The Big Short on Business Ethics

In the acclaimed movie, The Big Short, four professional investors in the world of high-finance predict the credit and housing bubble collapse of the mid-2000s, and decide to take on America’s big banks for their greed and lack of foresight. [1]

The Big Short simplified the complex circumstances surrounding the housing market collapse, allowing the average viewer to glean some valuable insights, for instance: (1) the majority of economic prognosticators-even captains of industry with superior knowledge to the average investor-lack foresight; (2) con​​trarian investing, or

​​diversification, can be a good investment strategy; and, (3) the success of a “free market” fundamentally relies on ethical actors.

Economists and Weathermen

The movie provides numerous examples of bankers and investment experts failing to foresee the housing market collapse, which begs the question, why did God create economists? According to David Rosenberg, former chief economist at Merrill Lynch, the answer is simple: “To make weathermen feel good about themselves!” [2]

A poignant scene in the movie happened just moments before the market collapsed. There was a staged debate between one of the contrarian investors and an executive with the American bank Bear Sterns. On one hand, the contrarian investor predicted an imminent market collapse. On the other hand, the bank executive recommended "doubling down" in the market. Likely only for dramatic effect, the market literally began to collapse during the debate. The lack of foresight by an industry leader was striking.

Though most investors lost, the catastrophe did not sink all boats.

Sometimes a contrarian investment philosophy works

The movie’s central character, an eccentric hedge fund manager named Michael Burry, discovers that the United States housing market is extremely unstable, because it is based on high-risk subprime loans. Making matters worse, Burry discovers that the banks are colluding, with (among others) a major bond-rating company. The scheme had the rating agency maintaining high ratings on inessential bonds, allowing certain investors to sell off their losing positions before the true values became known.

Eventually, the housing collapsed and Burry's fund increased by 489%, netting an overall profit of $2.5 billion.[3] Burry’s contrarian investment strategy lends credibility to world-renowned investor, Benjamin Graham's, time-tested investment strategy, diversification. Although Burry won big, he was riddled with disgust about the unethical industry practices, and decided to close his fund shortly after the market collapsed.

Learning that the business world is (still) unethical would come as no surprise to Graham, who once said:

"The investment world nevertheless has enough liars, cheaters, and thieves to keep Satan's check-in clerks frantically busy for decades to come." [4]

It could be argued that the success of a society that fundamentally protects liberty is dependent on the citizenries ethics. The more ethical the citizenry, the less need there is for government and law enforcement. Each individual polices himself.

A "free market" depends on ethical businessmen

While the West generally accepts Adam Smith’s proposition that the marketplace and society overall are most benefited by people pursuing their own self interests, The Big Short highlights an ethical asterisk to that proposition. If businessmen within a marketplace pursue their own self interests, with a disregard for ethics, unjust outcomes can result.

If America's goal is to establish a Just society, which implements "free market" principles, then its businessmen must not lie, commit fraud, breach promises, or act negligently, etc. The circumstances surrounding the collapse makes a compelling case for at least some regulation in the financial industry, and the marketplace overall.

The Big Short was an entertaining movie that simplified the complex circumstances surrounding the housing market catastrophe. It allowed the average viewer to glean some valuable insights from the mid-2000s economic (and ethical) collapse. An investor is wise to swallow economists' predictions with a grain of salt. Sometimes it pays to think contrarian. A perfectly free market fundamentally relies on ethical businessmen.

But, if there is any truth to Bertolt Brecht’s infamous quote, “Grub first, then ethics,” then a word to the wise: watch out for unregulated industries, and diversify!

Citations

[2] https://www.soundmindinvesting.com/articles/view/why-did-god-invent-economists

[3] https://en.wikipedia.org/wiki/The_Big_Short_(film)

[4] https://www.goodreads.com/author/quotes/755.Benjamin_Graham