Sideways: Loss, camera, action
The film of The Big Short provides a welcome reminder of the glory days of Morgan Stanley’s fixed income franchise, when Howie Hubler managed to lose $9 billion on botched structured credit tranche trades.
This is still a record for an individual trading loss, though JPMorgan made a valiant pitch for the title with its London Whale dealing, also in credit derivatives, which racked up losses of $6.2 billion. JPMorgan arguably deserves a special mention for managing to lose so much money in calm markets during 2012, but there is no denying that Hubler stands alone for his exceptional loss-making during 2007, as the US housing market started to crack and it turned out that retaining triple-A tranche exposure linked to mortgages, while shorting lower-rated deals, was not, in fact, a sure-fire way to make a profit.
As Morgan Stanley shuffles away from its latest bid to increase fixed income market share, staring at its shoes, the film version of the Michael Lewis non-fiction book on a few hedge funds that managed to profit from the US housing crisis puts the bank’s previous woes back in the spotlight.
The film also takes some liberties with the facts, for the sake of comic and dramatic impact.
Hubler does not feature as a central character and his dealing losses only get a look-in towards the end of the film in a section on a potential threat to the trading lines of Steve Eisman, a hedge fund manager who is renamed in the film as Mark Baum and played by actor Steve Carell. Eisman worked at FrontPoint Partners, a fund that was owned by Morgan Stanley and would eventually profit by around $1.5 billion from short mortgage positions when the market slumped into the credit crisis of 2008.
The film truncates the gap between Hubler’s trading loss in 2007 and the period straight after the collapse of Lehman Brothers in September 2008 when Morgan Stanley appeared to be the next investment bank that would fail, presumably to be followed by Goldman Sachs (though Goldman’s top executives have always disputed the assumption that it would have collapsed if the government had not bailed out the US banking system and backed the payment of default swaps flows owed by AIG to Goldman).
Goldman features in the film version of The Big Short, but with a lower profile than Deutsche Bank, home at the time of credit derivatives trader Greg Lippmann, who is renamed in the film as Jared Vennett, and played by actor Ryan Gosling.
Goldman’s traders are portrayed as opportunists who are willing for a price to facilitate default swap trades by the debatably heroic protagonists as they try to establish short positions on the US housing market.
Lippmann (or Vennett) is shown masterminding the creation of a new market for mortgage-based default swaps and is depicted as a cynic who gets a big bonus payment from Deutsche Bank without running any personal risk – a $47 million cheque features in one of the later scenes in the film.
In truth Goldman’s traders worked alongside Lippmann in creating the market for MBS default swaps, and the firm did a better job than Deutsche in profiting from short positions, even if it did need the intercession of the US government to guarantee its trades with failing insurer AIG.
The cost of carry of running Lippmann’s short positions and a debate within Deutsche over the likely severity of a mortgage downturn led the firm to scale back its hedges before the worst of the crisis hit. Losses by Boaz Weinstein, a credit trader who rivaled Lippmann as the highest-profile dealer at the firm, also counterbalanced gains from short MBS trading at Deutsche.
Still, while the film of The Big Short becomes repetitive in highlighting the ways traders helped to fuel and profit from the mortgage crisis, it is certainly creative. And any reminder of the trading excesses that accompanied the credit crisis can serve as an antidote to calls for a relaxation of regulatory vigilance in an attempt to return to an age of supposedly beneficial market liquidity.