An Inside Job

Blog 5 - 24/11/2019

In this week’s blog I am going to be reflecting upon the financial movie ‘An Inside Job’, a movie detailing the forensic analysis of the 2008 financial crash; they called it the worst recession since the great depression. The movie broke the crash down into 4 clear stages: ‘How we got here’, ‘The Bubble’, ‘The Crisis’, ‘Accountability’ and ‘Where we are now.’ 

So where to begin? Right at the start would make sense…

It began when the financial sector became oligopolistic, dominated by a few giant investment banks; these firms began the promotion of internet companies and so this created an ‘Internet Stock Bubble’. However, the banks already knew these internet companies would fail and it eventually led to huge losses for investors (as shown within An Inside Job). Then began the boom of derivatives, bundling together mortgages and other loans into collateralised debt obligations (CDO’s), which investment banks began to sell to investors. A collateralized debt obligation (CDO) is an asset-backed security whose underlying collateral is typically a portfolio of (corporate or sovereign) bonds or bank loans (Duffie & Gârleanu, 2019).The real issue that stood out to me here, was a section of the film where they interviewed Martin Wolff and he said the entire thing was ‘A global Ponzi scheme’ and throughout this blog you’ll really begin to see the actual scandal that occurred (Ferguson, 2010). 

So as for these CDO’s, the rating agencies that were around at the time as stated within the film were S&P, Moody’s and Fitch, and these 3 firms gave these CDO’s, which were subprime loans, AAA ratings. Were these subprime loans worthy of a triple A rating? Absolutely not. Did anybody stop them from being sold? Not a soul. And so here comes the creation of what the movie described as the securitization food chain. The investment banks created the CDO’s, investors bought the CDO’s, insurance companies insured said CDO’s and rating agents gave these subprime loans AAA ratings, hence the number of mortgages between 2000 and 2008 quadrupled. These rating agents had no accountability for the ratings that they gave and so the spiral of AAA rated subprime loans began. As you can see in the graph below, the growth of subprime loans from 2002 to 2006 increased dramatically, despite the fact these loans were given to those who wouldn’t be able to keep up with the repayments. And so began an epidemic of foreclosures and Wall Street entitlement. 

Source: An Inside Job Film 

During this time Wall Street became hugely powerful, to the point where the failure of a single one of the investment banks could cause a detrimental impact on the whole of the economy. The real issue was with this industry was the deregulation that occurred during this time period in regards to CDO’s. There were investigations by the FBI as early as 2004 against this large scale fraud however it was still allowed to continue with no criminal prosecutions. The Investment banks could see capital gain from the sale of these derivatives and due to it being an unregulated market there was nothing stopping them from benefitting. However, in 2003 Warren Buffett quote that the overselling of these CDO’s were ‘Weapons of mass destruction’ (Kelleher, 2008). And wow he couldn’t have been more correct! As the time bomb ticked away the bonuses on Wall Street grew, Moody quadrupled its profits from 2000-2007, Wall Street bonuses hit record levels and the finance moguls really were reaping the rewards (Ferguson, 2010). However, as Warren Buffet explained this really did illustrate a ticking time bomb… there’s only so long before it was going to explode, and so it did.

Source: An Inside Job Film 

Here comes the crash! An epidemic of mortgage fraud all came tumbling down, years and years of a booming Wall Street, huge bonuses and suddenly the CDO market collapsed (Ferguson, 2010). In February of ’08 Christine Lagarde says she remembered speaking to Henry Paulson, the US treasury secretary, and saying that ‘We can see a tsunami coming, and it’s as if you’re proposing that we ask which swimming costume to put on’ (Ferguson, 2010). Henry Paulson continued to persist that everything was under control and that the damage would be controlled and limited, but oh how wrong he could be. As the CDO market failed investment banks began to fail too, with Merrill Lynch becoming insolvent and Lehman Brothers going bankrupt, the entire infrastructure was falling and it was the poorest civilians who paid the most, foreclosing on houses and having no other choice but to live in tents. 

And so to reflect, who was accountable? 

I found this movie extremely interesting and informative, and I was blown away when I was made aware of the actual extent of the scandal that caused the financial crash of ’08. But when reflecting upon the severity of the problem, and the way it was caused, the one thing that stood out to me was the way that everyone seemed to be aware of the extreme risks involved with the sales of CDO’s and yet nobody stopped it. The CEO of Merrill Lynch, Stan O’Niell, was forced to resign following the events however, he received a huge severance pay packet of $161million. I mean if I was forced to resign with that kind of severance package I’d be more than willing...! 

In conclusion, the main theme throughout this movie was the clear signs of corporate greed and ignorance. The most interesting/mind-blowing thing to me that throughout the duration of ‘An Inside Job’ it was evident that the political ties to the financial sector and the total ignorance to the severity of the issue was extreme. The real question is, where was the corporate governance? 'The complexity is the diversity of governance systems and processes around the world. Form of corporate governance are shaped nationally by their economic, political, and legal backgrounds, by their sources of finance, and by the history and culture of the countries concerned' (Clarke, 2004). Clearly within the US during the 1990's and early 2000's the strong political influence meant that corporate governance was weak and the regulations regarding financial institutions were non-existent. There appeared to be several times when federations attempted to plea for regulations of the CDO markets however it was continued to be ignored and thus the biggest crash since the great depression occurred. It definitely stirred a lot of reflective thoughts regarding how such an event could occur for such a long period of time that has such detrimental impacts. It also bemuses me that all the executives who orchestrated such a huge fraudulent scheme were able to walk away with their ridiculous bonuses and salaries intact and with no further criminal prosecutions…. all at the expense of the taxpayer.

List of References

Clark, T. (2004 ). Theories of Corporate Governance . Philosphical foundations of corporate governance.

Duffie, D., & Gârleanu, N. (2019, January 02). Risk and Valuation of Collateralized Debt Obligations. Valuation, 41-59.

Ferguson, C. (Director). (2010). An Inside Job [Motion Picture].

Kelleher, J. B. (2008, September 18). Buffett's "time bomb" goes off on Wall Street.Retrieved from Reuters : https://www.reuters.com/article/us-derivatives-credit/buffetts-time-bomb-goes-off-on-wall-street-idUSN1837154020080918