The Big Short - Alaska Permanent Capital Management


The Big Short

There is a lot of animus directed at the big Wall Street banks and their role in the Panic of 2008. That was on full display in the movie “The Big Short”. It’s patterned after the bestselling book of the same name by Michael Lewis. I’ve read the book several times and watched the movie last week.

The plot surrounds several investors who figured out that the subprime mortgage market was a ticking time bomb ready to explode in a series of defaults and foreclosures due to poor underwriting, partly due to an originate to distribute model of mortgage finance (not an originate to hold model). You see, loans were made and rather than kept on the books of the originator (eat their own cooking) they were packaged up as securities. They were sent off to Wall Street, rated by Moody’s and S&P, and then made their way to every nook and cranny in the world, as global investors gobbled them up stretching for yield.

These guys shorted these securities (hence the title) betting that prices were going to fall. They plunged; big time. But not right away, which gave the shorts anxiety attacks as markets went against them early on, but they stayed the course and made a fortune.

I didn’t particularly like the movie but I’d say it fairly represents what happened, with respect to subprime. BUT, let’s be clear, there is a lot of blame to go around concerning the financial crisis and “bailouts”. Here are some points to ponder:

  • We got our money back with interest from all the big banks, including Fannie Mae and Freddie Mac.
  • Several banks were forced to take money even though they didn’t want or need it, including Wells and JP Morgan. This was to reduce the “stigma” of taking money from the government by the other banks.
  • Granted, no banker went to jail although the banks shareholders have paid over $100 billion in fines and settlements with the government.
  • The only “bailout” where taxpayers lost money were the auto bailouts. That’s where secured creditors were “crammed down” by the government and the rule of law was abrogated.
  • The system was vulnerable. Everyone (and I mean everyone) took on too much debt. Consumers, governments and financial institutions. A build-up of debt typically precedes a financial crisis, because it is an obligation that needs to be paid back on a timely basis (unlike equities). We lived beyond our means for a number of years in the early to mid-2000’s.
  • Regulation was lax and dispersed but now the pendulum has swung to much more intrusive regulations that stifle innovation and risk taking. Compliance costs have gone way up.

Policymakers did the best they could under trying circumstances. You can’t prove a negative – but I think it would have been worse if they did nothing. Ben Bernanke was the nation’s expert on the Great Depression, I’ll side with him. Although I do get tired of these policymakers portraying themselves as heroes. It did all happen on their watch after all.

Bad news: the top banks are bigger than before. Good news: today, the banking system is much stronger and better regulated. It is a bit more “utility-like”.

Jeff Pantages, CFA®
SVP, Investments


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