Five lessons to learn from The Big Short (film).

Usually I warn against making conclusions from fiction books or films about financial markets. However, the Big Short gives some genuine lectures, at least between the lines.

Lesson 1: Even if you are 100% sure, don't put all eggs in one basket.
Michael Burry is the first who recognizes the forthcoming mortgage crisis. He is eager to act since otherwise the opportunity may be missed. But later he, himself, admits that he might have acted prematurely (0:47). On 1:17 he writes down the drawdown of Scion Capital: -19.7%. His boss and investors are in panic, the Scion approaches bankruptcy by the width of hare.
Conclusion: Even if an opportunity is good, don't bet all you capital on it. Even if you don't exploit it completely, other opportunities will follow. But if you bet everything and lose, you are broke. Remember, you can recover from losses but not from the bankruptcy!
By the way, a similar case (however, without happy ending) is described in excellent book What I Learned Losing a Million Dollars by Jim Paul.
Jim bets on trend reversal and eventually he is right ... but unfortunately first he gets the margin call.

Lesson 2: Check yourself and trust your own eyes.
Jamie and Charlie personally talk to tenants (0:44). Mark Baum meets mortgage brokers (0:51) and even a stripper (0:53). Actually, there is an additional lesson from the dialog with a stripper (who blindly trusted her financial adviser and bought 5 houses).

Lesson 3:  Assessors are often not impartial.
On 1h 05m an S&P clerk admits that S&P has to rate mortgages as AAA otherwise the customers go to Moody's. Remark: I find it a little bit unfair since it was S&P who dared to downgrade US rating in 2011. But anyway you should always remember that the rating agencies and auditors work for the companies, not for (retail) investors.

Lesson 4: In crisis they fall together.
On 0:30 there is an excellent explanation how the CDO pyramid will fall.
Also have a look at my post on the limits of the diversification.

Lesson 5: The number of mortgage defaults increases but it takes long time until the market finally collapses (e.g. 1:17).
Conclusion:
 "The market can stay irrational much longer than you can stay solvent" (J.M. Keynes).


P.S. Due to complicated copyright laws I don't dare to put screenshots from the film here, instead I note the time of the respective scene. But, recalling the Lesson 2, I put some other images here
20160921_073725__emptycommercialrealestate1 20160921_073947__emptycommercialrealestate2 20160921_074030__emptycommercialrealestate3

In German cities like Stuttgart it is currently hardly possible to find an affordable residence but so much commercial real estate stays unleased. Moreover, there are more and more "strippers" that take mortgages, which are too risky for them...
Yes, the German real estate market is much more conservative that the US one by that time. In particular, the foreclose does not make a borrower completely free of debt, so the falling prices will not cause a chain reaction. But defaulting debtor will!.. However, also don't forget the Lesson 5 ;).

5 thoughts on “Five lessons to learn from The Big Short (film).”

  1. I like the remark from lesson 3: “But anyway you should always remember that the rating agencies and auditors work for the companies, not for (retail) investors.”

  2. Good rules, but alas they do not prevent future failures.

    History teaches we do not learn from our mistakes; we make new and more subtle errors.

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