Authors -Ajayya Kumar, Mohamad Abou-Zaki & Ghassan Khoury
One can never be cautious enough. Even when all is well with your business, even when your industry is booming and your profits are soaring, it pays to be on the vigil and look out for signs. This is what the 2015 movie The Big Sort shows us. And there is more. Let’s dive in.
“What gets us into trouble is not what we don't know. It's what we know for sure that just ain't so” -The Big Short starts with this quote of Mark Twain. In all likelihood, this is something you have experienced more than once: being utterly convinced in something that just wasn’t the case. And that’s exactly what happened on a massive scale across the globe during the global financial crisis of 2008.
The Big Short, based on the book ‘The Big Short: Inside the Doomsday Machine’ by Michael Lewis, isn’t about the crisis itself. Instead, it turns the lens to what led to the crisis and how a few men saw it coming.
The movie offers quite a few insights for entrepreneurs. Let’s look at a few of those.
1.Look at the numbers, not a popular opinion
In the movie, Michael Burry, a hedge fund manager, gives a newly hired guy his first assignment: to identify each and every individual mortgages in the top-20 selling mortgage bonds. Whilst bonds are made up of thousands of mortgages, Burry fetches the entire data and goes through it all by himself, he converts the data into insights, and discovers that the mortgage-backed securities are filled with a highly risky subprime mortgage; it’s a house of cards waiting to collapse. With this data in hand, he makes the decision to short the housing market and to buy credit default swaps. His strategy takes everyone by surprise as the housing market is considered rock solid. But Burry, less concerned with popular opinion than by his data, sticks to his decision despite the pressure, the accusations, the lawsuits and the ridiculing he is subjected to. When the bubble finally bursts and the market collapses, Burry has the last laugh.
2.When the opportunity comes, grab it quick
Burry doesn’t waste a moment to buy early credit default swaps from several bankers who, not understanding why anyone would bet against the housing market but seeing an opportunity for quick returns, even charge him substantial premiums. The bankers, certain that this is nothing but free money for them, celebrate. It is during one such party that Jared Vennet, an executive at Deutsche Bank, learns about Burry’s analysis. Unlike others, Vennel gets it quickly, and realises that he could make a fortune out of it. He decides to enter the market by trying to convince other firms to buy swaps and only pay him a fee when they start profiting from the failure of the underlying bonds. Most of them laugh him out of their offices. But finally, he laughs his way to the bank.
Then there is Mark Baum, the FrontPoint Partners hedge fund manager, who gets alerted about this opportunity through a misplaced phone call, and Charlie Geller and Jamie Shipley of Brownfield Capital who accidentally discover the marketing presentation of Vennet on a coffee table. All these stories happen separately, but in parallel, and they all have one thing in common: they show us that identifying an opportunity is nothing without quick and decisive action.
That’s the only way to grab the chance to cash in on an opportunity.
3.Research, research, research
When Mark Baum and his team receive the accidental call from Vennet, they could have simply dismissed it. Only they didn’t. They travelled around to find out what’s happening in the industry and spoke to retail bankers who bragged about the zero security checks on which they provided loans. They did not leave a stone unturned and even came across a stripper who had multiple properties and several loans. They established that CDO’s were a budding atomic bomb. After acting on the lead they got and doing thorough research to get the full picture on the time bomb the industry was sitting on, they decided to buy swaps.
4.Hedge yourself against the worst
Sometimes we miss out the obvious things that are in plain sight, simply because we don’t like to believe bad things would happen. When things are going really well, we like to go with the flow, and let our guards down. This is a recipe for disaster. In the movie, this is explained using the concept ‘hot hand fallacy’. When someone is repeatedly successful, people tend to believe that he is on a winning streak and that he would continue winning forever. It’s only when things start crumbling down that reality kicks in. This was the case prior to the 2008 crisis too. The banks were considered too big to fail. The housing market was considered very stable. Except for the few who were considered eccentrics, weirdos and misfits, nobody was prepared for what was to come. And then, the storm hit.
I am not being cynical nor asking you to be one, but you should know better than to get happily sucked into a system that tells you everything is fine and is always going to be so. Ebbs and flows are only natural during your voyage, and it is important to be well prepared for it. Keep a lookout for the clouds. So that when it pours, you have your umbrella.
5.Do not build on fraudulent foundations
If you would ask me to answer in one word why the financial crisis of 2008 happened, I would say ‘greed.’ A whole part of the economy was built on deceitful foundations. The bankers simply got greedy and came up with complex financial products that were beyond the understanding of most. In a race to fatten their bottom lines, all security checks went with the wind. The housing market was built on extremely risky subprime mortgages which were linked to the financial products. The banks were building up a bubble while sitting on a powder keg. The rating agencies backed this up by giving fraudulent ratings. In early 2007, defaults started kicking in. CDO prices rose and rating agencies still refused to downgrade the bonds. Banks and rating agencies colluded to maintain the high price of CDOs and bonds so as to sell and short them. But with the weak, fragile and shaky foundations, it all came crashing down finally.
That is what I call ‘greed’ in its purest form!
