Market Lessons From The Big ShortYes, there will be spoilers in this article — if we can even call it that. All of us have been deeply impacted in one way or another by the housing crisis of 2007, which ultimately led to the global financial collapse of 2008. A litany of books, documentaries, and films have covered the biggest financial disaster in modern history, and The Big Short is simply the latest iteration. However, it is arguably the most entertaining and thought-provoking of the bunch.

The film starts off with a hedge fund manager that has discovered a startling correlation — when a housing boom gets ahead of itself, a broad financial collapse soon follows. This is especially pertinent because at the time when the story begins, the housing bubble is on the very edge of bursting, yet few people realize it.

Because of this broad ignorance, the fund manager realizes to his chagrin that there are no ways to capitalize on the impending real estate disaster. Taking matters into his own hands, he approaches several major banks about a credit default swap. This is a contract in which the buyer of the CDS agrees to pay recurring premiums to the seller, but in case of a default of the underlying asset, the seller then compensates the buyer, usually in the form of the par value of the bonded asset, as well as the loan itself.

The contract is essentially insurance against disaster. But unlike auto insurance where the insured is financially protected in case of an accident — a high probability event — this contract is to designed to profit the insured under a nationwide default — a low probability event. In other words, this insurance is a short position, hence the title of the movie and the book from which it was based.

So unlikely was the forecasted event that every bank was willing to offer the CDS to the fund manager. After all, why walk away from free money? Through various circumstances, other Wall Street players caught wind of the trade, and through their own investigations, came to the same conclusion — the bubble was about to burst.

Of course it did, and did so in spectacular fashion. The individuals who risked everything by the most audacious of contrarian trades were fully vindicated, but from a greater perspective, there were no winners. Millions of Americans lost their jobs, their homes, and their trust in government.

Nearly a decade after the initial onset of disaster, the financial markets, though much improved nominally, are still standing on tenuous ground. What practical lessons can we extract from this tale of Wall Street excess?

Being right requires patience — Rome wasn’t built in a day and there’s rarely a time when someone predicts the markets with absolute precision. In fact, being right too soon can also have consequences. When the first CDS was purchased, the buyer was able to receive contracts at ridiculously low rates — because he was the first and the trade was unheard of. As more news trickled in, the rate of participation increased. This was one of the subtle lessons from The Big Short. Thus, patience is a virtue.

When it’s time to act, act! — On the other hand, being too patient can have its consequences as well. Another subtle tip from The Big Short occurred in its final sequences. As the markets were going into free-fall, those who owned short positions had to cut a deal immediately to get what they could of their contracts; otherwise, because the big banks were also facing default, they would get nothing even though they were right all along! Imagine the fury of owning the most lucrative trade in history, only to be denied by bankruptcy of the financial institution that created that very trade!

Complacency is the bubble — I believe the most important lesson from The Big Short is that complacency is the bubble. Although the movie takes great pains in explaining that one man saw something that others didn’t, it’s doubtful that he was the only one. The analysis to come to the protagonist’s conclusion wasn’t particularly complicated. He simply was willing to not let conventional thinking cloud his judgment.

I encourage movie-goers to watch The Big Short. It neatly and sarcastically provides a thought-provoking insight into the one of the greatest disasters of Wall Street. More importantly, it is a compelling warning to the complacency that has led to yet another unsustainable bubble in the global financial markets.