H Problem Set 8 / Homework 3

One assignment in this class is to view the movie The Big Short, which is based on Michael Lewis’ book, and available on Netflix.50 The next questions are based on a few particular sequences in the movie, which you can find on the Youtube playlist “Econ 102 - Required Watching” here. If you want to know more about the 2007-09 financial crisis, you can also watch some extracts from Margin Call on the playlist “Econ 102 - Additional Watching” here.

(Required Watching: Full Movie) Adam McKay. The Big Short. 2015.

(Required Watching: Movie Clips) Adam McKay. The Big Short. 2015.

H.1 The Big Short (1/6) - Michael Burry analyzes Subprime MBSs

  1. What’s Michael Burry’s hedge fund typically invested in?

  2. What was the fee on MBSs typically?

  3. Why did they start lending to riskier borrowers?

  4. What did Michael Burry do to assess the quality of mortgage bonds?

  5. What’s the main obstacle to shorting housing? How is Michael Burry going to short housing?

H.2 The Big Short (2/6) - Burry buys CDSs from Goldman

  1. Why do people at Goldman Sachs think CDSs are a “foolish investment”?

  2. What is Michael Burry worried about when he invests in CDSs?

  3. Which agreement is put in place between Michael Burry and Goldman Sachs to take care of this problem?

  4. How much MBS does Michael Burry insure from Goldman Sachs?

  5. Why do you think Michael Burry went to many different banks for these contracts?

H.3 The Big Short (3/6) - Vennett & Field learn about the CDS deal

  1. How much is the size of Michael Burry’s insuring of CDS in total?

  2. Why can’t Lawrence Field prevent Michael Burry from investing so much in MBS, even though he runs the fund?

  3. Who’s writing angry emails to Michael Burry?

H.4 The Big Short (4/6) - Vennett’s Pitch to Front Point Partners

  1. Compare the original mortgage bonds to the new ones.

  2. What’s the difference between B tranches and AAA tranches?

  3. What makes B tranches increasingly vulnerable?

  4. What are Credit Default Swaps?

  5. What are their potential returns?

  6. How are CDS in 2006 and fire insurance on a burning house comparable?

  7. What is a Collateralized Debt Obligation?

H.5 The Big Short (5/6) - Meeting with a CDO manager

  1. Why is the CDO manager not worried about the rise in default rates?

  2. Why are the CDO manager’s incentives more aligned with that of JP Morgan than with that of the investors he’s supposed to represent?

  3. (not in the video) Why is that not a fully satisfactory explanation for the bad quality of CDOs?

  4. What is the “hot hand fallacy”? Why is that a potential explanation for “real estate bubbles”?

  5. Explain what a synthetic CDO is.

H.6 The Big Short (6/6) - General Questions

The next questions relate the whole content in this movie, to what we have learned throughout the course.

  1. Explain how the Fed raising interest rates leads to a fall in disposable income for homeowners with Adjustable Rate Mortgages.

  2. Explain through the Keynesian multiplier how the crisis was self-reinforcing, and how a small initial shock could have led to so many homeless people.

  3. Why was it so hard to bet against the housing market? Give at least two reasons for this.

  4. What were the main contributing factors to the financial crisis, according to The Big Short? How can you make sense of it in terms of a fundamental excess of saving over investment?

H.7 Readings - Monetary Policy (NOT homework material)

  1. Michael J. Burry, “I Saw the Crisis Coming. Why Didn’t the Fed?”, The New York Times, April 4, 2010. According to Michael Burry, how could the Federal Reserve have seen the crisis coming?

  2. “Two out of three ain’t bad.” The Economist, August 27, 2016. Under Keynes’ plan at Bretton Woods, how would “creditor adjustment” work?

  3. “Should egalitarians fear low interest rates?”, The Economist, July 11, 2019. Why was John Maynard Keynes potentially wrong about the “euthanasia of the rentier”?

H.8 Readings - Theoretical Controversies (NOT homework material)

  1. “Minsky’s moment”, The Economist, July 30, 2016. List the 3 different types of financing according to Hyman Minsky. How was the financial crisis an example of Ponzi financing? (this question is related to The Big Short movie, see below)

  2. “Where does the buck stop?”, The Economist, August 11, 2016. Why did the Keynesian consensus fracture in the 1970s? What are the main beliefs of the “freshwater” and the “saltwater” school of macroeconomics?

  3. “Central bankers’ holy grail: The natural rate of unemployment.”, The Economist, August 26, 2017. What is the Phillips curve? What is the natural rate of unemployment?

  4. “The bull market in everything. Asset prices are high across the board. Is it time to worry?”, The Economist, October 7, 2017. What are the arguments in favor, and the arguments against putting your money in risky assets (stocks, property, bonds) versus in cash? What are the driving forces behind the bull market in everything?

  5. “Why is macroeconomics so hard to teach?” The Economist, August 9, 2018. Why is macroeconomics hard to teach?

  6. “The world economy’s strange new rules.”, The Economist, October 10, 2019. What are the most important recent failures of the Phillips curve?

  1. Michael Lewis, The Big Short: Inside the Doomsday Machine (W. W. Norton & Company, 2011).↩