There are three ways to make a living in this business: Be first, be smarter or cheat.
— John Tuld, CEO of the fictional investment bank in Margin Call
Who caused the 2008 global financial crisis? It’s impossible to lay all of the blame on one entity – there’s plenty of blame to go around. I’ve written about several of the strong contributors to the crisis, including investment banking psychopaths, greedy CEOs at Fannie Mae and Freddie Mac along with their Democratic congressional enablers, and conflicted credit rating agencies Moody’s and Standard & Poor’s.
Wall Street is Not Solely to Blame for the 2008 Financial Crisis
What amazes me today is that a few people are trying to rewrite history through a simple lens and lay all of the blame on either Wall Street or Washington. For example, on November 1st New York City mayor Michael Bloomberg stated that the Occupy Wall Street protestors were “misguided” in blaming investment banks for the crisis because the U.S. Congress “pushed the banks” to provide subprime loans to marginal borrowers in order to increase home ownership. Next up Barry Ritholtz, proprietor of The Big Picture financial blog, who called Bloomberg’s anti-government assertion “the Big Lie” and wrote that pretty much everyone was to blame except the U.S. Congress. But then Ritholtz contradicts himself at the end of his Washington Post op-ed by conceding that Bloomberg was “partially correct” in blaming congress for deregulating the financial services industry. Which is it, Barry? Can something that is partially correct be considered a big lie?
If Mayor Bloomberg’s partial truth blaming only government is a big lie, Ritholtz’ partial truth blaming everyone except government is a big lie also. Ritholtz completely ignores the role Congress played in pressuring Fannie and Freddie to make loans to people who had no means of paying them back. In 2009, the American Spectator Magazine called Ritholtz’ selective amnesia about government involvement a “desperate liberal legend.” The problem started in 1992 with a Democratically-controlled Congress and continued throughout the 1990s with the presidency of Democrat Bill Clinton:
U.S. Congress Shares Part of the Blame for the 2008 Financial Crisis
There are two key examples of misguided government policy. One is the Community Reinvestment Act (CRA). The other is the affordable housing “mission” that the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac were charged with fulfilling.
[Under the CRA], banks simply proving that they were looking for qualified buyers wasn’t enough. Banks now had to show that they had actually made a requisite number of loans to low- and moderate-income (LMI) borrowers. The new regulations also required the use of “innovative or flexible” lending practices to address credit needs of LMI borrowers and neighborhoods. Thus, a law that was originally intended to encourage banks to use safe and sound practices in lending now required them to be “innovative” and “flexible.” In other words, it called for the relaxation of lending standards, and it was the bank regulators who were expected to enforce these relaxed standards.
In 1992, an affordable housing mission was added to the charters of Fannie and Freddie, which–like the CRA–permitted Congress to subsidize low- and medium-income (LMI) housing without appropriating any funds. Fannie and Freddie used their affordable housing mission to avoid additional regulation by Congress, especially restrictions on the accumulation of mortgage portfolios (today totaling approximately $1.6 trillion) that accounted for most of their profits.
In fact, by 2007 “55 percent of all mortgages the two companies acquired had to be made to borrowers at or below median income.” Overall, half of all U.S. mortgages (27 million out of 54 million) were sub-prime when the global financial crisis began. Almost nobody realized that this amount of risk existed in the U.S. financial system because Fannie and Freddie were allowed under law to limit their classification of mortgage loans as “subprime” to those acquired from a subprime lender. All other mortgage loans could be classified as “prime” even if the borrower’s FICO credit score was below 660. The result: Fannie and Freddie reported that only 0.3% of their loans were subprime when the actual number of subprime loans based on credit score was 18%. Thanks for nothing U.S. Congress!
To be fair, while the Democrats were historically the primary supporters of Fannie Mae and Freddie Mac and mostly to blame for this mess, the Republicans aren’t completely blameless either. In 2005, legislation that would have imposed stricter regulation on Fannie and Freddie passed the House of Representatives with bipartisan support (but it was weak) and a stronger version died in the Senate. The Senate Banking Committee approved the bill 11-9, with all 11 Republicans voting in favor and all 9 Democrats voting against. So it looks like Senate Democrats were the prime stumbling block. Although Republicans were in control of the Senate with a 55-seat majority, this was not enough to prevent a Democratic filibuster. It also didn’t help that President Bush was threatening to veto the House version because it didn’t go far enough.
Margin Call is a Bad Movie
I was hoping that the new movie about the 2008 financial crisis called Margin Call would clear away all the partial-truth lies and put blame on everyone who deserved it. After all, the New Yorker Magazine – one of my favorite publications – called the movie “easily the best Wall Street movie ever made.” A hint that I would be disappointed came right away when I was looking for show times. In the entire Washington metropolitan area, the movie is being shown at only three theaters, which suggests that very few people were going to watch the movie. After being one of the unfortunate few to see it, I now understand why.
I understand that the subject matter of mortgage-backed securities (MBS) is a bit complicated and dry, but the cast is full of well-known Hollywood stars including Kevin Spacey, Jeremy Irons, Demi Moore, Stanley Tucci, and Zachary Quinto (also the producer and the guy who played Spock in the Star Trek remake). The film’s entire budget was reportedly no more than $3.5 million, so the actors must have agreed to work for peanuts. With the exception of Demi Moore who can’t act, all of the other actors were excellent, especially Tucci who plays a risk manager who gets fired in the movie’s opening scene. I’ve admired Tucci ever since he played murderer Richard Cross on the 1995-96 TV drama Murder One. Mr. Spock (Quinto), who plays a rocket scientist-turned-junior risk analyst, is also decent, but his eyebrows are distracting. They look painted on with artificial jet-black eyeliner. Did the director forget that Quinto is no longer playing a Vulcan?
Bottom line: the movie is dull, unrealistic, and ridiculous. I don’t care how many stars you line up, they are just talking heads and cannot bail out a bad script. More than 80% of the movie was filmed on the 42nd floor of a very dark midtown Manhattan office building near Madison Square Garden and Penn Station, which quickly became uninteresting. A dialogue-filled movie with no scenery can be enjoyable with a good script (e.g., the 1981 movie classic My Dinner with Andre), but Margin Call does not qualify.
What interests me about the investment-bank role in the 2008 financial crisis is three-fold: (1) the decision-making process by investment banks to leverage up their MBS portfolios by 30 to 40 times despite the huge risk of a ruinous margin call; (2) once the leverage decision was made, how the banks encouraged mortgage lenders to engage in predatory lending practices to produce the volume of high-interest subprime mortgage loans needed to feed the banks’ MBS-creating machine; and (3) how the banks sold these high-risk MBS securities – which they knew were junk — to institutions and claimed with a straight face that these MBS securities deserved a triple-A credit rating.
None of these three interesting issues were the subject of Margin Call. Rather, the movie focuses on the mundane mechanics of unwinding an overleveraged MBS portfolio. How boring can you get? Sure, in passing the characters mention that the MBS securitization process was “very lucrative” for the investment bank and that the bank’s risk manager (played by the miscast and completely unbelievable bimbo Demi Moore) had “warned” higher-ups that the firm was overleveraged, but those script lines constituted less than one minute of the movie.
Margin Call Isn’t About a Margin Call
Even worse, the movie characterizes the voluntary decision to reduce the firm’s leverage as a “margin call” which is completely inaccurate. A real margin call is imposed on a borrower by an outside lender who forces the borrower to raise cash by selling securities. In contrast, the fictional investment bank decided to unwind its MBS position because the value of the securities fell outside the bank’s value-at-risk (VAR) computer-model parameters. Nobody outside of the firm was demanding cash and the firm was not suffering from a liquidity crisis like real-life Lehman Brothers experienced before it went under.
Even though Tucci’s character Eric Dale was the best thing in the film, Dale deserved to be fired because we learn later in the movie that the bank’s MBS portfolio had violated VAR parameters for almost a week and Dale hadn’t identified the problem by the time he was escorted out of the building. Before he left, Dale gave a flash drive to Quinto’s character Peter Sullivan who finished the analysis and learned of the VAR violation around 9 PM that evening. Sullivan summoned back to the office senior trader Will Emerson (played by relative-unknown Paul Bettany, who was great as the doctor in that awesome 2003 movie about late 18th century British-French naval conflict called Master and Commander) and head of sales Sam Rogers (played by Bobby Darin impersonator Kevin Spacey). For some reason, as these guys all stared at a computer screen in the office, nobody thought to turn the office lights back on. Does it make any sense to work in the dark? A little quibble to be sure, but the lack of office lights is indicative of the movie’s problems with common sense and realism.
Margin Call Offers Up a Phony Moral Dilemma
But the movie’s biggest problem is the phony moral dilemma it sets up for salesmen Sam Rogers regarding the decision to unwind the firm’s MBS portfolio. Rogers, who apparently had no problem selling this MBS junk to clients at par value a year ago, now suddenly feels guilty selling this same MBS junk to clients at a discount to par value ranging from 7% early in the trading day and rising to 45% by the end of the day. What changed to stir these feelings of guilt? Nothing that would logically lead to guilt. The reason the bank’s MBS portfolio had violated the VAR limits is because their prices had dropped, so it’s not like the marketplace didn’t know that something was wrong in the housing market. The movie provided no indication that Rogers or anyone else in the firm had suddenly discovered that the mortgage loans underlying the MBS securities were fraudulent in some way. The only thing that had changed was the price of the securities and violation of the bank’s self-imposed VAR limits. There was absolutely no reason for Rogers to feel guilty for reducing the firm’s leverage.
This isn’t like the case of real-life Goldman Sachs (NYSE: GS) being two-faced and fraudulent by recommending that clients buy MBS securities while at the same time betting against them with the firm’s own money. No, this deleveraging simply involved selling MBS securities to other sophisticated institutional investors. Offering to sell provides full disclosure of intent – i.e., the firm “wants out” — and it is up to the buyers to determine if they “want in.” Differing opinions are what make a market. If everyone agreed on the merits of an investment nobody would ever trade. And it’s not like the buyers were willing to buy this MBS junk at par – they demanded an increasingly steep discount throughout the trading day which theoretically compensated them for the this MBS junk’s increased risk as the housing market worsened.
The only thing that Rogers would have had the right to feel guilty about is not reducing the firm’s risk by deleveraging and letting the company go under. It was the duty of the executive team to protect the firm’s financial viability.
Margin Call is a Whitewash of Wall Street
CEO John Tuld’s (played by Jeremy Irons and whose name is a veiled reference to real-life Lehman CEO Richard Fuld) quotation cited at the beginning of this article could have presented a genuine moral dilemma if the firm had decided to cheat in order to save itself. But Tuld follows that quotation up with the unexpected and unrealistic statement: “And I don’t cheat.” Wall Street doesn’t cheat? Tell that to the Securities and Exchange Commission (SEC) which recently fined Citigroup (NYSE: C) $285 million for defrauding MBS investors. Now a story about that would have made an interesting movie. Instead, Tuld makes the completely unobjectionable decision to “be first” in unloading MBS securities that he believes are going to fall further in value, which is what every investor would try to do. Booooring.
I bet 99% of people who read Tuld’s quotation on advertisements for the movie expect the Margin Call plot to be about investment-bank cheating. That screenwriter J.C. Chandor decided not to explore Wall Street malfeasance damns the film to irrelevance. Chandor’s father had worked at Merrill Lynch for more than 30 years and he probably didn’t want to offend his dad concerning his lifework, but sparing his daddy’s feelings ruined the film.
Margin Call’s Realistic Anecdotes Aren’t Good Enough
To be fair, a few things shown in the movie were very realistic. The way Tucci’s character Eric Dale was fired at the beginning of the movie – computer access and cellphone shut down immediately and given 30 minutes to pack up belongings in two boxes and leave the building under escort — was spot-on accurate (so I’m told by friends on Wall Street). The fact that highly talented people in socially-valuable disciplines (e.g., Tucci’s Eric Dale as a structural engineer who built bridges and Quinto’s Peter Sullivan as a rocket scientist) chose to waste their talent on Wall Street because of the money is also very true (unfortunately). Also accurate was CEO John Tuld’s request for rocket-scientist Sullivan to “please speak as you might to a young child or a golden retriever, I didn’t get here on my brains I can assure you of that.” Many Wall Street CEOs didn’t understand how their quant employees made money for their firms.
Rounding out the film’s realistic snippets were: (1) trader Will Emerson’s rant about how fickle the public is, loving the low interest rates and easy qualifications for adjustable-rate mortgages when times are good, only to bitch and moan when the mortgage rates reset, and (2) the scene on the trading floor and the sales pitches used to sell the MBS securities once the firm decided to deleverage. But realistic snippets do not a movie make, especially when the core theme of the movie ignores Wall Street criminality and focuses on a ridiculous and non-existent moral dilemma.
Inside Job is the Movie to See
If you want to see a good movie about the 2008 financial crisis that actually educates you, save $10 and skip Margin Call. Instead, watch for free the documentary by Charles Ferguson called Inside Job either here or here. Ferguson is well-respected and fair, having won many awards for his previous film No End in Sight, which presented in shocking detail the complete incompetence of the Bush Administration in planning the Iraq war and (more importantly) managing its aftermath.
Inside Job is an equally fascinating look at Wall Street criminality (including cocaine and prostitutes), government corruption by the financial services industry through campaign contributions and private-sector job offers, credit-rating conflicts of interest, and the bribery of economics professors by the financial services industry through the payment of research grants. Rather than whitewash Wall Street’s sins as Margin Call attempts to do, Ferguson makes it clear that Wall Street cheated early and often. In an interview, Ferguson stated the following:
It’s not like I didn’t know that there were greedy people in the financial world. When I started making the film I knew that there had to have been some bad behavior, but I had no idea that on a very large scale people had designed securities with the intention of selling them and gambling on their failure. I was stunned when I discovered it.
I asked [former New York governor and attorney general Eliot] Spitzer about that: Why this industry? I have some experience with high technology and the same thing doesn’t happen. His full answer was: Look, high technology is an industry where you create money by doing something different. In contrast, finance is really kind of zero-sum. It’s a trading game, it’s a gambling game. There’s a relatively fixed pool of money, but there’s a lot of money and the way you make more, as a banker, is by making sure that someone else makes less. It’s really hard to keep that industry ethical without appropriate legal and regulatory controls. If Intel made microprocessors that blew up the computers they’re in, Intel would go out of business. The same is not true for financial services. It was a very sobering moment.
In another interview, Ferguson voiced the moral outrage that I and most Americans feel about Wall Street:
I’m outraged by the lack of criminal prosecutions related to the financial crisis. I think it’s one of the most scandalous things about this entire affair. I find it utterly implausible that all of this occurred without anybody committing a single criminal act.
Bottom line: Inside Job is the final word on the 2008 financial crisis and blames everybody who deserves to be blamed. Margin Call is the exact opposite.