Margin Call — A forgotten gem

I’ve been binging on movies that deal with finance and money for the last few days, and soaked up all the new-age classics including 𝘞𝘰𝘭𝘧 𝘰𝘧 𝘞𝘢𝘭𝘭 𝘚𝘵𝘳𝘦𝘦𝘵, the award winning 𝘛𝘩𝘦 𝘉𝘪𝘨 𝘚𝘩𝘰𝘳𝘵 (2015) which perfectly captures the 2008’s financial crisis and the events surrounding it. 𝘛𝘩𝘦 𝘉𝘪𝘨 𝘚𝘩𝘰𝘳𝘵 expertly showcases the corruption and complacency and the dubious financial engineering that led to the whole house of cards to crumble, it paints most everyone on wall street with a broad brush and labels them as unscrupulous crooks and they all preyed on the same system, and of course their so called “whistle blowing” didn’t amount to anything. While the rest of the country suffered through what came to known as the Great Recession from 2008–2012, nobody on Wall Street went to jail, though some got fired, most emerged unscathed, some even richer with personal gains topping 100s of millions, most importantly Dr Michael Burry of Scion Capital, who saw the crisis way before anyone did and shorted the mortgage backed securities (i.e. he bet that the housing market will collapse) and emerged profitable when the dust settled. All said and done, trillions of dollars evaporated from the economy not to mention the millions of lost jobs, and foreclosed homes. Although 𝘛𝘩𝘦 𝘉𝘪𝘨 𝘚𝘩𝘰𝘳𝘵 got all the accolades and box office success and multiple awards it rightfully deserved, another film that came out way before it and took us behind the closed doors of a wall street firm to capture the “fire sale” that actually started the frenzy, that film is 𝘔𝘢𝘳𝘨𝘪𝘯 𝘊𝘢𝘭𝘭 (2011).

Before I discuss the film, for those who are not familiar with the events and conditions that led up to the subprime mortgage (these are mortgages that are sold to people with less than excellent credit scores with lower initial interest rates, so when the rates balloon up eventually, they can’t pay. When the underlying mortgage loses its value, bonds that bundle these mortgages lose value as well) crisis, let’s discuss a bit of finance and how these financial instruments work… If you have watched 𝘛𝘩𝘦 𝘉𝘪𝘨 𝘚𝘩𝘰𝘳𝘵, it features several famous celebrities (including Margot Robbie in a bubble bath sipping champagne) explain several of these key financial terms very effectively using simple analogies. This entire market we are discussing is about Mortgages, Mortgage backed securities, and other financial products that are designed on top of it (I won’t bore you with it, watch this clip where celebrities provide the exegesis in colorful language: https://www.youtube.com/watch?v=zZZb8GhsEfc). As Michael Lewis who wrote the book on it explains “If mortgage bonds were the match, the CDOs were the kerosene soaked rags then the synthetic CDO was the atomic bomb that a drunk president who’s holding his finger over the button”. Just to summarize, the entire infrastructure is based on individual mortgages that you and I own, and the firm belief that the mortgage industry is the bedrock of the American dream. He further explains that for a mortgage bond that is worth 50 million dollars, the “betting” via these other financial instruments could be upto a billion dollars.

What’s missing from those explanations is how these firms missed the early signs of weakness and what happened to all the money spent on risk management models and such? What actions by the firms actually acted as a catalyst that triggered the downturn?

(Financial wizards who are reading this, please forgive me)

First, let’s talk about “Leverage”. Leverage generally means borrowing, specifically the use of borrowed money to invest. It is usually measured as how much money a firm borrowed vs how much money they actually have in their accounts, so a highly leveraged firm has more money in debt than equity. For reference, Lehman Brothers which became the poster child of the subprime mortgage crisis was leveraged 30:1 at the time of the financial collapse, that means, for every dollar they had they borrowed 30 dollars to invest (or play with :)). So, needless to say, higher a firm’s leverage, higher their risk of failure.

The 2nd term I want to introduce is “Value-At-Risk” or VaR. VaR is a quantitative metric that determines the extent and occurrence ratio of potential losses in a firm’s portfolio. The key to understand is it works over a specific time-frame and, most importantly, it’s based on historical trends. So, as any computing method, it’s as good as the data that you feed it. The VaR models that’s been used by wall street firms have gone under tremendous scrutiny in the aftermath of the 2008 financial crisis. I personally worked in Lehman Brothers on VaR models (No, I didn’t work on the actual risk modeling, I am not that smart. I was a lowly software developer), so I know that Value-at-Risk came to represent a single number that indicates the extent of risk in a given portfolio for the traders and money managers. The downfall of VaR model is that it can’t take severe market events, or policy failings or plain fraud into account. A Black Swan event (A theory developed by Nassim Taleb to explain the disproportionate role of high-profile, hard-to-predict, and rare events that are beyond the realm of normal expectations in history, science, finance, and technology.) like the bursting of the subprime mortgage bubble totally throws all the models off, and the firms are left with no tools to handle the situation. For anyone who’s reading this, the question that immediately pops up into their brain is “what was the government doing? What about regulators?”. If you make one insider trade, the SEC will be on your ass so fast, you won’t have time to change your suit before you are taken to the court, but the subprime crisis wasn’t about trading stocks, it’s part of what they call shadow banking.

The “Shadow banking” represents the world of financial instruments and their trades are not subject to regulation.at.all… Examples include credit default swaps, mortgage backed securities, collateralized debt obligations, although these brought about the global crisis, hardly anything changed from a government oversight perspective. Lastly, any model, or warning, limit setting, all of it relies on traders taking the advice of the risk models presented by the risk management department.

𝘔𝘢𝘳𝘨𝘪𝘯 𝘊𝘢𝘭𝘭 is the inside story of events that transpired in a 24 hour period at a fictional wall street firm that is an amalgamation of multiple firms including Goldman Sachs, Bear Stearns. The story starts with a junior analyst in the risk management department of on the MBS (mortgage backed securities) desk finds the firm’s borrowed money is riding on basically failing mortgages, to put it in wall street parlance, toxic assets that’s carried on the firm’s books increased the highly leveraged exposure to such a level it could collapse the entire firm, how did they get there? Like I said before, leverage and VaR reports can’t predict an event like this, most importantly, the film hints at multiple warnings by the risk management that were ignored at the highest levels. So, what does the firm do? The entire upper echelon descends on the building (CEO literally lands in an helicopter) in the wee hours and the CEO John Tuld (played by the inimitable Jeremy Irons who just steals the entire scene… fun fact: Lehman Brothers CEO’s name was Dick Fuld ;)) puts it beautifully, “There are three ways to make money in this business: Be the first, Be smarter, and cheat”, so they choose to be the first to start dumping the toxic assets on the market at heavy losses so they can live and fight another day. He persuades with his best Aristotle rhetoric to make everyone agree with his decision. The domino effect that ensued comes to engulf the entire market when entire portfolios are erased, and then the shorts come calling (i.e. people who bet that that mortgage backed securities will lose their value). The rest, as they say, is history. The government had to step in and bail out some of the companies like AIG, while some companies like Lehman, Bear Stearns, MF Global etc either filed for bankruptcy or were gobbled up by bigger banks for cents on the dollar. Yes, there were lawsuits filed on firms who sold these toxic assets, most famously Basis Yield Alpha Fund Vs Goldman, which finally got settled in 2016. Goldman and other firms paid fines to the SEC to the tune of billions of dollars.

𝘔𝘢𝘳𝘨𝘪𝘯 𝘊𝘢𝘭𝘭 doesn’t portray everyone in the firm as bad guys but ordinary people who had to make a difficult decision on the brink of disaster, but if you want a manichaeistic distinction, the film does give you the CEO vs his head of sales Sam (played by Kevin Spacey) who has a conscience. The film also shows the volatility of wall street fortunes, especially those at the lower rung of the ladder, including the defenestration of some of the executives. For such a short film, it packs in two different culling events (where a bunch of people get fired).

When the film came out in 2011, the zeitgeist was wrestling with the “occupy wall street” movement and how to feel about it, so no wonder the film didn’t do well, but it packs such a powerhouse of talent, the sheer star power in every scene just boggles my mind, I would even dare to call it a modern classic. It has Kevin Spacey, Jeremy Irons, Demi Moore, Stanley Tucci, Zachary Quinto (who also produced the film), Simon Baker, Paul Bettany, and Penn Badgley and more. For a film that runs for a crisp 109 minutes, each of these actors get just one or two scenes, but give their best. If there’s one scene that captures the essence of the film, it’s the boardroom scene where Quinto’s junior analyst explains the firm’s exposure to the senior management. Another best part of the movie is, as they go up the hierarchy, people keep saying, “speak english” when someone under them tries to explain the technical aspects of their analysis. We see that when the analyst Sullivan (played by Quinto) tries to explain to his boss Emerson (Paul Bettany) who gets some of it, his boss (Spacey) understands even less, he even says so, “what do I know?”, and his boss, Cohen (played by Simon Baker) looks to the risk management officer (Demi Moore) for explanation, and finally the CEO (played by Irons) says to the analyst, “Mr. Sullivan, speak to me like you would speak to a child, or a golden retriever”. This perfectly captures the idea that they don’t even know what they are selling, at least not at the higher levels or on the sales side, this is not entirely true, but we get the gist of it.

The title of the film “Margin Call” is totally misleading because margin call is something when your broker demands to deposit additional money to cover your margin (borrowed) account. In the film, a “margin call” never occurs but it was chosen by the makers for it’s wall street-esque quality; we can probably associate that with the decision of the CEO to start selling, but that theory doesn’t hold water. Not withholding the title inaccuracies, the film does a brilliant job of capturing the goings-on at a wall street firm that started the “crisis”, though they were not entirely responsible for the crumbling, fake structure that was the subprime mortgage bubble.

The film is written and directed by debut director J.C. Chandor. The film feels like a David Mamet play namely 𝘎𝘭𝘦𝘯𝘨𝘢𝘳𝘳𝘺 𝘎𝘭𝘦𝘯 𝘙𝘰𝘴𝘴 (an excellent movie version is available and it’s one of the most quotable movies ever, especially the “motivation” scene by Alec Baldwin). It is a slow pot boiler but it provides a carefully crafted look at reality. The scenes are framed in typical wall street office environs or the trading floor visages (It was filmed in Manhattan at One Penn Plaza and on Citi’s trading floor). The dialogue is very authentic (It is said that the writer/director Chandor grew up around finance professionals) and is backed by good research, and as I said the actors are all at their best. The background score is very subtle and some scenes are totally silent and left to our own interpretation. Jeremy Irons sums it up in the penultimate scene, “This has been happening since the beginning of civilization. We overextend ourselves, regroup and keep on spending. It’s the way of the land.”, as I said, he has some of the best lines in the film. While the credits roll, Kevin Spacey’s Sam is burying his dog and you can hear the sound of his shovel digging painfully into the ground way after the movie ends.

We need to watch this film, if not for it’s semi-fictional representation that unveils big truths about wall street, (the President seem to think a good day on wall street is akin to good economy no matter how many jobs are lost or debt Americans are getting themselves into), and to remind ourselves what happens when people ignore facts and rely on trends.

Written on Apr 24, 2020

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I love to build software and write.

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Bhaskar Gandavabi

Bhaskar Gandavabi

I love to build software and write.

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