I was watching a movie called The Big Short, at the behest of a very good friend of mine who works in the options trading industry, which for those of us uninitiated with the world of finance and economics, is basically under the huge umbrella of stock trading.
Well, options trading isn’t strictly stock trading per se, but that’s not the parable for today we want to tell you.
In essence, The Big Short is basically a reverse of Wolf of Wall Street. Yes, it does deal with wall street, it does deal with the murky world of finance, it does touch on ethics and making money off the misery of others, and it does touch on the whole system of greed and governance in the American finance industry.
I hesitate to actually call it an industry, and I’d more like to call it a market. Industries are industrious. they produce and have factors of production. After watching The Big Short(at 2 am nonetheless) with lots of explaining and guidance from my friend as to the financial terms used in the movie, Wall Street seems more like a place for people to make money off money from money. Nothing is produced, and you only win when someone else loses.
But let’s not get all sentimental – I’m here to tell you what the movie is about, and lessons learned and applied to us entrepreneurs.
The Big Short follows four groups of people, or rather, takes 3 perspectives in the movie – about people literally betting against the American loan market.
The WHAT?
Yes, the American housing economy in essence.
Why? How? and most importantly, who?
Banks who loan money to people, people who buy houses, property agents, the ratings agencies who are supposed to fairly rate how trustworthy and reliable loans for housing are.
SO in short – these people go against the naysayers and bet big against the very badly managed(read, FRAUDULENT) loans that ordinary laymen take to buy houses.
How? One of them created and bought an instrument called credit default swaps.
This is basically a contract that says “I will get money for betting against you(the bank) for when the economy crashes(and the bank closes down) due to your shitty loans that you gave out that no one is repaying”.
Simply put – it’s like buying insurance against a bank for when the bank runs out of money.
In return, I’ll pay you(the bank) a monthly fee(called a premium) that is a percentage of the credit default swap’s total value(of the bet) for when the market crashes till the end of the contract.
But insurance for shitty loans(subprime mortgages)? That’s basically a credit default swap.
Yes. The banks basically sold a financial product based on shitty loans that people couldn’t pay, were late in paying, or had too high-interest rates to be possibly repaid (CDOs). This was the main key driver of the 2007-9 financial crisis, a.k.a the subprime mortgage crisis.
Either through ignorance or plain old fraud, these banks continued selling them until they couldn’t anymore, and in comes our four protagonists asking to bet against them, at what they thought were, impossible odds.
How do we know this? In the movie, the four groups of people did their research – talking to people who were involved in the housing market and the issuance of these loans, people who took these loans, people who approved these loans, people who rated the stability and credit rating of the financial product sold, so on and so forth.
On top of that, they noticed the discrepancies between the official reports and the actual opinions and figures from their research.
Off track – Christian bale stars in this as an autistic savant with Asperger’s – he manually analyses hundreds of thousands of loans off raw data to come to his conclusion that the housing market will crash. Now – I personally don’t recommend that, but props to the person he played.
Now – how the hell does all this apply to us? We’re in the business of delivering products, services, and creating solutions for the consumers!
As of so far, you only hear of entrepreneurs and wall street mixing when a start-up
i) Goes public
ii) seeks funding from investors that also happen to be hedge fund managers etc.
These are business dealings of course. Certain sectors such as crowdfunding loans, and fintech, or finance tech entrepreneurs, of course, interact with wall street more than others on a smaller scale daily basis.
Well – let’s not look too far. Many newer tech companies have been funded by VC’s and their valuations are just plain and simply, ridiculous. This has had the effect of a tech bubble that’s already in effect right now.
Sure – the valuation of the company is based on research on the market, or is it? Without actual credible research and a single dollar of revenue, some tech start-ups raise valuations of millions. Others do have revenue, but not as much as warrant’s their valuations.
I’d call that plain old speculation. Of course, investing in a start-up sometimes works best for the VC when an idea is revolutionary and a first mover in that market, but sometimes that just doesn’t work.
But without actual credible data, or any cashflow, or even sales, and just opinions, a business idea isn’t actually worth much. Best to let the startup face natural market forces of competition as well as the demand for their services first to see if it is an actual viable business idea.
In that spirit, let’s all make start-ups that work, not start-ups that are funded by hot air and dreams, and the speculation fuelled by greed. We’re not wall street, we’re entrepreneurs, we make things happen.
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