JESSICA DESVARIEUX: Welcome to the Real News Network. I’m Jessica Desvarieux in Baltimore.
The film The Big Short is garnering significant attention for its portrayal of the leadup to the financial crisis in 2007 and 2008. The film examines four people involved in the banking world that decide to bet against the banks and make a killing while the financial sector falls to its knees. And we all know what happened next: they get bailed out by Congress, they being the banks.
With us to discuss this is our guest Bill Black. Bill’s an associate professor of economics and law at the University of Missouri, Kansas City. He’s also a white-collar criminologist, a former financial regulator, and the author of the book The Best Way to Rob a Bank is to Own One. And of course, he’s a regular contributor to the Real News.
Thanks for being with us, Bill.
BILL BLACK: Thank you.
DESVARIEUX: So Bill, I’ve seen the movie, you’ve seen the movie. We were discussing it before we, we were on air. And we both say it’s a must-see. Viewers should see it. What did you think the movie did particularly well, Bill?
BLACK: And I saw it with a group, and that was everyone’s reaction as well. So first, it’s just fun. Michael Lewis is a brilliant writer. Everyone agrees on that. He’s brilliant at capturing quirky characters, and the movie is filled with quirky characters. And the movie is surprisingly good in bringing that to the screen, which is a really tough act to do. It’s well-paced. I think it’s pitched at the right level. You can understand it, but it makes you think and work as well, while you’re having fun. And it does fund things, you know, like Latin American, magical realism, where they suddenly break from the movie, and there’s a Nobel Prize winner in economics at a roulette wheel type of thing, or blackjack, you know, with a beautiful woman. And the two of them combine to explain how synthetic collateralized debt obligations work, which you would never think anyone would even attempt, much less with this magical realism.
And I think it all works. So you’ll be entertained, you’ll learn a lot about a number of different things. But I hope you’ll come away asking, well, you know, great. But it was a fun movie. What did I not learn about this crisis?
DESVARIEUX: Okay. Let’s first talk about what we did learn from the movie. There was one particular scene that struck me, and it’s when Steve Carell’s character, he goes into the credit–I’m sorry, the ratings agency S&P, and he’s asking about why these mortgages that have been bundled, a lot of them with toxic mortgages, why the ratings haven’t gone down. Can you talk about that a little bit, Bill?
BLACK: Yeah. First I’ll give you the real economic reason they’re talking about it. So the problem when you short something, and the title of the book of course is The Big Short. When you short something you’re betting it’s going to fall in price. Is–you can be right, but it can take too long for it to fall in price, and your bet expires after a while. And if you haven’t won it yet, you lose everything, potentially, right. So they not only had to be right about the bet, which was that housing values would fall dramatically, but they had to be right quick enough, and that had to be recognized in the markets.
And the quickest way it would be recognized in the markets is if the credit rating agencies admitted the truth, that the stuff which they called AAA, which is pristine, the best in existence, supposedly, was actually toxic crud, in which case the ratings would fall literally 20 levels. By the way, the ratings on average fell more than 20 levels on much of this product, which is unprecedented for, you know, really large volume stuff like this. So that’s why the Steve Carell character is hammering them, because as soon as the credit rating agency downgrades, their gamble, their big short, is going to win, and they’re going to be billionaires. So of course they’re going in and hammering S&P.
Now, they don’t explain, and it would have been even greater, in terms–much greater, in terms of their movie, that the lead-in, the character says something that’s never explained, which is: tell me that you’re looking at the tapes and analyzing them. And no explanation, right? So the tapes are, loan files, of course, are supposed to be voluminous. One you did liar’s loans they were often tiny. But they’re supposed to be big. And so nobody wants to crate around all those files, because they would be entire buildings. So we take pictures of them, and we put them on computer tape, and that’s what they mean by the tapes. So that had the underlying information from all the loan files, right. So he’s saying, I trust that you’re actually looking at reality.
BLACK: Right. Well, here’s the key. As early as 2001, there’s an infamous S&P memo. It’s a flame-gram. And we’ll get it up on the website for Real News. But it’s the poor, you know, guy who’s the actual professional credit rating guy. And his boss has told him to rate one of these garbage CDOs. Right, again, this is early. 2001.
DESVARIEUX: CDOs, just so people know–.
BLACK: It’s collateralized debt obligation. They’re explained in the movies, but basically it’s a whole bunch of mortgage-backed securities put together. And then what we called structured, which means they have different priorities and such, and therefore different prices and different ratings, right. So these were the things that, hilariously, obviously not really hilariously, the Fed said were essentially plain vanilla and posed no risk. Because this was Greenspan, right.
So, anyway. The professional rating guy at S&P has been told by his boss to rate the collateralized debt obligation. And what’s the name of the rating [agencies]? Credit rating agencies. So you have to evaluate credit risk. How do you evaluate credit risk? You look at the–what’s called the underline, the thing from which the derivative gets its value. What’s the underline? Mortgages. And there, if you looked at them, you would know that they were garbage. That they were massively fraudulent. And therefore, S&P, Moody’s, and Fitch, the big three, looked at exactly zero of the tapes.
DESVARIEUX: And why? Why–why, Bill?
BLACK: Because you can’t give them a AAA rating if you look.
DESVARIEUX: But in the movie there’s a suggestion, essentially, that they work for the banks. Why would they even want to look?
BLACK: Exactly. Why would they want to look? So here’s the scoop of the real economics. The deal to sell the CDO only works if the top 80 percent of this structure gets a AAA rating. Now, that’s insane, right. We’re starting with liars’ loans that have a 90 percent fraud incidence, and supposedly this is going to end up not just okay, but the best, least-risky security in world history. Right?
Now, you, the credit rating agency, only get your fee and people will only come to you if they can sell the product. They can only sell the product if it’s AAA. So if you don’t give it AAA, no more deals, no more income. And credit rating agency income shot up amazingly during this time period, driven overwhelmingly by these, giving AAAs to the CDOs.
But there’s a problem. If you look, as a credit rating agency, you will document that you knew not only was it not AAA, in rating terms, it was single-C or worse. In other words, garbage. Absolute garbage. In which case, how did you give it a AAA? Everyone will sue you, say look, your files show you knew it was garbage. Answer: never look.
DESVARIEUX: Gotcha. Gotcha.
BLACK: It’s really the financial version of don’t ask, don’t tell.
DESVARIEUX: The financial version of don’t ask, don’t tell. Really, really fascinating stuff, Bill. Let’s pause the conversation here. In part two, let’s talk about what the movie doesn’t do, or what questions were never asked in the film. Bill, thank you so much for being with us.
BLACK: Thank you.
DESVARIEUX: And thank you for joining us on the Real News Network.
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