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 emerged from a combination of factors that created a perfect storm in the financial markets. Low interest rates, relaxed lending standards, and a booming housing market led to a surge in subprime mortgages – loans given to borrowers with poor credit histories.

Systemic failures. Financial institutions packaged these risky loans into complex securities, which were then sold to investors worldwide. The assumption was that housing prices would continue to rise indefinitely, and that the risk was spread out enough to be negligible. This assumption proved catastrophically wrong.

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. Wall Street firms created increasingly complex financial instruments, such as collateralized debt obligations (CDOs), to repackage and resell subprime mortgages. These instruments were so complicated that even many industry insiders didn't fully understand them.

Illusion of safety. The complexity of these instruments created an illusion of safety, as they were often given high credit ratings despite being based on risky underlying assets. This false sense of security led to massive over-investment in what were essentially ticking time bombs.

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. Credit rating agencies like Moody's and Standard & Poor's played a crucial role in the crisis by giving high ratings to risky mortgage-backed securities. These agencies were paid by the very banks whose products they were rating, creating a clear conflict of interest.

Flawed models. The rating agencies relied on flawed models that didn't account for the possibility of a nationwide decline in housing prices. They also failed to adequately assess the risks of the new, complex financial instruments being created 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 neurologist-turned-hedge fund manager with Asperger's syndrome, was one of the first to predict the subprime mortgage crisis. His unique perspective and obsessive attention to detail allowed him to see what others missed.

Against the tide. Despite facing skepticism and opposition from his investors, Burry bet heavily against the subprime mortgage market through credit default swaps. His conviction and persistence ultimately led to massive profits when the market collapsed.

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, a blunt and outspoken hedge fund manager, became a vocal critic of the subprime mortgage industry and Wall Street's practices. His personal experiences and research led him to bet against the housing market.

Exposing the truth. Eisman used his platform to challenge industry leaders and expose the flaws in the system. His confrontational style and deep understanding of the market made him a key figure in uncovering 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. Greg Lippmann, a bond trader at Deutsche Bank, recognized the flaws in the subprime mortgage market and started betting against it. He played a crucial role in creating and promoting credit default swaps on subprime mortgage bonds.

Spreading the word. Lippmann actively sought out investors to take the other side of his trades, essentially betting against his own bank's positions. His efforts helped to create a market for shorting subprime mortgages and spread awareness about the risks in the system.

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, a small investment firm started by Charlie Ledley and Jamie Mai, approached the market with a unique perspective. They sought out mispriced options and unconventional bets, ultimately leading them to profit from the subprime mortgage crisis.

David vs. Goliath. Despite their small size and lack of Wall Street connections, Cornwall Capital managed to identify and exploit the flaws in the system. Their success demonstrated how outsiders could sometimes see risks that industry insiders missed.

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. Behind the complex financial instruments and billion-dollar bets were millions of ordinary Americans who found themselves unable to pay their mortgages. The crisis led to widespread foreclosures, job losses, and economic hardship.

Predatory practices. Many subprime mortgages were sold to people who didn't fully understand the terms or risks involved. Adjustable-rate mortgages and other exotic loan products led to ballooning payments that borrowers couldn't afford.

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 collapse of major financial institutions like Bear Stearns and Lehman Brothers marked the peak of the crisis. These events sent shockwaves through the global financial system and led to a severe credit crunch.

Too big to fail? The fall of these institutions raised questions about the stability of the entire financial system and the concept of "too big to fail." The government's decision to let Lehman Brothers fail, in particular, had far-reaching consequences.

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 U.S. government and Federal Reserve took extraordinary steps to stabilize the financial system, including bailouts, asset purchases, and near-zero interest rates. These actions prevented a complete economic collapse but were controversial.

Long-lasting effects. The crisis led to major regulatory changes, including the Dodd-Frank Wall Street Reform and Consumer Protection Act. It also resulted in a prolonged economic recovery and ongoing debates about financial regulation and income 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