Inside Job, one of the most educational documentaries I have had a change to see, captures the plight of recession in a way that can be processed by a common man. The bubble that led to recession, also led to this movie and definitely, this movie does justice in enlightening the economic crisis in a way that many around the world do not even know. It does not take enough financial background to understand what the movie tries to infer, for the commendable job of Director Charles Ferguson explains each ingredient in the bubble’s recipe, that swept the global economy and led to the greatest recession witnessed since the Great Depression.
I have tried to highlight some important facts that I took from the movie, in my words for people who still are unaware of the discourse. I would recommend each and everyone to watch the film, since recession affected every single life on the planet and everyone deserves to know the truth. Remember, that incomplete information does not lead to a clear understanding and often postulates incorrect results. Its important to know the true story. So, lets find ourselves an in-depth analysis for clear perception.
What change has Recession brought?
- Global recession caused the world over $20 trillion, rendered 30 million people unemployed,
- Doubled national debt of US
What caused the Recession
- Massive private gains at public loss attributed to the monopoly of investment banks in the financial sector. The strategies were for higher profits and revenue generation in short interval, not accounting bankruptcy as the final verdict.
- The bonus system, which payed highly, to the employees working for the investment banks and security insurance agencies as soon as the contracts were signed based on short term profits.
- The derivatives market which entitled anyone to bet on future contracts, options derived from other form of assets.
- The competition among Investment banks which further led to riskier loan schemes, especially on houses for everyone, not bothered about the financial standing of the borrower.
- Faulty rating attributed to the CDO (Collateralized debt obligation) which were to be payed to the investors at last. Even the CDO which investment bank bet would fail were sold to costumers based on high ratings by rating agencies.
- Bankers were prohibited to speculate depositor savings
- They were tightly regulated, as businesses were partnerships and these partners who put up the money watched it closely
- The lenders were mostly local
Earlier instances in history
- 1982, deregulation of saving and loan companies allowed them to pursue risky investments with the depositors money, caused tax payers their money and many people their life savings.
- The next crisis came at the end of the nineties, investment banks fulled the massive bubble in internet stocks which was followed by a crash in 2001 that cost 5 trillion dollar in investment losses. Internet companies were promoted which were likely to fail and stock analysts were paid based on how much business they bring in.
Understanding Concepts and Happenings
Securitization food chain
- Participants in the chain – home buyers, lenders, investment banks and investors. Later, rating agencies and security insurance companies become very crucial.
- Collateralize debt obligations (CDOs) are derived from fixed income assets. The customer loans were placed in sub-prime loans which were riskier and further, formed major component of the CDO. These CDO were mere payments to the investors. The investment bank earn commission at the time of its issue and since, they added these mortgage payments into the complex CDO, the problem of riskier sub-prime loans seemed diluted.
- Home buyers borrowed money from local lenders, but as is the trend that mortgage payments are to be payed to local lenders, saw a shift. The payments were forwarded to the investment banks, and then on to the investors as CDO. Thus, the chain is more like a bridge where the two ends are borrowers and investors, but there is no interaction between the two. Thus, the connecting dots are lenders and investment banks, who are practically non existent in the system. They are simply forwarding the money and making profits based on interest rates and maximizing the same for greater forwarded CDO. Thus, To increase the number of CDO, the number of loan borrowers need to be maximized, thus lenders proposed easier loan schemes.
- Credit Rating Agencies assign ratings to the debt obligations such as CDO which are used by broker-dealers, investors, investment banks and governments. These agencies have been speculated to receive compensation for giving higher ratings to CDO by the Investment banks to lure in customers and investors.
- Further, Investment banks payed rating agencies which gave most of the CDO good rating, resulting in increase of the number of investors and clients, and hence greater earning on commission on part of Investment banks.
- Derivative Market – a financial innovation, an unstable 50$ trillion unregulated market. When a person invests in derivative, the underlying asset is usually a commodity, bond, stock, or currency. He bet that the value derived from the underlying asset which can be future contracts or options, will increase or decrease by a certain amount within a certain fixed period of time.
- The role of security insurance companies was to take quarterly premium from investors to secure their stand if their CDO ever failed. These insurance companies went a step ahead and accepted premiums from third parties such as Investment Banks as well. This became possible because of unregulated derivative market, so if the payments went bad, the company had to pay the third party as well. The investment banks used the derivative market to bet on CDO especially designed to fail, and earn money on it. They did not disclose the information of faulty CDO to their customers or investors.
What Government did wrong
- The public law that prevented banks with consumer deposits to involve in riskier investments was later changed by “Gramm Leach Bliley Act ” which cleared the way for future mergers such as the formation of Citigroup and other conglomerates.
- On April 28, 2004, the SEC met to consider leverage limits on the investment banks.
- Never considered regulating highly risky derivative market.
- Investment Banks were allowed to manipulate market economics by not levying bar on them as they involved in corruption, unprecedented betting etc.
Who was responsible
- The Government for all the above reasons.
- The entire system of securitization of food chain, that saw the giants of financial services exploiting borrowers money, practically gambling with it to increase their short time earnings and revenue, comprising the long term standing of the company. Also, luring the public into loan schemes, unprotected by Government, not in public interest, and finally dumping them with the burden of unemployment.
- To buy a home is an American Dream, and does it not bother one when the dream becomes so much real, that everyone can own it. The current financial turmoil that eventually led to the severe global recession, undoubtedly urges people to remain more vigilant, to think harder before putting money into the hands of such companies.
Some Quotes in the movie I found essentially Great
- When you start thinking that you can create something out of nothing it is very difficult to resist.
- Recently neuroscientists have done experiments where they have taken individuals and put them into an MRI machine and they have to play a game where the price is money and they noticed that when the subjects earn money, the part of the brain that gets stimulated is the same part that cocaine stimulates.
- Why should a financial engineer be paid 4 – 100 times more than a real engineer? A real engineer builds bridges, a financial engineer build dreams and you know when those dreams turn out to be nightmares, other people pay for it.