Disclaimer: All the details mentioned here are from the movie and not independently researched to be accurate by the author. Any opinions expressed here are my own and do not reflect the opinions of my employer.
At the Las Vegas Securitization Forum, Mark Baun happens to meet a CDO Manager. A CDO manager gets commission on the bonds they sell for the banks, fees, investment to run their business and are also provided clients from the banks who “offer” these toxic sub-prime bonds to be sold under the CDO.
Mark Baun gets really perturbed as to how these managers are supposed to represent the best interests of the “investors” who buy the bonds though they are being courted so much by the banks who sell them.
The CDO manager smirks that there is nothing illegal about this and assures that these bonds are of the highest quality with no risk. He also remarks that they are not in the same location of the bank, so technically not working for them.
This CDO manager then introduces a new type of bond called “CDO Squared” which instead of containing mortgage bonds, consists of different components of other CDOs, essentially “a CDO of a CDO”
Then another term is introduced which Mark Baun is shocked to know that such a thing even exists. “Synthetic CDOs” — These are CDOs made with the Opposite side of the bet made with the swaps. The definition from Investopedia is:
A synthetic CDO is a form of collateralized debt obligation (CDO) that invests in credit default swaps (CDSs) or other non cash assets to gain exposure to a portfolio of fixed income assets. Synthetic CDOs are typically divided into credit tranches based on the level of credit risk assumed.
The most intriguing problem is that the market for CDOs and mortgage bonds are almost 20 times greater than the actual mortgages themselves i.e., if there are around 50 Million worth of sub-prime loans, the market capital in CDOs, swaps and Synthetic CDOs based on these loans was around a billion.
Selena Gomez and Dr. Richard Thaler explain this in simpler terms.
If the Mortgage bonds were a Match, with CDOs being Gas soaked rags, then Synthetic CDOs were the Atomic Bomb
A more theoritical explanation is available at:
After his discussion with the CDO manager, Mark Baun decides to go all in and shorts another 500M with credit default swaps.
The inevitable Fall
The final leg of the movie begins with an ominous quote
Everyone, deep in their hearts , is waiting for the end of the world to come.
— Haruki Murakami
The first signs of trouble start on April 2, 2007 when a mortgage lender “New Century” filed for bankruptcy and fired around 3,200 employees.
However, the banks and rating agencies were indulging in self-delusion with the CDOs and Bonds increasing in value though the mortgages within them are becoming delinquent by the day and the mortgage market crashing.
Jamie Shipley and Charlie Geller attempts to go public with this information and discuss this with Casey from Wall street Journal and tries to explain that these banks selling these bonds are unloading the bonds onto unwitting customers and are not devaluing these bonds until they are offloaded from their books making them worthless in the hands of the investors.
Dr. Burry attempts to find the banks who have issued the credit default swaps to understand how can the value of an insurance contract has not changed in spite of the “demise of the very asset that it insures”. Goldman attempts to mull over the position stating that these are independent markets and not correlated.
The final bell
The banks start realizing that they are in deep trouble and attempt to buy back all the credit default swaps given out knowing that these swaps will result in huge returns to the holders and loss to the providers, the banks themselves.
Goldman finally calls Dr. Michael Burry to review his marks/positions and finally accepts that “Goldman secured a net short position themselves and free to mark his swaps more accurately as it is now in their interest to do so”.
Ironically for Mark Baun, who works under Morgan Stanley finds from Jared Venett that Benny Kleeger who heads Morgan Stanleys’s bond department had started shorting sub-prime housing, 2 Billion in “BBB” labelled bonds which is a smart move considering the current situation.
However, since the premium for the swaps ate into this desk’s profit and in order to cover the short position, he issued credit default swaps on a lot of “AA” and “A” rated bonds as protection assuming they would never get under. He was betting only against BBBs, and gave contracts for the A and AA’s swaps whose contracts were still held by the bank (unlike Goldman who quickly secured a short position as earlier discussed)
Mark Baun is bemused that he had not realized that all this time, he has been betting against his own parent bank who were holding the credit default swaps on these toxic bonds. Morgan Stanley’s total exposure was 15B since Benny Kleeger assumed that default rates of 8% was impossible, since millions will need to be homeless for those default rates.
Mark Baun attempts to rationalize with his team not to sell the swaps yet since that would mean, acknowledging Morgan Stanley might even file bankruptcy.
On the other side, Charlie Geller & Jamie Shipley have 80% swaps from Bear Capital who are risk of going under and unable to find a buyer for these swaps whose contracts are help by Bear Capital. Finally they sell their swaps with Ben’s help with most of them going to UBS, who closes the trade on his vacation in England, seated in a pub and make around 80M in profits. The Euro markets already start tumbling by this time, with many countries already freezing trading at this point.
Dr. Michael Burry, the primary protagonist and whose research helped the other two finally sells his position for 1.3 Billion dollars who at the end increases his Scion Capital stock price go up by 489% profit with a total profit of 2.69B.
Jared Venett makes a bonus of 47M over his commission for selling the credit default swaps.
Mark Baun vs. Bear Capital
Mark Baun has not still sold his position and takes part in a panel alongside Bruce Miller from Bear Capital. This was a dramatic sequence of scenes where Bruce Miller assures everyone that the mortgage markets are still strong while his company stock drops 38%, leaving Mark Baun shaking his head at the ignorance and their self-denial of the impeding doom and how people have accepted fraud as a way of life.
September 15, 2008
Lehman Brothers stock goes to zero and the markets crash. The scene opens with all employees leaving the building and Mark finally relenting to sell his position returning a profit of 1B.
- Banks used the bail out money to give themselves bonuses and lobbied the Congress to kill any reforms.
- Only one banker went to jail from Credit Suisse.
- 5 Trillion dollars disappeared in pension money, real estate value, 401k, savings and bonds.
- 8M people lost their jobs, 6M lost their homes in USA alone.
- In 2015, Banks began selling billions in something called “bespoke Tranche opportunity”, which according to Bloomberg News, is just another name for CDO.