The Big Short Explained

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The Big Short is a 2015 film, directed by Adam McKay, about a handful of investors who saw that the U.S. housing market was being held up by bad mortgages and bet against it before the 2007 to 2008 collapse. It is adapted from Michael Lewis’s 2010 nonfiction book The Big Short: Inside the Doomsday Machine, a loose follow-up to his Liar’s Poker, which drew on his years at Salomon Brothers in the 1980s. The title refers to those bets: large short positions on mortgage bonds that paid off when homeowners defaulted and the securities built on their loans lost most of their value. The characters are real people or closely based on real people, and the trades really happened.

What The Big Short is about

The film runs three plot strands that rarely meet. Each group reaches the same conclusion by a different route, which lets the audience see the housing bubble from inside a hedge fund, a trading desk and a two-man startup.

Michael Burry and Scion Capital

The story begins in 2005 with Michael Burry (Christian Bale), the eccentric manager of Scion Capital. Reading through the loan data inside mortgage bonds, he concludes that the housing boom rests on high-risk loans, many with low introductory rates set to reset higher, and that defaults will rise once those resets arrive. To bet on that outcome, he persuades major banks to sell him credit default swaps on subprime mortgage bonds. The banks are happy to take his premiums, since they believe housing is safe.

Home prices keep rising for a long time after Burry places his bets, and he has to keep paying premiums the whole time. His investors grow furious, and when they ask for their money back he restricts withdrawals from the fund, which angers them further. Those who stayed through the collapse earned returns of nearly 500%.

Mark Baum, Jared Vennett and the trading desk

Jared Vennett (Ryan Gosling), a Deutsche Bank bond salesman, learns about Burry’s trade, agrees with the analysis and starts selling the same kind of swap protection to other investors. He also narrates much of the film directly to the camera. A misdirected phone call brings his pitch to Mark Baum (Steve Carell), a hedge fund manager with a deep distrust of Wall Street.

Baum’s team investigates before committing. They visit Florida, where they find empty houses, borrowers with several mortgages and brokers who boast about lending to people who cannot repay. They see that collateralized debt obligations packed with weak loans are carrying AAA ratings, and that the securities are being repackaged and resold. Baum comes to believe that Wall Street’s demand for these products is driving home prices far beyond what the underlying market supports, and that the whole system could fail. He buys protection on mortgage bonds and bets against financial companies exposed to them.

Charlie Geller, Jamie Shipley and Ben Rickert

The third strand follows Charlie Geller (John Magaro) and Jamie Shipley (Finn Wittrock), two young investors running a small fund out of a garage. They come across Vennett’s material on credit default swaps, grasp the trade, but lack the size and standing to deal with large banks directly. They turn to Ben Rickert (Brad Pitt), a retired banker and pessimist whose contacts get them into the market.

Geller and Shipley also spot a further edge: the market priced the highest-rated tranches as almost certain to survive, so protection on them was cheap. When the market breaks, the pair make a fortune. In one of the film’s sharpest scenes, Rickert scolds them for celebrating, reminding them that their profit depends on people losing jobs and homes.

The real people behind the characters

Burry kept his own name. Most of the others were renamed, and their firms were sometimes renamed as well:

• Mark Baum is based on Steve Eisman, a hedge fund manager.
• Jared Vennett is based on Greg Lippmann, a bond salesman and trader at Deutsche Bank.
• Charlie Geller is based on Charlie Ledley, a founder of Cornwell Capital, which appears in the film as Brownfield Capital.
• Jamie Shipley is based on Jamie Mai, Ledley’s partner at Cornwell.
• Ben Rickert is based on Ben Hockett, a former Deutsche Bank trader.

The cast also includes Marisa Tomei as Baum’s wife and Jeremy Strong, Hamish Linklater and Rafe Spall as members of Baum’s team.

How the big short worked

Short selling and why these bets were different

A conventional short sale means borrowing a security, selling it, and hoping to buy it back later at a lower price, keeping the difference. The trader profits if the price falls and loses if it rises. Every main character in the film is short in the broad sense: each is positioned to gain if mortgage-related securities collapse. The bet is “big” both because of the sums involved and because housing is so large a part of the U.S. economy.

There was no simple way, however, to borrow and sell short a mortgage bond. The characters mainly used credit default swaps, and that changes the mechanics and the risks.

Credit default swaps

A credit default swap works like insurance on a bond, except the buyer does not need to own the bond. The protection buyer pays the seller a regular premium. If the referenced bond defaults or suffers losses, the seller pays the buyer to cover them. If nothing goes wrong, the buyer has simply paid premiums for protection that was never needed.

Consider a hypothetical case, not taken from any real trade: a fund buys protection on $10 million of mortgage bonds at an annual premium of 2%. It pays $200,000 a year. If the bonds become worthless, the fund can collect up to $10 million. If housing holds up for three years before cracking, the fund has paid $600,000 before seeing any gain. That carrying cost is the pressure Burry faces in the film.

The swap also carries counterparty risk. A payout is only as good as the bank that owes it. Late in the film the characters worry that the banks on the other side of their trades will fail before paying, and they scramble to sell their positions while those banks are still standing.

Mortgage-backed securities, CDOs and tranches

Lenders sold home loans to Wall Street firms, which pooled them into mortgage-backed securities. The pools were divided into tranches with a ranked claim on borrowers’ payments. The senior tranches were paid first and rated highest; the lower tranches absorbed losses first and paid higher yields to compensate.

Banks then took hard-to-sell lower tranches, combined them into collateralized debt obligations, and split those into new tranches. Much of the resulting CDO earned top ratings even though the loans underneath were the riskiest in the pool. Baum’s realization that the ratings did not reflect the risk is the center of his storyline, and the film suggests the rating agencies had a commercial reason to keep rating these products generously, since the banks were their paying customers.

Synthetic CDOs

A synthetic CDO is built from credit default swaps instead of actual mortgage bonds, essentially a pool of bets on whether those bonds would fail. Because any number of side bets can reference the same bonds, losses on one bad loan could be multiplied many times across the financial system. The film treats this as the point where an ordinary housing downturn turned into a crisis for the banks themselves.

The cameo explanations

McKay interrupts the story with direct explanations, often delivered by celebrities playing themselves:

• Margot Robbie, sitting in a bubble bath with champagne, explains subprime mortgages and mortgage-backed securities, and then tells the viewer to leave.
• Anthony Bourdain compares a CDO to a seafood stew that hides fish gone off, as banks mixed bad loans into fresh products.
• Selena Gomez and economist Richard Thaler use a blackjack table to show synthetic CDOs: when she loses, every side bet on her hand loses with her, just as falling home prices triggered losses across bets referencing the same loans.
• Ryan Gosling, as Vennett, stacks Jenga blocks to show tranches: pull out the weak lower blocks and the top-rated pieces fall too.

Characters also break the fourth wall to tell the viewer which scenes are accurate and which were changed, part of why the film is used in finance classes.

How the collapse played out

As interest rates rose in the mid-2000s and teaser rates reset, defaults climbed and home prices began to fall. Mortgage bond values dropped, yet the film shows a disturbing lag: the banks kept marking positions as healthy, so the shorts initially saw little gain even as defaults mounted. Then the market broke.

In March 2008 Bear Stearns, a major investment bank heavily exposed to mortgage securities, nearly failed and was sold to JPMorgan Chase with support from the Federal Reserve. For the characters, Bear’s collapse confirms both their thesis and their fear about counterparties. In September 2008 Lehman Brothers filed for bankruptcy, and the stock market fell sharply, a turning point in the 2008 financial crisis.

The winners were the protection buyers who held on. Losses fell on homeowners, banks and investors holding the mortgage securities, and in the end taxpayers who financed the bailouts. The Federal Reserve Bank of Cleveland has put the number of Americans who lost their homes to foreclosure as a result of the housing collapse at 3.8 million. Some of Burry’s own investors lost out on the gains by pulling their money before the payoff, which is the film’s clearest illustration that being early can look identical to being wrong.

The moral of The Big Short

The film does not treat its heroes as simple winners. Baum is torn because he can only profit if the system he despises collapses on ordinary people. Burry, having been right, is left isolated and largely without credit.

The broader argument is that the crisis came from greed and from incentives that rewarded everyone involved for ignoring risk: brokers paid to write loans, banks paid to package them, rating agencies paid to rate them and investors chasing yield. The closing title cards stress how few bankers faced criminal charges and how the large banks survived with government support.

Reception and criticism

The Big Short received five Academy Award nominations, including Best Picture, Best Director and Best Supporting Actor for Christian Bale, and won Best Adapted Screenplay for McKay and co-writer Charles Randolph. Critics praised its energy, humor and willingness to explain complex products without simplifying them away.

Not every critique was positive. Economist Paul Krugman, a Nobel laureate, pointed out that the film gives the impression that only a few outsiders saw the problem, when several others had warned about subprime lending. Others argued that it underplays the Federal Reserve’s role in the low-rate environment and lax oversight that allowed the bubble to grow.

It is also not the only dramatization of the crisis. HBO’s Too Big to Fail (2011), adapted from Andrew Ross Sorkin’s book, concentrates on the weeks around Lehman’s failure and the government’s decision to rescue the largest banks. The Big Short covers a longer stretch and stays with the people who bet against the system instead of those trying to save it.

FAQs

The Bottom Line

The Big Short matters to anyone who wants a clear picture of how mortgage bonds, CDOs and credit default swaps fed the 2008 crisis. The film shows that a correct bet can still cost years of premiums and angry investors, and that a payout depends on the bank owing it. Viewers should pair its story with critics' point that more people warned about subprime lending than the film suggests.