The Big Short - Movie Analysis Essay

Introduction

The Big Short' is an American biographical drama film shot in 2015 and was directed and written by Adam McKay and Charles Randolph, respectively. The movie is grounded on the 2010 book, the "big short" inside the Doomsday Machine by Michael Lewis, which shows how the financial crisis of 2007- 2008 was prompted by the United States of America's "housing bubble." The paper will focus on using the movie "big short" to connect the "housing bubble" to the great recession.

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Summary

In the movie," big short," three separate though matching stories of the United States mortgage housing crisis is told. Michael Burry, Steve Eisman, and Greg Lippmann predicted that the United States housing market is built on a bubble and that it would burst in the next few years (Bangay,2016). Burry decided to place a bet against the housing market with the financial institutions who are more than happy to accept his proposal since they believe Burry is a crackpot and thus get confident to transact with him. Other people, such as Baum and Jared, decide to follow suit and further believe the bond agencies overvalue most of the mortgages. The three groups, Michael Burry, Frontpoint partners, and Jared vennett, and Brownfield capital, made these investment choices that seemed insane for everyone (Bangay,2016). In the end, Burry was very right. The housing bubble burst such that people couldn't pay their debts, and thus banks were forced to pay Burry as per the contract hence making a massive profit. This collapse of the housing market was very catastrophic to the global economy to date.

Housing Bubble and the Great recession

Through the movie "Big Short," it is clear that the housing bubble had a massive and catastrophic impact on the global economy at large. People lost jobs, long time standing companies collapsed, banks were in a liquidity crisis, stock markets crashed, people lost homes while governments were in overdrive.

Credit Default Swap (CDS) played a significant role in the great recession in the United State's Economy. A CDS is a credit derivative contract between counterparties where the buyer makes periodic payments to the seller and later gets a payoff of the security's premium and the future interests if an underlying financial instrument defaults (Bangay,2016). Credit default swaps act as insurance security against a potential default. Although the housing bubble occurred, CDS played a role in the financial crisis since the banks had to give back the total premium and all future interest payments to the three investor groups, which had invested billions of money in the housing bubble bet that came to pass.

Collateralized debt obligations Were also a significant contributor in the impending housing bubble, which in return led to the great recession. A Collateralized debt obligation is a financial tool that banks use to repackage individual loans into a product sold to investors in the secondary market (Bangay,2016). Economically, the banks sell CDOs to move the default risk to investors and get more liquidity. In the case of "big short," the personal loans were the mortgages where the banks used them as mortgage-backed securities (MBS). Unfortunately, the extra liquidity by the CDOs created the housing bubble where housing prices rose steeply, and people bought homes for reselling, people took more loans while the banks gave more unsecured loans ("Northwestern Business Review," 2016). The Opaqueness of CDOs led to a market panic in the year 2007, where banks realized they could not price the assets and products they were holding (Bangay,2016). Banks cut off lending since they did not want more CDOs in the balance sheet. MBS went south with the housing prices going down while people were unable to pay their loans. The fall housing market crash resulted in the great recession, which was fatal to the economy.

Prospect theory has been evident in the 'Big Short,' and it was majorly one of the contributors to the great recession after the housing bubble. Prospect theory is a behavioral model in economics that determines how people make decisions between alternatives relating to uncertainty and risks (Zimmerman, 2016). People dislike losses and therefore go to an extreme of avoiding losses by alternatively taking risks. In the case of the housing bubble and recession, banks feared losses that would come in hand with defaulted loans and, in return, sold them to investors in the secondary market was CDOs (Zimmerman, 2016). The bank's main aim was to transfer the risks of default losses and face uncertainty. It went south after the financial institutions got overwhelmed with the fact that they could no longer place value on the assets and products they had.

Conclusion

Although Michael Burry predicted the housing bubble, it is complicated to identify a housing bubble until it pops. Through the movie 'Big Short,' it is evident how the struggle of risks transfers through CDOs, a corrupted housing market, borrowing more than one is worth, and lending of loans to people who are not creditworthy can ruinously affect the economy just like the housing bubble led to the financial crisis.

References

Bangay, T. (2016). The economies of The Big Short, Explained. Retrieve from https://www.ecnmy.org/engage/the-big-short/

Northwestern Business Review. (2016). What the big Short Teaches Us About the 2007-2008 Financial Crisis? Retrieved from https://northwesternbusinessreview.org/what-the-big-short-teaches-us-about-the-2007-08-financial-crisis-9cb30793ad92

Zimmerman, A. (2016). 3 Essential Financial Lessons From 'The Big Short.': How Behavioral Economics Shape the Financial Decisions We Make. Retrieved from https://www.inc.com/angelina-zimmerman/3-essential-financial-lessons-from-the-big-short.html