Movies and the 2008 Financial Crisis

I started out wanting to review the documentary titled “Too Big to Fail” which is based on a book of the same name by Andrew Ross Sorkin. It basically covers the 2008 financial crisis from the point of view of the then Secretary of Treasury, Henry M Paulson.

The documentary somehow ended up glorifying him, making him seem some kind of hero. This however is not true, in the slightest aspect. Another documentary- “The Inside Job” confirms it. He was pretty much why the crisis took place. He strongly opposed regulation of Investment banks when he was the CEO of Goldman Sachs and made big, tax-free money before he took up office as Secretary of Treasury.

In order to make the film appealing, there have been deviations from facts. In order to have a better understanding of the crisis, I would rather recommend watching “The Inside Job”.

The movie revolves around how the government, after bailing out Bear Stearns, deals with the almost insolvent Lehmann Brothers, and the events that unfold later. How Bank of America buys Merrill Lynch, How Lehmann Brothers declare themselves bankrupt, and so on.

The actors have done a really good job, and the movie passes off quite brilliantly as something a person without any prior knowledge would understand. To those who want to know about how exactly the 2008 crisis occurred, The Inside Job would prove to be a better, although comparatively dull watch.

To better understand the movie, it would be better to do a basic reading on what Freddie Mac and Fannie Mae are.

Freddie Mac:

The Federal Home Loan Mortgage Corporation (FHLMC), known as Freddie Mac, is a public government-sponsored enterprise (GSE), headquartered in the Tyson's Corner CDP in unincorporated Fairfax County, Virginia.

The FHLMC was created in 1970 to expand the secondary market for mortgages in the US. Along with the Federal National Mortgage Association (Fannie Mae), Freddie Mac buys mortgages on the secondary market, pools them, and sells them as a mortgage-backed security to investors on the open market. This secondary mortgage market increases the supply of money available for mortgage lending and increases the money available for new home purchases. The name, "Freddie Mac", is a variant of the initialism of the company's full name that had been adopted officially for ease of identification.

Fannie Mae:

The Federal National Mortgage Association (FNMA), commonly known as Fannie Mae, was founded in 1938 during the Great Depression as part of the New Deal. It is a government-sponsored enterprise (GSE) and has been a publicly traded company since 1968. The corporation's purpose is to expand the secondary mortgage market by securitizing mortgages in the form of mortgage-backed securities (MBS),allowing lenders to reinvest their assets into more lending and in effect increasing the number of lenders in the mortgage market.

To people who are waiting for “The Big Short” to release, which is also based on the 2008 financial crisis, It would be beneficial to read up a bit about the 2008 financial crisis:

2008 Financial Crisis:

The financial system of The United States was heavily deregulated in the late nineties. The 2008 crisis was caused because of banks giving out sub-prime mortgages, (risky loans, loans they wouldn’t expect the borrower to repay) and the subsequent burst of the housing bubble. In the years leading to the crisis, the leverage ratios of the various investment banks were allowed to reach astronomical figures allowing them to take up huge debts. This money was then used to issue sub-prime mortgages.

The banks gave away home loans in excess to people. A bunch of these loans were clubbed into a Collateralized Debt Obligation (CDO) and then sold to investors in the derivatives market. The banks really, weren’t concerned whether or not they receive money from the borrowers, since they were anyway selling these sub-prime mortgages to investors, earning millions in the process.

Moreover, the investors were fooled into buying such CDOs on the basis of the false credit ratings (high ratings like AAA, on par with government bonds), firms like S&P, Moody’s, Fitch gave them. To insure themselves against the returns of such CDOs, investors could opt for a Credit Default Swap (CDS) provided by Insurance firms like AIG.

This was different from a typical insurance. Non-owners of the CDOs could opt for the CDS as well. An apt analogy would be of taking a loan on a house you don’t own. Investment banks would bet against their own CDOs, fully knowing that the borrowers are bound to default on their loans.

AIG, ended up giving away a lot of these CDSs, without caring about how they would pay back in the event of failure of the CDO. The failure of these CDOs meant AIG had to pay a lot of money, at the same time, leaving AIG insolvent. This led to another bail-out by the government after the Bear Stearns bail-out. AIG failed due to its inability to pay off credit default swaps.

The Investment banks were left with toxic assets in the housing sector. There was a lot of supply of houses and no takers, which drove down the prices of realty. News of supposed insolvency and inflated assets led to falling stock prices. Manufacturing firms were left without any credit, and funds were difficult to obtain. Cash strapped customers led to reduced demand, which further contributed to rising unemployment and slowing down of the global economy in general.

-Abhijeet Singh