The Mortgage Professor: "The Big Short" comes up short on truth


“The Big Short” reinforces a widespread misperception about the financial crisis.

This highly rated new movie is about a few sharp operators who saw the financial crisis coming and decided to profit from their insight by shorting the private mortgage-backed security market.

“Shorting” means to sell at the current inflated price, but not deliver until later, when the price of buying the security will be lower.

Most reviews of the movie that I have read have been favorable, based on the usual criteria used by movie reviewers: its plausibility, whether the story line held their interest, whether it engaged their emotions in a favorable way, the quality of the acting, and so on. But I am not a movie critic, and felt free to assess this one entirely on the basis of how well it depicted the circumstances that led to the financial crisis of 2008.

Misconceptions about the causes of the crisis are many, and any movie dealing with the crisis should get it right. This one didn’t.

It could be argued, of course, that my approach is not fair. The movie is not presented as a documentary, and the plot is not about the causes of the financial crisis, but about the speculators who profited from it. But the movie incorporates numerous documentary features, including real names, and it has a well-defined point of view about the causes of the crisis and where the blame lies, even though this is marginal to the central plot.

The point of view of the movie is that the crisis was caused by the greed of large financial institutions. This comes out inferentially in dialogue, and explicitly at the very end, when the names of major financial institutions stream across the screen, accompanied by a statement to the effect that no one has yet gone to jail. In these ways, the movie expresses its point of view about responsibility without having to explain or defend it.

While mortgage lenders and investment bankers were important cogs in the market machinery that went off the rails, the view that their greed was responsible does not make any sense. They are always greedy in the sense of striving to make as much money as possible in the conditions in which they find themselves. In the pre-crisis period, it was the conditions that changed, in two important ways.

The first was emergence of the housing bubble, a rise in house prices based on the self-reinforcing expectation that the price will rise further. Between January 1996 and July 2006, house prices rose by more than 8 percent a year. Price increases of this magnitude convert almost all mortgage loans, including the “garbage loans” referred to in “The Big Short,” into good loans by increasing the borrower’s equity. The borrower who can’t make the payment often can refinance into a loan with a lower payment, or, if necessary, sell the house at a profit and repay the mortgage.

A housing bubble creates massive opportunities for mortgage lenders and investment bankers to make money. While most of them realized that the price increases were abnormally large, none anticipated that the aftermath would be a significant price decline as opposed to a more benign leveling off. Prior to 2006, house prices had not declined on a nationwide basis since the depression of the 1930s.

Lenders and investment bankers could have had more foresight, but they were responsible to shareholders, who expected them to take full advantage of the opportunities provided by buoyant markets. In this regard, they were no less myopic than the regulators and the Federal Reserve, who had no shareholders to whom they were beholden but did nothing to deflate the bubble.

The second change in the conditions affecting the operations of lenders and investment bankers in the pre-crisis period was the growing strength of a movement to ease the path to homeownership by lower-income/disadvantaged segments of the population. Reflecting this policy, Fannie Mae and Freddie Mac were subject to legal mandates that loans to this group comprise some minimum percentage of their total mortgage acquisitions.

In response to these pressures, the agencies liberalized the underwriting requirements on the loans they purchased, but Congress kept raising the bar. When the agencies found it difficult to comply solely with loans purchased from originators, they were allowed to count private mortgage-backed securities issued against sub-prime mortgages, which they purchased in the market, A large portion of the garbage loans referred to in “The Big Short” was either purchased by the agencies directly as individual loans, or indirectly after the loans had been securitized.

The mortgage lenders who originated these loans and the investment banks that securitized them had every reason to believe that what they were doing was what the government wanted them to do. None of the Congressmen responsible for imposing purchase quotas on the agencies have yet gone to jail.

The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at For a more detailed description of how federal government policies led to the crisis, read “The True Origins of This Financial Crisis,” by Peter J. Wallison.

Last modified: January 9, 2016
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