The Big Short is a Hollywood movie about Financial Crisis’08 which led to global recession from 2008-2012. This movie won the academy award for best adapted screenplay. I personally enjoyed this movie more than The Revenant. And I know it’s absurd to compare both.
There is a lot of finance in the movie but trust me the movie is fun even if we don’t understand any. I will try my level best to add more fun by detailing few concepts I understand.
Sub-Prime Mortgage – A risky mortgage loan made to someone (Home loan in this case).
Mortgage backed security (MBS) – A bundle of mortgages including sub-prime ones and sold as securities.
Collateralized debt obligation (CDO) – A bundle of mortgage backed securities.
Finally what we get is chicken roll!
Thanks to the housing boom in US, financial institutions came up with the innovations like MBS and CDO. But most of the mortgages were not properly analyzed and CDOs were exposed to high risks. Only a few found this incorrect pricing of risks and started “Shorting” CDOs. Thus “the big short”.
Short/Short Selling – In the conventional practice called “going long” in stock markets, investors buy shares, hold them for a period of time and then sell for profit or loss. Whereas “going short” means investing in the exactly opposite way. First borrow shares (probably from brokers), sell them and wait for the share price to go down. Once the price is down buy the shares and return it to lender.
Ex: Last month, you borrowed a share of X company for 100 bucks, sold it in market and made 100. In a week, X’s share price were down to 80. Then you bought back a share of X for 80 and returned it to the lender. Congrats! You made a profit of 20 bucks.
Still confusing? Forget it. Short sellers bet that prices will go down. In this movie, our heroes bet against CDOs that they would default. Hence they signed contracts with banks which would pay off if CDOs default. Those contracts are called Credit Default Swap.
Finally CDOs started losing value as home buyers couldn’t pay their mortgages and eventually defaulted. When CDOs defaulted, protagonists of the movie made their fortune even though the American economy was collapsing. Whether they did the right thing? Watching the movie might answer.
(P.S : If you want to dig deeper on this, please contact me for more resources and explanations)