The Inside Job

Apurva Sheth
Earlier this year, Asad Dossani and I spoke about the future of trading at the Equitymaster Conference 2016. There we had the opportunity to listen and interact with many renowned personalities.

I particularly enjoyed the question and answer session with Bill Bonner and Ajit Dayal. The audience asked various questions and Bill and Ajit were happy to oblige.

Someone asked for book recommendations. Bill recommended Sapiens by Yuval Noah Harari. Ajit took a different route and recommended a movie - The Inside Job. I noted both and put them on my list.

I read Sapiens a few weeks ago. The book takes you on a journey of human evolution. It starts about 1 lakh years ago when at least six different species of humans existed. It leaves you in the modern world where humans have the ability to design everything around them, including themselves. It covers everything between these two extremes - from when sapiens were just like any other animal to now when they are just short of gods.

The book is a fascinating read, and I second the recommendation. But the movie - The Inside Job - now that was a startling revelation. It literally sent chills down my spine as one frame unfolded after another...

I want to talk about this movie today as it is based on one of the four key pillars at the core of everything we stand for and do.

The movie is about the 2008 global financial crisis. It interweaves key events with research and candid interviews of people in the know. It also features our very own RBI governor, Raghuram Rajan. It is a great watch if you want to understand everything that happened and why it happened. Its split in to five parts.

Part I: How We Got Here

The American financial industry was regulated from 1940 to 1980. Over the next 20 years, derivatives trading became very popular. They were outside the purview of regulators. All attempts to regulate these complex financial instruments were thwarted by regulators and government officials. This led to recklessness in the entire financial services industry.

Part II: The Bubble (2001-2007)

Home ownership is a big part of The American Dream. Politicians encouraged lending and relaxed rules so that even the average American could borrow money for his own home. This eventually gave rise to subprime lending. People with no income or jobs were given home loans.

Why would a lender loan money to a person who does not have repayment capacity?

They bundled subprime loans and sold them as 'collateralised debt obligations' (CDOs).

Who would buy a CDO and why?

Investors like pension funds, hedge funds, and sovereign wealth funds because credit rating agencies gave CDOs the highest possible ratings.

Why did the ratings agencies give high ratings to CDOs?

They assumed that not all homeowners would default at the same time. Even if some defaulted, they reasoned, the houses could be sold and the loan amount could be recovered.

How did they insure this default risk?

With credit default swaps (CDSs). Investors bought CDSs as an insurance policy against a default. Insurance companies like AIG sold CDSs not only to the investors who had an interest in the home loan or CDOs but to anyone willing to buy them.

Part III: The Crisis

Since loans were bundled together and sold as CDOs, the lenders didn't care much about the credibility of individual borrowers. As long as they could convert their loans in to CDOs and pass the onus on to others, lenders were happy to offer loans to anyone and everyone who was willing to borrow.

AAA ratings and CDSs gave a false sense of security to investors. Everyone was happy to be making money and turned a blind eye to the risk.

It was a recipe for disaster. At this point, the crisis was inevitable.

The music stopped when Bear Sterns ran out of cash in March 2008. Fannie Mae and Freddie Mac soon followed. Two days after Fannie and Freddie Lehman Brothers collapsed. Merrill Lynch was bailed out by Bank of America. AIG was taken over by the US government.

All of these institutions were highly leveraged and yet had AAA rating just days before they went bust. Despite repeated warnings from various groups, regulators and government officials let the storm brew right under their nose.

Part IV: Accountability

After the crisis, which cost taxpayers billions of dollars, one might expect a higher level of accountability and for the guilty parties to be punished. But nothing of the sort ever happened. On the contrary, top executives of these defunct firms walked away with billions of dollars in bonuses. And academics and economists who were expected to shape policy for the benefit of the public had conflicts of interest and collected huge sums from the companies involved in the crisis.

Part V: Where We Are Now

The Obama administration came to power shortly after the crisis on the promise of 'change'. Obama promised to change the way the American financial institutions are run. But the administration's financial reforms were weak and barely changed how the financial sector functions. In fact, the very same people responsible for the crisis were appointed to key positions. Europeans tightened regulations, but Americans have resisted strong action. American financial institutions are bigger, stronger, and more vulnerable to crisis than ever before.

It all reminds us of one of the four key pillars behind everything we do:

    Regulators cannot protect you from your own greed. The financial industry is inherently crooked: It works for its own enhancement of wealth, not for yours.
We'll never be 'wrong' as long as we are empowering investors with credible, honest, and above all, unbiased opinions.

Whether it is helping a low-risk investor pick safe stocks or showing a high-risk investor the right way to trade equities, we can help a wide range of investors achieve their financial goals. But what we are most proud of is helping cheated and dejected investors win back their trust in sensible investing.

    In a bad world, Equitymaster is an open oasis: those who wish to seek shelter and shade are welcome. - Ajit Dayal
P.S.: You can now enjoy access to all Daily Profit Hunter and Equitymaster content on our mobile app. It's available for Andriod and iOS, so get access today!

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3 Responses to "The Inside Job"
29 Jul, 2016
Inside Job - Enlightening movie about the 2008 global crisis. The movie was pretty straight forward with the facts leading to the crisis and it's aftermath. Nevertheless, I have few unanswered questions. 1. The role of academicians and economists, even though have an unwritten responsibility to help the next generation stand up to the faults committed by previous regime and create a better economic situation for their nation and the world at large, failed on this front. Also, during the interview process, some of the economists were not expecting accountability where they bluntly shied away from piercing questions. One of the academician argued stating there is no conflict of interest even though he got paid by the same firm whom he was researching. 2. Why did Obama administration appoint the same officials to key positions knowing fully they failed miserably on all warnings and heeds and went ahead with their audacious decision. 3. Also another interesting movie crossed my mind - "MARGIN CALL'. It Follows the key people at an investment bank, over a 24-hour period, during the early stages of the financial crisis. Like 
26 May, 2016
EQM is OASIS where investors take shelters from crooked people.I salute MR AJIT DAYAL for creating such honest service.Some time I pinch myself that is it real in these dog eat dog world? Very hard to believe that still there are such people left on earth who are there to show the right way of earning money.Due to this I believe many people would retire peacefull and happily and MR AJIT DAYAL and his team would collect lot of blessings.Like 
Dr. K. S. Ananda Kumar
19 May, 2016
I sincerely thank you for your views. All along I had known that such irregularities exist. But, how to be safe from such malpractices in India? The entire history is given in a few lines. I know a lot more and in detail. Let me be very clear. In USA due to their FREEDOM, the malls and book-stalls sell all these stories and mischief, and all irregularities for a few $. They criticize even their President. But, there is no hold up. The fear is once any one is put up for action, it will result in tremendous turmoil. Even now, I am getting many foreign e-mails on this subject, and give their own simple solutions almost free. If you have these tales to you, please read them. It is not for me to refer such stories to you. Please save India and also save our Indians and investors and customers. Just be clear that USA has a total $14trillion due and owe to the public. Please think how it can be faced or tackled.Like 
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