facts that might be useful to know before watching The Big Short (2015) again | GFC explained

After watching a review of the movie The Big Short, 2015 (from below youtuber who is also a hedge fund trader), I was keen to watch the movie myself. And I ended up watching it twice because it was that good.

But it wouldn’t be me if I am not doing any youtube research after I find something I like.

So I found this below video that really explains the whole GFC/ subprime mortgage crisis very well (with the reference to the movie, The Big Short).

Consequences of not being able to pay off mortgage

• Homeowners: default on their loan → house will be taken off of them.

• Commercial banks: might be able to put through as a distressed sale, but banks will only be able to recover say 50 of that original loan amount.

• Investors: have to try and figure out how many people are going to end up defaulting on their mortgages.

Timeline

• 1970s: the securitisation of mortgages began.

• Commercial banks could essentially write as many home loans as they wanted, because at the end of the day they could just bundle the loans together and sell them off to an investment bank that would then sell it onto the wall street.

• 1982: the Depository Institutions Act legalised adjustable rate mortgages (teaser rate mortgages) for the very first time.

• 1984: President Reagan signed the Secondary Mortgage Market Enhancement Act, which allowed pension funds and insurance companies to buy mortgage-backed securities.

• 1990s: adjustment mortgages started taking off with additional regulatory and legislative changes.

• 2001-2003: interest rates fell from 6% down to 1% in the US → home loans become very popular → inflated house prices naturally.

• 2003: introduction of the interest only adjustable rate mortgage.

How could Michael Burry predict GFC

• Michael Burry was able to profit personally $100 million and made $700 million for his investors (Scion Capital).

• Nov 2000 inception - Jun 2008: ended up posting returns of 489.34, while the S&P 500 returned just under 3% including dividends.

• All due to the introduction of:

*Interest only negatively amortizing adjustable rate sub prime mortgage*

• This meant that borrowers of subprime quality were able to take on big loans where they didn't even have to pay a monthly repayment.

“specifically i set out to buy credit default swaps on subordinated tranches of subprime residential mortgage-backed securities” (Michael Burry)

Credit default swaps -

• buyer: makes payments to the swaps seller until the maturity date of the contract.

• seller: agrees that in the event that (in this case, the subordinated tranches of the mortgage-backed security fails), the seller will pay the securities value + all interest payments that would have been paid between that time and the securities maturity date.