Movie time - Margin Call

Last night I saw Margin Call (with Jeremy Irons, Simon Baker, Kevin Spacey, Zachary Quinto, Stanley Tucci, Paul Bettany, Demi Moore and Mary McDonnell) and I have to say that the movie was quite chilling.

The story isn't complex at all. Overall, it describes the 36 hours leading to a financial crisis identical to the 2008 subprime crisis and it goes like this:

A risk assessment specialist (Tucci) at a trading company (the company is never named, just hinted that it's big) is fired and leaves some unfinished work to a junior analyst (Quinto) who discovers that given the way the firm packages its MBS' (mortgage backed securities), they will exceed the volatility levels in such a way that when combined with existing excessive leverage and a decrease in assets of 25%, it will result in a loss greater than the company's capitalization (effectively ending the company). Furthermore, it becomes obvious that given the way the company handles its MBS' and given that more and more of them are secured by packs of mortgages that fall in the subprime category, this kind of decrease will occur. More, the company had been experiencing fluctuations around the historical volatility levels earlier but chose to disregard them given the fact that the risk meant more gains.

The analyst warns the head of trading (Bettany) who in turn calls the boss of their floor (Spacey). It is revealed that risk isn't something that the boss is even familiar with and when calling the CEO (Irons), neither of them got to where they are by being smart but by having appetites for gains.

Division head (Baker) doesn't want to accept the loss and proposes to dump all the toxic assets into the market, something that the CEO agrees with. The floor chief disagrees but as there's no way the company can get away from the issues it has created, he is overruled by the CEO.

The head of trading returns to the trading floor and orders his men to dump the suprime MBS' also telling them they are effectively ending their careers as nobody will trust a trader that knowingly made bad trades for their clients. Secretly, the managers also know that it is likely they will be investigated by a federal commission.

As the crisis errupts, the CEO leaves the analysts to ponder what everyone else will do when the financial institutions they placed their trusts with (banks, loan companies, etc) will fall and what they worked for to achieve will be lost. Meanwhile, the trading chief congratulates himself for having safeguarded a good share of his income from the previous year (over 2 million dollars) from the onset of the crisis. Alone, the floor chief burries his dog, dead from cancer, after his resignation was rejected.

What is chilly about all this is that when describing the events, the movie doesn't even hint at a way out. The system, along with everyone who depends on it (starting from everyday people to those working in the financial system itself) would be least affected if the company itself would simply take the losses incurred and accept that nobody involved will ever work in a financial institution again. Their assets would be sold at real value (nearly worthless), creating a gap in the market that would soon be filled back.

Instead, they sell the losses to everyone and making everyone think they got a good deal. Like creating millions of expanding bubbles ready to pop, all over the world. Rather than sink, the force everyone else to deal with the results of their ... well ... their something.

The movie doesn't name a primary cause. You can dismiss it as greed and leave it like that.

But that doesn't help at all. Greed is human. Some of us fight it, some manage to keep it at bay, others manage to even use it for good by giving to others what they gained by greed.

It's not really the system as whole either. The financial system manages and even creates wealth. Whether based on real, hard resources or virtual products, the system distributes wealth in a 'law of the jungle' kind of way which puts the cunning at an advantage. Surprinsingly, the only law in the process is: don't lie about what you're selling.

So people resort to hinding it. You take a loan, pack it together with futures contracts, put an equal value mortgage on top to secure it all and sell it. The more stuff you cramm in there, the less people will look into it. So what if one of those things is worthless?

We have all sorts of stuff being traded. From the actual bets that people take with futures contracts (where you bet on what course the price of a good will take in the future) to shares, bonds of all types and various complex packages.

So where do we draw the line? Any new invention like this leads to another way to create artificial wealth, but aside from making it harder and harder to track it also means more risk. It means new ways to fail are injected into the system making it more and more vulnerable.

Being able to pass around non-liquid assets is important. If you couldn't sell mortgages, that money would be blocked until its paid. Liquidity should go where it is needed. But playing a deceitful game is risky.

And the worst part, when thinking back to the movie, is that I'm sure this is close what happened. It didn't happen in a single office, it probably happened in several companies around that time. I can imagine risk analysts scrambling in the offices of BNP Paribs or Lehman Brothers ... or later in the offices of Fanny Mae when they realized that the crappy mortgages they allowed on the market were coming back with a vengeance.

In a world of winners, nobody wants to take one for the team. But at one point you have to realize that when you're "too big to fail", each and every risk you take, you're not taking it yourself - you're taking it for the world and don't be surprised that the world will want to have a say in that decision.