The Big Short Reflection

In the movie the big short, Lewis Ranieri, who is a banker of the Wall Street, created an idea that companies packed thousands of mortgage all bundled together to sell, which is the AAA credit-rating bond, and can obtain high yields with low risk because everyone should pay for their mortgage. The concept of Lewis Ranieri is called mortgage-backed securities (MBS). However, the demand of buying MBS is more than MBS supply. Therefore, when the risk of MBS is high, Collateralized Debt Obligation (CDO) is a way to change subprime loans to high- rating bonds and it can be sold again. Although CDO is full of subprime loans, it still can get AAA rating because

The world’s financial system was almost brought down in 2008 by the collapse of Lehman Brothers that was a major international investment bank at that time. The government sponsored these banks’ bailouts that were funded by tax money in order to restore the industry. Before the crisis, banks were lending irresponsible mortgages to subprime borrowers who had poor credit histories. These mortgages were purchased by banks and packaged into low-risk securities known as collateralized debt obligations (CDOs). CDOs were divided into tranches by its default risk. The ratings of those risks were determined by rating agencies such as Moody’s and Standard & Poor’s. However, those agencies were paid by banks and created an environment in which agencies were being generous to ratings since banks were their major clients.

It’s a risk that these investors took where in the end, they were financially hurt by it due to the part of the subprime lenders acting unethically. Not only the subprime lenders, but also the investors because they started to loose their standards once the subprime mortgages were booming and becoming more profitable. The investors were blinded by the profit and not paying attention to the qualities of business and the loans. Once the investors started to loose their standards, that’s when the subprime mortgages were being overlooked in which they were hurt by it.

The Wall Street bankers ignored the fact that the mortgages were risky is mainly due to the confirmation bias, specifically, the Anchoring Heuristic.

Rep. Barney Frank (D-MA) explains the old system of lending and the new securitization process. Matt Demon narrates how the home buyers repaid their loans to lenders, and consequently, the lenders sold the loans to the investment banks which combined the mortgage loans with other credit loans creating a collateral debt obligation a complex derivative. The collateral debt obligation sold to investors who paid the rating agency to evaluate the CDO's. The home buyers were now paying investors through this

Prior to the 2008 economic depression, obtaining a mortgage was relatively simple for home buyers. However, many of those mortgages had provisions that made it difficult for borrowers to repay their mortgages (“Dodd-Frank,” n.d.). As a result, many homeowners lost their homes when they were unable to repay their mortgages, which led to the real estate crisis. In 2010 the Mortgage Reform and Anti-Predatory Lending Act, also known as the Dodd-Frank Act, was enacted to reform how mortgage servicers vetted borrowers and to eliminate the use of predatory loan practices (Cheeseman, 2013, p. 485). Under the Dodd-Frank Act, creditors must establish borrower’s credit history, income and expected income, debt-to-income ratio, and other factors before

Michael Lewis, The Big Short, film strategically provided three separate but parallel stories of the U.S mortgage housing of 2008. The movie demonstrated how Wall Street, in a desperate search for profits, lunched “bonds” products with riskier mortgages. As a result, lenders were no longer interested in if a borrower could pay them back. In disbelieved, I noticed deceitful tactics that lenders used, throughout the movie, to convince Americans to take out mortgages they could not afford. Chronologically, Americans’ saving levels dropped while countries ' savings tripled. Once the Recession was in full effect, the US government rescued Wall Street, passing an unimaginably large bill, the bill we are still paying off. To most Americans’ surprise, nearly all of the rescue money went into Wall Street executives’ pockets.

During the time of recession, there were many contributing factors that lead to the overall fall of the stock market. The collapse of the housing market bubble is single handily the biggest determining factor in the 2008 stock market plunge (Fry, Ebsco). Mortgage and credit lenders were partaking in unethical business practices that were going unnoticed during this time. These lenders tend to focus on balancing the level of risk and return in the market but

CDSs are used as an insurance against the possibility that the borrower could not repay his or her loan. In such case the issuer has to pay a specified sum to the buyer. Of course they are sold for a premium and if no credit events occur, the issuer makes profit. After the subprime mortgage crisis began, and many borrowers started defaulting on their loans, the pressure on the companies that had issued CDSs was rising. There were companies that simply did not have enough money to repay everything they owed. A famous example is AIG. The subprime mortgage crisis and the bankruptcy of big financial companies, like Lehman Brothers, meant that AIG had to pay much more money that it expected and made the company insolvent. The company itself had AAA rating shortly before this. This made the investors confident that even their high-rating investments failed, the insurer would certainly be able to repay them. A bailout from the US government followed. Generally, the issuers of these instruments can be held accountable for issuing them, without the ability to pay what they had to, when the credit events occurred. Of course many of them were mislead by the credit rating agencies and the overall conviction in the market that it was not as risky as it actually was. Many people argue that such instruments need to be regulated much better. They can create clear conflict of interests. For example, a

The Meltdown is a PBS special on the events of the financial crisis of 2008, in a timeline format, revealing the thinking behind decisions made during the fateful months before the stock market crash in August of that year. Some financial gurus on Wall Street devised a plan to bundle several mortgages together into a group, and then selling that bundle to another group of investors looking to invest in securities. The lender did not need to earn money from the loans he was giving out, he merely gained enough of a profit from the bundling operation that billions were being made on Wall Street from 2005-2008. The problem is that these bundles were risky, and as credit unworthy individuals defaulted on their mortgages, the entire system crumbled into what is now known as the Stock Market Crash of 2008, and have subsequently lived during the Great Recession.

In 2007, the CIO had begun constructing the synthetic credit portfolio as a hedge against the

Collateralized debt obligations (CDOs) refers to a kind of innovative derivative securities product which simply bundling mortgage debt, bonds, loans and other assets together and then rearranging these assets into different tranches with different credit ratings, interest rate payments, risks, and priority of repayment to meet the needs of different investors. As borrowers began to default, investors in the inferior tranche of the CDOs took the first hit, so the owner of this tranche of CDOs may be riskier. In order to compensate for the higher risk, the subordinate tranche receives higher rate of return while the superior tranche receives lower rate but still nice return. To make the top even safer, the banks ensured it small fee called the credit default swap (CDS). The banks do all of the works so that creating rating agencies will stamp the top tranche since as a safe, triple A rated

In the new system, an investment banker buys the mortgage from the lender, borrowing millions of dollars to buy thousands of mortgages, and every month he gets payments from homeowners for each of the mortgages. The banker then consolidates all the mortgages and splits the final product into three sections: safe, okay, and risky mortgages, which make up a collateralized debt obligation (CDO). As homeowners pay their mortgages, money flows into each of the sections, with the safe filling first and the risky filling last, contributing to their respective names. Credit agencies stamp the top two safer mortgages with a triple A or triple B rating, which are then be sold to investors who want a safe mortgage, while the risky slice is sold to hedge funds who want a risky investment. The bankers make millions, pay back their loans, and investors also make a worthwhile investment. So pleased are the investors, however, that they want more. Unfortunately, back at the beginning of the cycle, the mortgage broker can no longer find qualified mortgagers

The Big Short: Inside the Doomsday Machine by Michael Lewis is a non-fiction New York Times #1 bestseller. This text is published by W.W. Norton & Company and contains 320 pages. This is a book that focuses in on the 2008 financial crisis and the build up of the housing and credit bubble during the 2000’s. The author channels in on the persons who saw the crisis coming that wanted to protect their investments or did not want to speak of the issue.

Another key event described in “The Big Short,” was when American International Group found a way to insure subprime mortgage loans while being able to bury these risks on its balance sheet. This was made possible by the fact that AIG was a triple-A-rated corporation with an enormous