The Big Short and The Big Lie

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There is no doubt about it:  Michael Lewis is a wonderful storyteller. He demonstrated his skill in his beguiling autobiographical best seller, Liar’s Poker. And again in The Blind Side and Moneyball.

Then in 2010 came The Big Short — the fascinating story of a handful of hedge-fund managers and speculators who bet on the U.S. housing market crash of eight years ago and made billions. The compelling narratives of real-life market movers Michael Burry, Steven Eisman, and John Paulsen, as well as millennial speculators such as Jamie Mai and Charlie Ledley, make spellbinding reading even when dealing with arcane subjects like short selling and collateralized debt obligations. Not only was the book a big success, but so was the subsequent movie.

There is one problem, however:  the underlying theme is pure left-wing propaganda. The Big Lie is that the housing crash and the financial panic of 2008 were solely the work of greedy investment bankers, unethical mortgage brokers, and crooked rating agencies. (In short:  Wall Street.)  There are long rants in the movie about how the entire U.S. financial system is fixed against the common man.

At the end we learn that the financial alchemists of Wall Street not only created the problems that destroyed countless lives but then had the audacity to blame it on immigrants and the poor — and were never held accountable for their misdeeds in a court of law.

The movie repeats these themes endlessly — and, as many millennials learn their history from movies, The Big Short has become, for many, what passes for wisdom about this wrenching chapter in American history.

But what actually happened?

To be fair, mortgage brokers, bankers of all stripes, and rating agencies made important mistakes. But there is ample blame to go around — including the legions of borrowers who took on debt far above their capacity to repay; and the U.S. government, which mandated high quotas of weak mortgages in order to expand home ownership.

Let’s turn first to the U.S. government, which sponsors two quasi-private corporations designed to provide liquidity and stability to the nationwide mortgage market by purchasing mortgages from lenders and holding the mortgages in their portfolios or packaging the loans into mortgage- backed securities that may be sold.  In the 1990s, during the Clinton Administration, the U.S. Department of Housing and Urban Development set annual targets for those corporations (known as Fannie Mae and Freddie Mac) to purchase high-risk home-purchase loans (known as “subprime mortgages”). By 1996 the government mandated that 42 percent of all mortgages purchased by these corporations had to be subprime. (To put that in perspective:  Imagine if 42 percent of everything you own carried a high risk of losing much of its value.)

By 2002, Fannie and Freddie had acquired $1.2 trillion in subprime and other high-risk mortgages, and by 2006, they had $3.4 trillion of these high-credit-risk assets on their balance sheets. Thirty-one million loans in the country — more than half of all U.S. mortgages — were subprime or otherwise problematic! Seventy-six percent of those mortgages were on the books of so-called government-sponsored enterprises — principally Fannie and Freddie.

Thus, it was the government’s drive to increase the percentage of homeowners in America by weakening lending standards that was the primary cause of the debacle. Rather than maintaining vital credit standards such as requiring a down payment of 20 percent when purchasing a home (as Canada did, thereby escaping a financial crisis), mortgages were underwritten with as little as 3 percent down, and so-called Alt-A loans (nicknamed “liar loans”), requiring no documentation verifying income and assets, were widespread. (To put that in perspective:  Imagine if more than half of everything you own not only carried high risk of being wiped out but that you also knew little or nothing about the people you were depending on to make sure your assets kept their value.)

Next let’s consider the borrowers. Remarkably, neither the book nor the movie ever suggests that a borrower has a legal and moral obligation to repay a mortgage used to purchase a home. Nor are the home buyers ever portrayed as anything other than passive victims. It is as if home mortgages were forced on robots or people without the intelligence or wisdom to borrow amounts within their means. There appears to be no room for free will in the story, as the borrowers in The Big Short appear to be literally forced by bankers to sign for huge mortgages.

What happened to the age-old culture in America where it was considered dishonorable and immoral to default on a loan? Two examples of repaying debtors despite onerous costs of doing so come from the lives of two great American presidents, Abraham Lincoln and Harry Truman.

In 1832, Abraham Lincoln took a risk and bought a village store in New Salem, Illinois with his partner, William Berry. Lincoln did not have the capital and borrowed his share of the equity. Lincoln was a poor shopkeeper, and within a year, the store went bust. Lincoln had no assets to pay off the loan, and when Berry died in 1835, Lincoln was required to pay off Berry’s debts as well as his own.

Lincoln did not declare bankruptcy or flee to another state but rather worked as a postmaster, surveyor, and later a lawyer for years to pay off debts which he had willingly contracted. Sometimes he referred to his debts, which seemed impossible to ever pay off, as the “national debt”; but he persevered. He finally paid off all his creditors in 1848 — more than fifteen years after the store closed down.

Harry Truman also fell on hard times early in his career. When he returned from France after World War I the economy was booming. So Truman opened a haberdashery in Kansas City with a partner. It was a bad idea. The economy cooled, and the store was unprofitable. After struggling to keep it open, they finally had to shutter it, leaving large debts to be repaid. After three years, Truman’s partner gave up and declared bankruptcy. Truman refused to declare bankruptcy, so he assumed his partner’s share of the debt as well as his own. Truman continued to pay off his debts for the next ten years, when a generous friend helped him liquidate the remaining amount he owed in 1934.

In The Big Short, Michael Lewis spins a great yarn about a small number of people who were prescient about the housing bubble and had the courage to go against the crowd and reap great rewards.

But the end result of the false narrative of the causes of the housing bubble and the Panic of 2008 has been the demonization of Wall Street in general and bankers in particular. This narrative, which ignores the culpability of the U.S. government and the willing participation of borrowers, has cost U.S. banks more than $100 billion in fines and penalties from the U.S. government. It has also fueled excessive regulation that hurts economic growth in America and a false populist mindset from both the left and the right that banks are the enemy. (Witness the mindless demonstrations of Occupy Wall Street several few years ago.)

With the coming of the new administration in Washington many heretofore unlikely things now seem possible. Perhaps one of them is that the story of the housing bubble crisis can be told accurately — and financial institutions can once again play their critical role of supplying capital to credit-worthy borrowers without fear of retribution and micromanaging.


Robert H. Bradley is Chairman of Bradley, Foster & Sargent Inc., a $3 billion wealth management firm that has offices in Hartford, Connecticut, and Wellesley, Massachusetts. This column represents his personal views and does not represent the views of the firm.