The Big Short

1. The subprime mortgage crisis: A perfect storm of greed and ignorance

"The problem wasn't confined to individual stocks. The Internet bubble had burst, and yet house prices in San Jose, the bubble's epicenter, were still rising."

A brewing disaster. The subprime mortgage crisis was the result of a specific convergence of market conditions. Low borrowing costs and the erosion of lending standards fueled a massive expansion in subprime loans, which were provided to individuals with unstable credit profiles.

Systemic failures. Financial entities aggregated these high-risk loans into intricate securities for global distribution. Market participants operated under the flawed premise that real estate values would rise perpetually and that risk was sufficiently diversified. These assumptions proved to be incorrect, leading to a widespread financial breakdown.

Key players in the crisis:

• Mortgage lenders
• Investment banks
• Credit rating agencies
• Regulators
• Homeowners

2. Wall Street's dangerous obsession with complex financial instruments

"The constant argument over the value of the shares of some major publicly traded company has very little value, as both buyer and seller can see the fair price of the stock on the ticker, and the broker's commission has been driven down by competition."

Financial alchemy. Financial firms developed highly intricate products, such as collateralized debt obligations, to redistribute subprime mortgage debt. The complexity of these instruments was so high that many professionals within the industry struggled to understand their underlying mechanics.

Illusion of safety. This complexity fostered a false sense of security. Risky assets were often assigned high credit ratings, encouraging massive capital investment into unstable financial structures. This environment created significant systemic vulnerability that was largely ignored by the broader market.

Examples of complex financial instruments:

• Mortgage-backed securities (MBS)
• Collateralized debt obligations (CDOs)
• Credit default swaps (CDS)
• Synthetic CDOs

3. The role of credit rating agencies in facilitating the crisis

"You know how when you walk into a post office you realize there is such a difference between a government employee and other people," said Vinny. "The ratings agency people were all like government employees."

Conflict of interest. Rating agencies were fundamental to the crisis because they assigned favorable ratings to low-quality mortgage-backed securities. A primary issue was the compensation model, where the banks creating the products paid the agencies for the ratings, leading to a significant conflict of interest.

Flawed models. The agencies utilized deficient analytical models that failed to account for a potential nationwide decrease in housing prices. Furthermore, they did not accurately evaluate the hazards associated with the new, complex financial products being introduced by Wall Street.

Problems with credit rating agencies:

• Paid by issuers, not investors
• Lack of accountability
• Outdated risk assessment models
• Overreliance on historical data

4. Michael Burry: The eccentric investor who saw it coming

"Only someone who has Asperger's would read a subprime mortgage bond prospectus," he said.

Unlikely prophet. Michael Burry, a hedge fund manager with a background in medicine, was among the first to identify the instability of the subprime market. His specific focus and meticulous examination of data allowed him to recognize trends that other market participants overlooked.

Against the tide. Burry utilized credit default swaps to bet against the subprime market despite facing significant pressure from his own investors. His persistence in this strategy ultimately resulted in large-scale returns when the housing market eventually failed.

Burry's key insights:

• Recognized the fundamental flaws in subprime mortgages
• Understood the danger of adjustable-rate mortgages
• Saw through the complexity of mortgage-backed securities
• Predicted the correlation between different subprime mortgages

5. Steve Eisman: A crusader against Wall Street's excesses

"The upper classes of this country raped this country. You fucked people. You built a castle to rip people off. Not once in all these years have I come across a person inside a big Wall Street firm who was having a crisis of conscience."

Righteous anger. Steve Eisman became a prominent critic of the subprime mortgage sector and the general practices of the financial industry. His research led him to conclude that the housing market was unstable, prompting him to take an opposing position.

Exposing the truth. Eisman challenged the narratives of industry leaders and highlighted the vulnerabilities within the system. His analytical approach and willingness to confront institutional figures played a significant role in identifying the risks of the impending crisis.

Eisman's key contributions:

• Exposed predatory lending practices
• Challenged credit rating agencies
• Bet against subprime mortgage-backed securities
• Raised awareness about systemic risks in the financial system

6. Greg Lippmann: The Deutsche Bank trader who bet against the housing market

"Dude, you owe us one point two billion."

Inside man. Working as a bond trader, Greg Lippmann identified the weaknesses in the subprime market and began shorting it. He was a central figure in the development and marketing of credit default swaps as a tool to bet against subprime mortgage bonds.

Spreading the word. Lippmann worked to find investors to take the opposing side of his trades, effectively betting against the positions held by his own institution. This helped create a broader market for shorting the housing sector and increased general awareness of the systemic risks.

Lippmann's strategy:

• Created credit default swaps on subprime mortgage bonds
• Convinced investors to bet against the housing market
• Used data analysis to identify the riskiest mortgage bonds
• Profited from the market's eventual collapse

7. Cornwall Capital: Outsiders who profited from Wall Street's blindness

"We were looking for nonrecourse leverage," said Charlie. "Leverage means to magnify the effect. You have a crowbar, you take a little bit of pressure, you turn it into a lot of pressure."

Unconventional approach. Cornwall Capital operated with a unique perspective, focusing on identifying mispriced risks and unconventional opportunities. This approach allowed the small firm to profit significantly from the eventual collapse of the subprime market.

David vs. Goliath. Despite their lack of traditional industry connections, the firm successfully identified systemic flaws that insiders failed to see. Their success highlighted how an outsider's perspective could be more effective at recognizing widespread market risks.

Cornwall Capital's key strategies:

• Focused on identifying mispriced risks
• Invested in long-shot bets with asymmetric payoffs
• Used credit default swaps to bet against subprime mortgages
• Leveraged their outsider status to think differently

8. The human cost of financial innovation gone wrong

"A single pool of mortgages, against which Burry had laid a bet, illustrated the general point: OOMLT 2005-3. OOMLT 2005-3 was shorthand for a pool of subprime mortgage loans made by Option One--the company whose CEO had given the speech in Las Vegas that Steve Eisman had walked out of, after raising his zero in the air."

Real-world impact. The failure of complex financial products had direct consequences for many individuals who could no longer manage their mortgage payments. This resulted in a surge of foreclosures, increased unemployment, and general economic difficulty.

Predatory practices. Many borrowers were entered into mortgage agreements without a full understanding of the associated risks or terms. Products such as adjustable-rate mortgages led to significant payment increases that many individuals were unable to fulfill.

Human consequences of the crisis:

• Millions of foreclosures
• Widespread unemployment
• Loss of retirement savings
• Long-term economic damage to communities

9. The collapse of Bear Stearns and Lehman Brothers

"By Monday, Bear Stearns was of course gone, too, sold to J.P. Morgan for $2 a share."

Domino effect. The failure of major financial institutions marked the height of the crisis, causing widespread disruption across the global economy and a contraction in available credit.

Too big to fail? These events led to significant debate regarding the stability of the financial system and the concept of "too big to fail." The decision to allow the bankruptcy of Lehman Brothers had particularly deep and lasting effects on the market.

Timeline of key events:

• March 2008: Bear Stearns collapses and is sold to JP Morgan
• September 2008: Lehman Brothers files for bankruptcy
• September 2008: Merrill Lynch is acquired by Bank of America
• September 2008: AIG receives an $85 billion government bailout

10. Government intervention and the aftermath of the crisis

"The Fed and the Treasury were doing their best to calm investors, but on Wednesday no one was obviously calm."

Unprecedented measures. The government and the Federal Reserve implemented significant interventions, such as financial bailouts and low interest rates, to stabilize the economy. While these actions prevented a total collapse, they were met with public controversy.

Long-lasting effects. The crisis prompted major regulatory changes, including the Dodd-Frank Act, and led to a slow economic recovery. It also generated ongoing discussions regarding financial oversight and the nature of economic inequality.

Key government actions:

• Troubled Asset Relief Program (TARP)
• Federal Reserve's quantitative easing programs
• Creation of the Consumer Financial Protection Bureau
• Stricter capital requirements for banks

Last updated: January 22, 2025