The Big Short is probably one of the most insightful and interesting films on the topic of finance and investing. It provides a very informative and unfiltered representation of some of the actions and attitudes that preceded the 2008 financial crisis. The film focuses on a group of people who predicted the crash and acted accordingly.
I watched the film again last week, and it made my realise that there's a lot that can be learned from those who predicted the crash. The underlying principles that drive their decision making can be applied to real life investing, and could help you to make winning decisions. Here are three common key principles that I found in each of the characters:
#1 Independent thinking:
The film starts by explaining the build up to the crash - Lewis Ranieri and the invention of mortgage bonds, growth and expansion of the banking sector, a lack of due diligence, then the crash itself. Many people were so caught up in the hype that they were blind to the fact that one day everything could come crashing down.
Michael Burry is one of the first characters introduced, and the first in the film to predict a possible collapse of the housing market with a theory based on a prior crash in 1930. The second group of people are introduced to us when a phone call to the wrong number means that Mark Baum and his team about the existence of a credit swap instrument (to be able to short the housing market), suggesting that the system could be going to collapse. Baum and his team decide to question the theory and investigate it as a result. Young fund managers Charlie and Jamie also decide to investigate the theory after they find a rejected investment proposal whilst at the JP Morgan Chase offices. They seek help from retired trader Ben Rickert, who acts on their behalf with large banking stakeholders.
Given the economic context of the US and World economy at the time preceding the crisis, such a theory would be undoubtedly be unpopular and certainly not widely accepted. However, both Dr Burry and Dr Baum and his team were able to block out the noise and look at things objectively. Not only did they look at how things were in the present, but they also thought about how the present could dictate the future. It is very easy to get sucked into the hype and noise circulating around the market and follow the crowd. At the end of the day, only you are responsible for the investment decisions you make, and it is your money at stake. In the Big Short, the crazy people were the ones that beat the odds and won, because they thought independently and were right about what they thought.
Being able to think independently is the first step, and is a good start. However, a theory without strong support to it is worthless.
At the beginning of the movie, Dr Burry asks one of his new recruits to investigate all the mortgages packaged into the top selling mortgage bonds. After seeing how many people are late on their repayments, this confirms to him that a lot of the mortgages packaged within the bonds are likely to default at some point in the future, supporting his theory and prompting him to short the housing market through credit swaps.
A wrong phone number means that Mark Baum and his team hear news of the Credit Swap instrument created by Jared Vennett, and they decide to investigate for themselves. They meet with bankers, home owners, credit ratings agencies, brokers and even strippers. After seeing the carelessness and lack of due diligence from the bankers and brokers, and the extent to which ordinary people are getting played without them realising it, they also buy credit swaps with the expectation that the system will fail one day. Jamie and Charlie obtain similar findings and also buy credit swaps after visiting the American Securitization Forum in Vegas, where Baum and his team went.
The information collected by everyone was a sound indication that something going on behind the scenes was wrong. This research was extensive, with multiple sources confirming their findings, thus providing strong support to the idea that the system was going down soon. Every investment decision should be backed up by solid research that supports the overall idea behind the decision. This will allow the investor to take confidence in their investment decisions.
The actual crisis in the US began around 2007-2008, but the main events of the movie take places in the years before. The characters in the movie took up their positions (i.e. bought the credit swaps) in the years leading up to the crisis when the economy was still going strong, and they were ridiculed and heavily criticised. Many people investing in Dr Burry's fund wanted to withdraw their money, and Baum came under fire from his reporting line at Morgan Stanley for poor investment strategy.
To make matters even worse, even though mortgage defaults began to increase (confirming that the collapse was about to happen), credit ratings agencies did not change the credit ratings of the bonds and their value continued to go up. This cost Dr Burry millions of dollars in premiums until their value began to decrease, and equally left Baum, his team and Charlie and Jamie outraged and confused.
Nevertheless, all the characters showed extreme patience and held out through all of this, and made a lot of money doing so. Sure enough, the inevitable eventually happened. "I may have been early but I'm not wrong" says Dr Burry, when he is challenged about investor sentiment and people pulling their money out. When the crisis begins to kick in and talk of selling begins in Baum's office, he continues to hold his positions, yelling "I say when we sell!"
As mentioned in the first point, there will always be noise around the market. Noise may dictate investor sentiment and the short term movement and volatility of stocks, but should never dictate an investor's decision making. Strong research to back an independent theory allowed the characters in the movie to ignore the noise and to continue holding their positions. It takes time for longer term trends to materialise, and there will likely be times of volatility and unexpected short term disruption. Stay focused, trust in your decision making, and let the storm pass.
Though not directly related to investment decision making, the characters in the movie benefited whilst millions of people lost big. They essentially bet on a bad outcome and were right, and won. When Jamie and Charlie talk with Ben Rickert, they realise they are betting against the American economy, betting that people will lose houses, jobs and savings. When they close their positions and make their money, they realise what a messed up position they are in. As long as you are aware of any ethical implications of your investment decisions, only you can decide what is "right" or "wrong" when investing.
What did you think of The Big Short movie? What do you think of the characters' investment strategies? Leave us a comment with your thoughts!
Millennials With Money exists to provide personal financial education to Millennials and young people, and build a community of people who are motivated to creating long term financial health.
Disclaimer: This article is for informative, non-advisory purposes. Millennials With Money will accept no liability for any losses for investment decisions made based upon the content of this article.