the real estate market.
- Synthetic CDO An even more ridiculously complicated kind of CDO made up of insurance payments from a credit default swap on CDOs made up of MBSs. Got that? Unfortunately, neither did most of the people buying and selling them.
If this stuff is still unclear, that's okay. The film explains it, like I said, and it's fun even if you don't follow the details.
4. This story isn't just about bad policies, over-extended borrowers, and risky bets gone bad.
It's about fraud and deception, too. Many people who got caught up in the crash—ordinary homeowners and investors alike—had fallen under a kind of mass delusion in which the American housing market was considered invulnerable. But many people knew exactly what was going on and went to great lengths to exploit the situation, often through out and out dishonesty.
While an embarrassingly small number of people were held accountable, the circumstantial evidence is pretty strong on numerous fronts. There were would-be home buyers who overstated their income on mortgage applications; lenders who looked the other way knowing they wouldn't be responsible for the clean-up; appraisers who overstated the value of homes; rating agencies who rubber-stamped securities to get business; traders who knowingly sold investors on securities they knew to be a “sack of sh-t.” The deception and treachery may be best captured by a perusal of the SEC’s full laundry list of complaints against banks. It's slightly satisfying when you look at the millions in settlements, until you consider that those fines might have been a few orders of magnitude higher, and that taxpayers spent gazzillions helping many of these banks.
5. There are no true heroes in this movie.
To win over moviegoers, the Big Short positions its protagonists (played by Steve Carell, Ryan Gosling, Christian Bale, and Brad Pitt) as scrappy underdogs engaged in an ethically justified heist-like gambit against the greedy and faceless big banks. But the reality isn't so simple. It's impossible to shake the fact that these guys became fantastically wealthy betting against the fortunes of millions of ordinary Americans, many of whom lost their homes and jobs to the crisis—not to mention the global after-effects that we are still seeing unfold. Some analysts have even argued compellingly that The Big Short dudes (and guys like them) actually made the housing crisis and economic meltdown worse than it otherwise would have been.
The movie vaguely acknowledges this moral ambiguity. "You just bet against the American economy. And if you win, hardworking people will suffer," the Brad Pitt character says, "so try not to celebrate."
But overall, it celebrates their victory. Now you have the tools to decide how you feel about that.