From a small northwestern observatory…

I just saw HBO’s “Too Big To Fail”, staring a whole host of Hollywood “names” (James Woods, John Heard, William Hurt, Paul Giamatti, Cynthia Nixon, Topher Grace, Ed Asner etc.). Sadly, it’s a fairly boring movie, albeit about a terrifically exciting piece of near-term history. It focuses on the collapse of Lehman Brothers, mostly through the eyes of Treasury Secretary Hank Paulson (played spot-on by William Hurt). Asner does a wonderful Warren Buffett (who almost, albeit reluctantly, came to Lehman’s rescue) and Giamatti is a wonderful Ben Bernake. (As an aside — Bernake is the most dead-pan person I’ve ever met. Giamatti’s version of Bernake is even more deadpan than reality.)

The movie gets one thing right and one thing wrong. First, the wrong, and then the right.

The movie keeps referring to Lehman’s “real estate”. No one will buy Lehman if they have to buy its real estate holdings, too. Lehman’s real estate “problem” is at first estimated at $40 Billion, then $70B, then “who knows”. The truth, of course, was “who knows”. Cynthia Nixon plays Paulson’s press secretary, who serve as an amiable foil to allow Paulson and his Chief-of-Staff Jim Wilkinson (Topher Grace) to explain the nature of the crisis to her (and thus to the viewer). Unfortunately, Lehman’s “real estate” isn’t “real estate” but “real estate mortgages”. More to the point, they have “tranches” of real estate mortgage pools, and to understand what a “tranche” is would be well beyond the capacity of a two-hour movie. Tranche, by the way, comes from the French word for “slice”. Imagine we pool $100 million or so in mortgages, then split up the ownership into three equal parts — an “A” tranche which will get paid in full, including interest, before anyone else gets paid; a “B” tranche which gets paid next, and a “Z” tranche which only gets paid after everyone else gets paid.

In theory, all three tranches should be good securities, since the underlying mortgages are pretty safe bets, and in practice the “A” and “B” tranches really were pretty good. However, the “Z” tranches will bear all the default risks. Banks (both mortgage and investment) made tons of money on these things, because the default risks could be “priced” as long as market continued to rise. Various investment banks then borrowed money to buy “Z” tranches, and coupled with credit-default swaps (essentially, a mutual insurance pact among investment banks), they were able to borrow huge amounts of money with very little capital.

The Paulson/Wilkinson explanation in the movie makes it sound like the whole problem came from mortgage defaults and foreclosures. In reality, mortgage defaults DO cycle up when a recession comes along, but these are usually predictable cycles. The REAL problem came from borrowing huge amounts of money — with almost no capital — to buy “Z” tranches that didn’t reasonably price the increased in defaults. A slight up-tick in defaults sent everyone to the emergency room, and when owners couldn’t sell or re-finance, the whole market went down the tubes. THAT was the “real estate” problem which plagued Bear Sterns, Lehman Brothers, Salomon Brothers, Morgan Stanley (my old alma-mater) and all the others. Sadly, the movie perpetuates the myth that the real estate down-turn was an exogenous event, and fails to discuss the sins of the secondary mortgage market which took a simple, cyclical downturn and turned it into a long-term, world-wide crisis.

But, even with that, the movie got one thing so very right that made up for the mistakes. In one pivotal scene, Paulson and his team are presenting the TARP idea to the leaders of Congress. (Central Casting found some excellent look-alikes for Pelosi, Dodd, Shelby, Frank, and the rest.) Note that this comes very late in the movie, well after Paulson (an almost billionaire, who really didn’t sign on for this level of stress) and his team have tried ever possible solution to stem the crisis. The movie does a great job of playing Paulson up as the unsung hero who really saved the world’s economic life, by the way. Anyway, the leaders of Congress don’t “get it” until Giamatti’s Bernake gives the most important 2-minute economic lecture in history. He notes that while the Great Depression started with a stock market crash, it was the failure of the credit markets which made the depression last so long. The current crisis, if left un-solved, would spin the world into a much worse, much longer economic depression. Giamatti really nails the tone of the reality which was facing the nation’s top economic thinkers at the time.

Anyway, I don’t watch very many movies. I saw Adam Sandler and Jennifer Anniston in “Just Go With It” on an airplane last week, and thought it was a hoot. As movies come-and-go, “Too Big To Fail” doesn’t even rise to the entertainment level of “Just Go With It”, but as an educational piece, it’s a must-see, even with its critical flaws.