‘The Big Short’

Last weekend I watched, and loved, The Big Short, a film based on the book of the same name by Michael Lewis, which describes a group of disparate outsiders who each spotted the colossal financial malfeasance which gave rise to the banking and housing crisis of 2008. The writer-director Adam McKay manages to create a hilarious, sharp, clear and compelling movie, all the more impressive given that the subject matter is, frankly, pretty dry and horrendously complex - riddled with acronyms and nuanced money manipulations in identikit boardrooms. I remember finding this story difficult to get my head around when I was working on my guide to UK politics last year (None Of The Above - still available in bookshops, makes a great birthday/anniversary/Valentines present). I wanted to write a chapter describing the reasons for, and consequences of, the crash, but was really struggling. At least until I came across Inside Job, a brilliant documentary by Charles H Ferguson which explores and demystifies the whole thing. After seeing that I spewed out quite an angry chapter. Ultimately I never sent that chapter to the publisher because I felt it was too emotional and would jar within the context of a neutral, non-partisan book.

However, after seeing The Big Short I went home and dug out that chapter. I re-read it and thought "This might make people want to go and watch the film". So here is an excerpt:

"Capitalism and so-called 'corporate greed' go hand-in-hand. Capitalism is an economic model where private companies own pretty much everything, and operate for profit. That basic truth - that corporations and businesses exist almost exclusively to make money - is what drives our economy. 'Corporate greed' is just a pejorative term for 'profit-driven', really, and it is built into the system. Corporations usually reward the people who make them the most money, with money. They prioritise profit over everything else. In the case of publically-owned companies, they have a duty to their shareholders to make as much money as possible. The famous economist Milton Friedman said 'The social responsibility of business is to increase its profits.' He was right - whilst some businesses may take the lead when it comes to social welfare, we cannot expect them to. That's where government policy comes in.

A totally 'free market' is one where there is no government intervention whatsoever. You let the private businesses run the economy, and then see what happens. The prices for goods and services are set by a sort of mutual consent between the seller (the businesses) and the buyer (us, the consumers). The businesses also control wages and the payment of bonuses and so on. The government does not interfere. A 'controlled market' or 'regulated market' is one where the government does interfere - there are a variety of ways in which they can do that, including setting the prices of things, controlling who or what can produce and sell certain things, setting taxation levels, imposing wage restrictions and so on. Most major global economies are mixed, so that there is a bit of both. The economy is run partly by the private sector, and partly by the state. In the UK we have a mixed economy where the government exerts a certain amount of regulation over big business, and provides some public services itself (like the NHS, and schools). The UK used to have a much larger public sector, but much of it was sold-off to private companies in the 1980s.

So what happens if you let corporations and big business do what they like? Well, sometimes it will end in catastrophe. The financial crash of 2008 was triggered in September of that year by the collapse of Lehman Brothers, a huge global bank based in the US. It nearly brought the entire global financial system down. Without going into detail, because it's incredibly complex, what was happening was that loans, in particular mortgages, were made to people who were going to struggle to pay them off. That in itself is clearly irresponsible. These high risk loans, charging high interest rates on repayments, were then passed onto the big banks, who lumped them together into pools of debt that were now, as if by magic, low-risk. These pools of debt, with their high interest repayments and 'low-risk', seemed pretty attractive to investors, who bought them. Unfortunately, the people who were assessing the level of risk - the ratings agencies - were being, shall we say, far too generous. Giving high-risk debt pools low-risk ratings. These ratings agencies would later say that they were just giving their opinions. Bear in mind that the credit agencies were being paid by the banks. You can see how that arrangement might work, 'We're going to pay you to rate the risk of this debt. We'd like it to be low-risk because we'll be able to sell it for more money. See what you can do, guys'.

In some cases, the banks selling these debt pools as low-risk, knowing full well that they were high-risk, would take out insurance. So that if (as was quite likely), the debt is defaulted on - the people owing the money can't afford the repayments - the bank would be protected. Let's say I have a piece of shit. I then pay my friend to stick a label on the piece of shit that says it is in fact solid gold. You trust the label and buy the piece of shit off me for quite a lot of money. Knowing that you will probably find out that it is a piece of shit at some point, I have taken out insurance to cover me just in case the 'gold' turns out to be shit. So I am making money no matter what happens. You, on the other hand, are left with a piece of shit. That's essentially what happened to thousands of American investors. Lots of people's pension funds were basically swapped for worthless pieces of shit. The banks, meanwhile, conjured lots of money out of thin air. Billions and billions of dollars.

Ultimately, the banks borrowed an awful lot more money to enable them to keep on doing this - buying and selling more chunks of debt. They bet on themselves, with money that wasn't theirs, and eventually they lost. The huge amount of debt that they had taken on, and convinced everyone wasn't risky, was in fact - really risky. In October 2008 several UK banks were on the brink of collapse. The government decided to bail them out, with a lot of taxpayers' money. In 2009 the National Audit office said 'if the support measures had not been put in place, the scale of the economic and social costs if one or more major UK banks had collapsed is difficult to envision. The support provided to the banks was therefore justified, but the final cost to the taxpayer of the support will not be known for a number of years.' We are still not entirely sure how much the bailout cost the taxpayer, but it is true that there wasn't really much of an alternative.

Figures from 2011 suggest that the government gave several UK banks a combined total of £123billion in cash. And promised to spend up to a peak of £1.2trillion (!!!) if it became necessary. The government bought shares in the banks, whose values decreased. That's bad news for the taxpayer. The banks are paying back the loans, but very slowly. The interest on the repayments is also quite low. The Royal Bank of Scotland was given £46billion by the government - or, to put it another way, we, the taxpayer, gave RBS £46billion. As of February 2014, RBS confirmed that its losses over the six-year period since it was bailed out, totalled £46billion. A neat symmetry. It's not all bad news for the employees of RBS, though - the bank put aside £576million to pay staff bonuses for the year 2013 (a year in which it made losses of £8.2billion)."


The chapter continued like that, with a few qualifications about the size of the UK financial sector (it's big), the number of people it employs (a lot) and the amount of tax it contributes (also a lot - some £20bn/year). I'm glad I didn't put it into the book in the end but equally it is a story that needs to be told. The Big Short does that magnificently. Go and see it.

A brief footnote: Brendan Miller (@brenkjm) - my frighteningly smart producer on BBC3's now defunct Free Speech, and a man who was instrumental in whipping my book into shape - offered some interesting thoughts about all of this stuff, as is his wont. He pointed out that "the banking system is literally no-one's idea of how things should work". He reminded me that the essence of the free-market is that you let bad companies fail and go bust, and that's what should keep everyone honest - more careful and more likely to innovate and create and so on. Those who disagree with free-market principles think it's all too risky, and that the only way to keep things in check is heavy regulation or public-ownership. The reality was that we had just enough regulation to make us, the customers and shareholders, not worry about what the banks were up to, but not enough to stop them from taking huge risks. So if I had included this chapter in the book, I would have incorporated these observations somewhere. But I didn't, so I haven't.

Comments are closed.

‘The Big Short’

Last weekend I watched, and loved, The Big Short, a film based on the book of the same name by Michael Lewis, which describes a group of disparate outsiders who each spotted the colossal financial malfeasance which gave rise to the banking and housing crisis of 2008. The writer-director Adam McKay manages to create a hilarious, sharp, clear and compelling movie, all the more impressive given that the subject matter is, frankly, pretty dry and horrendously complex - riddled with acronyms and nuanced money manipulations in identikit boardrooms. I remember finding this story difficult to get my head around when I was working on my guide to UK politics last year (None Of The Above - still available in bookshops, makes a great birthday/anniversary/Valentines present). I wanted to write a chapter describing the reasons for, and consequences of, the crash, but was really struggling. At least until I came across Inside Job, a brilliant documentary by Charles H Ferguson which explores and demystifies the whole thing. After seeing that I spewed out quite an angry chapter. Ultimately I never sent that chapter to the publisher because I felt it was too emotional and would jar within the context of a neutral, non-partisan book.

However, after seeing The Big Short I went home and dug out that chapter. I re-read it and thought "This might make people want to go and watch the film". So here is an excerpt:

"Capitalism and so-called 'corporate greed' go hand-in-hand. Capitalism is an economic model where private companies own pretty much everything, and operate for profit. That basic truth - that corporations and businesses exist almost exclusively to make money - is what drives our economy. 'Corporate greed' is just a pejorative term for 'profit-driven', really, and it is built into the system. Corporations usually reward the people who make them the most money, with money. They prioritise profit over everything else. In the case of publically-owned companies, they have a duty to their shareholders to make as much money as possible. The famous economist Milton Friedman said 'The social responsibility of business is to increase its profits.' He was right - whilst some businesses may take the lead when it comes to social welfare, we cannot expect them to. That's where government policy comes in.

A totally 'free market' is one where there is no government intervention whatsoever. You let the private businesses run the economy, and then see what happens. The prices for goods and services are set by a sort of mutual consent between the seller (the businesses) and the buyer (us, the consumers). The businesses also control wages and the payment of bonuses and so on. The government does not interfere. A 'controlled market' or 'regulated market' is one where the government does interfere - there are a variety of ways in which they can do that, including setting the prices of things, controlling who or what can produce and sell certain things, setting taxation levels, imposing wage restrictions and so on. Most major global economies are mixed, so that there is a bit of both. The economy is run partly by the private sector, and partly by the state. In the UK we have a mixed economy where the government exerts a certain amount of regulation over big business, and provides some public services itself (like the NHS, and schools). The UK used to have a much larger public sector, but much of it was sold-off to private companies in the 1980s.

So what happens if you let corporations and big business do what they like? Well, sometimes it will end in catastrophe. The financial crash of 2008 was triggered in September of that year by the collapse of Lehman Brothers, a huge global bank based in the US. It nearly brought the entire global financial system down. Without going into detail, because it's incredibly complex, what was happening was that loans, in particular mortgages, were made to people who were going to struggle to pay them off. That in itself is clearly irresponsible. These high risk loans, charging high interest rates on repayments, were then passed onto the big banks, who lumped them together into pools of debt that were now, as if by magic, low-risk. These pools of debt, with their high interest repayments and 'low-risk', seemed pretty attractive to investors, who bought them. Unfortunately, the people who were assessing the level of risk - the ratings agencies - were being, shall we say, far too generous. Giving high-risk debt pools low-risk ratings. These ratings agencies would later say that they were just giving their opinions. Bear in mind that the credit agencies were being paid by the banks. You can see how that arrangement might work, 'We're going to pay you to rate the risk of this debt. We'd like it to be low-risk because we'll be able to sell it for more money. See what you can do, guys'.

In some cases, the banks selling these debt pools as low-risk, knowing full well that they were high-risk, would take out insurance. So that if (as was quite likely), the debt is defaulted on - the people owing the money can't afford the repayments - the bank would be protected. Let's say I have a piece of shit. I then pay my friend to stick a label on the piece of shit that says it is in fact solid gold. You trust the label and buy the piece of shit off me for quite a lot of money. Knowing that you will probably find out that it is a piece of shit at some point, I have taken out insurance to cover me just in case the 'gold' turns out to be shit. So I am making money no matter what happens. You, on the other hand, are left with a piece of shit. That's essentially what happened to thousands of American investors. Lots of people's pension funds were basically swapped for worthless pieces of shit. The banks, meanwhile, conjured lots of money out of thin air. Billions and billions of dollars.

Ultimately, the banks borrowed an awful lot more money to enable them to keep on doing this - buying and selling more chunks of debt. They bet on themselves, with money that wasn't theirs, and eventually they lost. The huge amount of debt that they had taken on, and convinced everyone wasn't risky, was in fact - really risky. In October 2008 several UK banks were on the brink of collapse. The government decided to bail them out, with a lot of taxpayers' money. In 2009 the National Audit office said 'if the support measures had not been put in place, the scale of the economic and social costs if one or more major UK banks had collapsed is difficult to envision. The support provided to the banks was therefore justified, but the final cost to the taxpayer of the support will not be known for a number of years.' We are still not entirely sure how much the bailout cost the taxpayer, but it is true that there wasn't really much of an alternative.

Figures from 2011 suggest that the government gave several UK banks a combined total of £123billion in cash. And promised to spend up to a peak of £1.2trillion (!!!) if it became necessary. The government bought shares in the banks, whose values decreased. That's bad news for the taxpayer. The banks are paying back the loans, but very slowly. The interest on the repayments is also quite low. The Royal Bank of Scotland was given £46billion by the government - or, to put it another way, we, the taxpayer, gave RBS £46billion. As of February 2014, RBS confirmed that its losses over the six-year period since it was bailed out, totalled £46billion. A neat symmetry. It's not all bad news for the employees of RBS, though - the bank put aside £576million to pay staff bonuses for the year 2013 (a year in which it made losses of £8.2billion)."


The chapter continued like that, with a few qualifications about the size of the UK financial sector (it's big), the number of people it employs (a lot) and the amount of tax it contributes (also a lot - some £20bn/year). I'm glad I didn't put it into the book in the end but equally it is a story that needs to be told. The Big Short does that magnificently. Go and see it.

A brief footnote: Brendan Miller (@brenkjm) - my frighteningly smart producer on BBC3's now defunct Free Speech, and a man who was instrumental in whipping my book into shape - offered some interesting thoughts about all of this stuff, as is his wont. He pointed out that "the banking system is literally no-one's idea of how things should work". He reminded me that the essence of the free-market is that you let bad companies fail and go bust, and that's what should keep everyone honest - more careful and more likely to innovate and create and so on. Those who disagree with free-market principles think it's all too risky, and that the only way to keep things in check is heavy regulation or public-ownership. The reality was that we had just enough regulation to make us, the customers and shareholders, not worry about what the banks were up to, but not enough to stop them from taking huge risks. So if I had included this chapter in the book, I would have incorporated these observations somewhere. But I didn't, so I haven't.

Comments are closed.