The Big Shortcoming By: Gabriel PotterMBA, AIFA® 2016.04.19
Occasionally, I have used our blog posts to draw attention to cultural reflections of finance and investing.  I’ve highlighted podcasts like NPR’s Planet Money, cartoons like Scrooge McDuck and Money, books like Freakonomics, and movies like Moneyball.  I finally got around to seeing The Big Short only recently and although it hardly needs my endorsement (having already earned +$100MM at the box office, critical acclaim, and an Oscar for Best Adapted Screenplay of Michael Lewis’ bestselling book), I still feel compelled to remind everyone how good it is.  As a reminder, the film describes the blow-up of the US housing market bubble which lead to the financial crisis of 2008.  The film justly earned kudos for explaining complicated financial concepts like Collateralized Debt Obligations and Synthetic CDOs in entertaining ways and accessible language.

Despite my genuine admiration for the film, I can’t fully accept one element of its narrative thrust.  For most of the film, it equally spreads the blame around for the financial crisis.  It retains a fair amount of ambiguity about the nature of the bad behavior done by banks, brokers, rating agencies, and individual homeowners, exemplified by this exchange (which you can see in the trailer):

“How can the banks let this happen?”
“It’s fueled by stupidity”
“But that’s not stupidity.  It’s fraud.”
“Tell me the difference between stupid and illegal and I’ll have my wife’s brother arrested.”

By the end, the film has become explicit about placing blame squarely on the banks for doing what they were incentivized to do.  You could walk away from the movie ready to start an angry mob with torches and pitchforks ready to hound out the evil Wall Street bankers.  On the other hand, throughout the entire film, they showed many bad actors –ambitious and overextended homeowners, unscrupulous mortgage brokers, credit agencies willing to overrate bad debt, and so on – willing to make bad decisions because it’s what they were incentivized to do.  Why do they get a pass?   I think the more useful lesson might have been to consider changes of the system’s built-in compensation structure.  Changing the incentives can promote better behavior and it’s more useful than just being angry.  I haven’t read Michael Lewis’ book yet (although careful readers will know I’m already a fan, having endorsed his book Flash Boys), but I’ll see if it ends with some more constructive suggestions.

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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