Thursday, December 24, 2015

The Big Short Falls Short

The Big Short Falls Short

After you’ve seen The Force Awakens for the second or third time you might be in the mood to watch The Big Short, the movie adaption of Michael Lewis’s book.  This post is not meant as a movie review, and there’s a very good chance that I’m not going to see The Big Short.  However, I have read the book, and I expect that the movie will tell the story as well as Mr. Lewis constructed it in his book.  Even if the movie is true to the book, the book is not a serious explanation of the financial crisis or the housing bubble. I’m sure you’ll get caught up in the detective work of the hedge fund managers who figured out that Wall Street was manufacturing fraudulent products.  It’s likely you’ll feel a bit of admiration for the hedge fund managers as they put down their bets (selling short) and wait for the housing market to crash.  However, the protagonists in the movie/book aren’t heroes, and they didn’t do anything to prevent the crisis or staunch the losses when the market crashed.  They just cashed in when the housing market collapsed.

Investors who short are selling securities they don’t own in the expectation that they will be able to buy those securities at a lower price.  They aren’t better investors than conventional money managers. Instead of seeking investments that are likely to go up in price, they are looking for securities that are prone to fall in price.  Sometimes short investors get it right and generate handsome profits, and sometimes they get it wrong and lose a lot of money.  And like your average money manager, the difference between those that make money and those that lose money is usually determined by pure chance.

Contrary to the central contention of the movie, the protagonists weren’t the only ones who thought that housing and mortgage securities were vastly overvalued.  Many investors, economists, and regulators believed that a housing bubble had formed.  Unfortunately, the tactics of Wall Street and the insatiable appetite of all too many investors for yield kept the bubble inflated.

The movie will leave you a strong feeling that the protagonists are heroes.  Investors, long or short, aren’t heroes.  They aren’t moral or immoral.  They are just making bets, hopefully informed bets, about the direction of security prices.  As I’ve written many times before, investing is an amoral exercise.  When we turn portfolio managers into heroes, we’re distorting their role and exaggerating their power, whether they buy or sell stocks, bonds, or derivatives.  Hero worship in the financial sector is a dangerous practice as it leads to excess, gross inequality, and severely distorted public policy.

Adam McKay and Charles Randolph, who wrote the screenplay, deserve great credit for turning money management into viewable entertainment.  However, The Big Short tells a story that has little to do with the sources of or resolution of the greatest financial disaster since the Great Depression.

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