What Went Wrong With The Financial Markets Of 2008? – CineMBA – The Big Short

CineMBA is a series where InsideIIM and Professors from Top Business Schools endeavour to make learning fun and interesting instead of dull and boring. In this video, Mr Carlo Altomonte from MISB Bocconi explains what went wrong with the financial markets of 2008 with the help of the 2015 movie called ‘The Big Short’.

The Big Short tells the story of how 4 different men spotted the inevitable downfall of the housing markets of USA and profited from it.

 

Prof Altomonte explains how and why some of the biggest financial institutions fell on their knees.

 

Let’s begin by understanding how it all started. Home owners took loans from banks to build their houses. Traditionally, the loans were provided based on the ability of the borrower to repay on the basis of his financial stability and affluence. Later, bonds (Collateralized Debt Obligations)  were created on these loans which were unlikely to be defaulted. These bonds were available for purchase in the open market. As the demand for these bonds increased, banks became less stringent while disbursing these loans. This led to the creation of sub-prime loans which are loans that are given at higher rates to people who were unlikely to be able to pay them off.

The bonds became shakier as more and more sub-prime loans were introduced. Enter Credit Default Swaps. Now these CDS- an insurance policy against the housing market, allow the people to bet against the system  Investment banks create the bonds and sell it and at the same time buy protection through CDS. In the end there is a giant web where everyone has insurance against the risk of somebody else. So as more people default on the bonds, it creates a ripple effect that wipes out 5 trillion dollars of wealth, 6 million people lose their house and 8 million people lose their job all over the world.

 

Now what can we learn from this?

1. It requires hours and hours of data crunching to arrive at a robust conclusion
2. A great manager keeps an eye out for anomalies and doesn’t explain anything away as accident
3. When faced by widely accepted market rules and dynamics that you don’t believe hold true anymore, you can make profit by betting against them
4. You have to stand firm by your beliefs even in light of criticism and negative initial results
5. In the complex world of finance, it requires a deep technical knowledge, hours of study and dedication to understand the situation and have a correct forecast to make profit

 

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