Reflection on “The Big Short”: Overconfidence, Greed, and the 2008 Crisis

Overconfidence and the Housing Crash

The financial downfall in 2008 is depicted in the book and movie The Big Short, which tells how a group of traders foresaw the housing crash before anyone else. Their predictions made them pocket hundreds of millions while Wall Street associations collapsed. Michael Burry, a hedge fund manager at Scion Capital, recognized that the U.S. housing market was virtually an asset bubble inflated by high-risk loans; therefore, he created a credit default swap that would allow him to short the housing market.

As his clients grew angry in disbelief, they demanded their money back, so he placed a moratorium, a temporary prohibition of activity, on their withdrawals.

Throughout The Big Short by Michael Lewis, many themes contribute to the relationship between risk and reward. Of course, without certain risks, a minimal amount of reward is attainable within the business, especially in a financial market; contrary, too much confidence leads to the first theme of this paper.

Overconfidence can be seen throughout both the book and movie by not just the characters but all Americans with a subprime home loan mortgage. Many believed that the subprime mortgages would never fail, including those who worked for large investment firms: those who invested in the subprime mortgage bond market and expected long-term success. Overconfidence is one of the main problems on Wall Street, as so many people need more confidence in their own companies’ abilities, power, and prestige. With such confidence, many people overlooked the problems with the subprime mortgage bond market until its downfall in 2008.

Unraveling Wall Street’s Greed

Greg Lippmann, former bond salesman at Deutsche Bank, discovered Burry’s goal to establish the credit swap just as hedge fund manager Steve Eisman joined Burry in investing in the credit default swap market and wrote a paper forecasting financial trouble. Eisman soon recognized that poorly structured loan packages known as collateralized debt obligations (CDOs) received AAA ratings, which exacerbated the mortgage crisis. Baum saw the risk in the CDO market and concluded that the housing bubble would ultimately lead to the collapse of the U.S. economy.

Two investors, Charlie Ledley and Jamie Mai, took investment advice from retired banker Ben Rickert after discovering Lippmann’s paper with the forecast for financial trouble. After profiting from a series of bets against the housing market, Rickert became angry that they profited without his benefit off of the downfall of America. This relates to the second theme in this paper, greed. Burry betting against the “steady, safe” housing market can be seen as greedy due to investing more than $1 billion of his investors’ money into credit default swaps. Though the investors made substantial wealth on their trades, they were also left with moral instability and shock from the large amount of risk they had just taken, which fueled the bailouts of several banks.

Society, Class, and “The Big Short”

Charlie and Jamie later sued the rating agencies for their misleading rankings of mortgage-backed securities and mortgages. At the same time, Burry produced roughly a 5,000% return for his investors who stayed with him during the housing market’s collapse. (Investopedia, Baldwin). Due to large banks bundling America’s home mortgages into CDO bonds, they targeted working-class, blue-collar folks with the initial low interest rates before increasing the prices after the grace period. Soon after, they cannot repay the loans when the price increases, leading to one of the biggest economic crashes in American history.

These actions attracted Rickert’s attention negatively, which leads to the third and most important theme within ‘The Big Short’: society and class. Rickert and the other greedy opportunists took advantage of those with subprime mortgages as they watched America’s economic collapse. “The growing interface between high finance and lower-middle-class America was assumed to be good for lower-middle-class America.” (1.19, Michael Lewis).

This quote from The Big Short expresses how subprime bonds allow working-class citizens to borrow money at reasonable rates. While holding a promising theory, the problem is that they are designed with deception and spiral out of control. These Americans relied on the increasing value of their homes in which they could and did borrow more money against their property for bills – a catastrophe waiting to happen. After a short period, the financial market bellied up as home prices decreased.

References

1. Lewis, M. (2010). The Big Short: Inside the Doomsday Machine. W. W. Norton & Company.
2. The Big Short. (2015). [Film]. Directed by Adam McKay. Paramount Pictures.

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