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The Big Short Goes Long on Bias

For most people who see The Big Short, what it teaches about the 2008 financial crisis will likely be the sum total of their knowledge about the event. And that is troubling. The movie is entertaining and offers a good description of securitized mortgages and similar financial instruments but oversimplifies the cause of the crisis as the greed of bankers. Worse still, it omits important facts that about the crisis that are at odds with this explanation.

The Big Short has been nominated for Best Picture. Its great commercial and critical success may portend Hollywood’s growing capacity to manipulate public opinion, because the film perfects a smoothly innovative form—the hybrid fact-fiction documentary. Except for Michael Burry, the characters are fictional but loosely based on real people. This fictionalization creates a powerful mechanism for spinning the facts to support a tendentious and politically motivated thesis.

The movie’s most important omission is the role of government in creating the crisis. First, there is never any mention that banks had incentives to make bad loans because they could offload them to Fannie Mae and Freddie MAC, government-sponsored entities that were effectively supported by the full faith and credit of the United States. Second, the movie implies that large banks exploited their position as entities deemed “too big to fail,” but never acknowledges that the United States government bailout of Bear Stearns reinforced this doctrine. Indeed, the failure of Lehman Brothers – depicted at the end of the movie – was almost certainly caused by the Bear Stearns bailout. Because of it, Lehman thought it could pursue business as usual rather than putting itself up for auction.

A fundamental truth of banking law is that government is so pervasively and sometimes perversely involved in banking that its actions are a substantial cause of banking crises. Attributing the recent financial crisis simply to greed is not very persuasive, because greed was hardly limited to the early twenty-first century. But the movie’s assignment of guilt does underscore a persistent Hollywood trope—that private enterprise is at the root of social dysfunction. Bankers surely deserve some blame for these disasters, but the actual allocation of responsibility is not captured by the cartoonish morality of this film.

The film does have some compensating virtues. It is very well acted. Moreover, it happily celebrates the value of eccentricity.   Among the few who thought mortgage bonds wildly overvalued came to their unusual perspective because they were eccentrics.  One was an autistic doctor with one eye, another a profane investor haunted by the suicide of his brother. Two others were kids out of college who had not been socialized in the ways of Wall Street. It shows how diversity of perspective leads to good results, and, contrary to another favorite trope of the left, that such real diversity can be found even among a group of white males.

Reader Discussion

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on February 26, 2016 at 09:50:29 am

The author makes many important and insightful points. No U.S. bank is or ever was too big to fail, not even the First and Second Banks of the United States (which probably came the closest to being genuinely TBTF). Government regulators created the concept because of their worry of headlines that are too big too run. It has been the headline risk of failing banks--suggesting failing bank supervision--that has led to government officials propping up failed banks, and doing so in inconsistent and unpredictable ways. Remember, some 700 banks of all sizes received TARP money, and for contradictory and inconsistent purposes.

When explaining the boom and bust of the most recent recession, people must explain what was new about conditions that caused the problem. Greed in banking--and in any industry and in the population in general--is one of those more or less constants of humankind. Little new there. The degree of government steering of lending into the mortgage markets during the decade or so leading up to the 2007-2009 bust was new, and cumulative.

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Wayne Abernathy
on February 26, 2016 at 10:37:16 am

1. Haven’t seen the movie. That said, any statement of fact is a partial statement of fact. As someone said, to know anything, one must first know everything; to discuss anything, one must omit a great deal.

2. Causation is a poorly defined concept. What caused the financial meltdown? The Big Bang. I believe this statement to be accurate – but not very helpful to guiding policy. So let’s dig deeper.

A. What would it mean to say that Fannie Mae and Freddie Mac caused/contributed to the housing bubble (which, in fairness, McGinnis never quite says)?

Hypothesis: In the absence of Fannie and Freddie, home ownership would be restricted to the wealthy. Thus, any home ownership crash would be small because the share of the population owning homes would be small. Thus, we might say that Fannie and Freddie caused/contributed to the crash in the same way we could say that penicillin caused/contributed to the HIV epidemic: In the absence of the prior events, where would have been many fewer people in a position to be hurt. These claims may be accurate, but it would not follow that we would prefer a world without the prior events.

Thus, the larger question about Fannie and Freddie is whether we think the world is better as a result of their existence, netting costs and benefits, than it would have been in their absence. While people sometimes think that the US goes overboard in promoting home ownership rates, the US actually has among the lowest home ownership rates in the world. (Admittedly, apples-to-apples comparisons are tricky.)

B. Similarly, we might conclude that but for the bailout of Bear Sterns, Lehman Bros would not have ended up in so much trouble. But the larger question is whether we think the world is better as a result of bailing out Bear Stearns, netting costs and benefits, than it would have been in the absence of the bailout. This is unclear to me.

Hypothesis: Investment banks have interrelationships that can lead to contagion, but some investment banks have a central role in the over-the-counter derivative system (Bear Stearns) while others (Lehman Brothers) have a peripheral role. In addition, financial troubles that came to light later in the crisis were less problematic than those that arose earlier because by the later stages investment banks had had sufficient time to reduce their involvement in the derivative market. Those two facts meant that normal bankruptcy would be possible and contagion fairly impossible in the case of Lehman Brothers but not possible in the case of Bear Stearns.

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nobody.really
on February 26, 2016 at 10:58:32 am

(hope this stupid computer doesn't crash again &again so i can finish this).

"Thus, the larger question about Fannie and Freddie is whether we think the world is better as a result of their existence, netting costs and benefits, than it would have been in their absence. "

This does not mean that these agencies could not also have been responsible for the "crisis."
Indeed, they may have, over the years, made it easier for the average person(s) to finance a home; yet, there may have been a point where this *ease* and its associated good intentions transformed itself into a near criminal disregard for standard and reasonable constraints on lending by the agencies.

Just saying!

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gabe
on February 26, 2016 at 11:52:48 am

Fair enough. We don't need to limit ourselves to a dichotomous "Fannie/Freddie are good or bad." We could conclude that they're better than nothing, yet less beneficial than they might have been/some alternative would have been.

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nobody.really
on February 26, 2016 at 12:15:11 pm

" Its great commercial and critical success may portend Hollywood’s growing capacity to manipulate public opinion, because the film perfects a smoothly innovative form—the hybrid fact-fiction documentary"

Heck, what is innovative about this? Our (tax subsidized) movie moguls have long since perfected this *art* form. One may go back over, perhaps, a century of Hollywood myth (oops, I must mean "film") making and notice the ever growing skill the "artistes" have deployed the years - starting with, say, D.W. Griffith's "Intolerance", through "grapes of Wrath", etc. etc. to China Syndrome, etc etc.

Nowadays, all that appears to be new is the amount of computer graphics employed and the fact that one can download the silly thing onto your bloody phone - but i suppose THAT is what engneders the "growing capacity."

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gabe
on February 26, 2016 at 17:02:19 pm

Well, you seem to believe that Fannie/Freddie, in addition to their substantial costs and risks, somehow produce social benefits. Do you have a theory of how they do that? Is there some market failure (other than those caused by the government) that they are mitigating? I'm skeptical. Of course, there are lots of ways that they have conveyed benefits to individuals -- especially to their well-compensated managers and to their political allies, and even to some individual homeowners. But taking money from Peter and giving it to Paul is not, by itself, a social benefit. As far as I can tell, these agencies have no redeeming social value.

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BMan

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