The board meeting with CEO John Tuld on the make or break situation. They had two
options, alert the world the calamity it faces and possibly go under themselves but
contain and control this drama. Or, unload the merchandise, survive themselves,
but cause a global meltdown. In the movie they chose the latter.
Analysis:
The movie obviously depicts the hours leading to the global financial crisis in 2008.
The firm, a financial institution most likely an investment bank, discovered that the
losses are greater than the current value of the company a scenario they did not
expect. If the losses were to be realized one day it would be bankruptcy tomorrow.
Securitization Food Chain
A new system which connected trillions of dollars of mortgage payments and other
loans to investors around the world. In the old system, when a home owner paid
their mortgage every month the money went directly to local lender and since
mortgages took decades to repay, lenders were careful. In the new system lenders
sold the mortgages to investment banks. These investment banks combined
mortgages they received and sold them to investors around the world. In short,
when homeowners paid their mortgages, the money went to investors all over the
world. The result was a ticking time bomb because lenders did not care anymore
whether a borrower could repay. Borrowers were needlessly placed in expensive
subprime loans, and many loans were given to people who could not repay them.
Leverage
During the bubble the investment banks were borrowing heavily to buy more loans
and create more MBS. The ratio between borrowed money and the banks own
money was called leverage. The more the banks borrowed the higher their leverage.
At this time, SEC lifted leverage limits for investment banks which made investment
banks gamble a lot more leading to high risk profile transactions. In the movie,
Peter Sullivan said, If those assets decreased by 25% and remain on our books
then that loss would be greater than the market capitalization of this entire
company. From that we can guess that their leverage at that time was 4:1.
Meaning their borrowed money was 4 times greater than their own money which
means that a 25% decrease in those assets would render them insolvent.
Result
The company claims they have found a way to make more profits with less risk, in
fact they have a found a way to make more profits with more risks, and theres a
difference. It wasnt real income actually, it was just money created by the system.
In the movie, the firm did not care about the risks evidenced by the gutting of
personnel in the risk management to just two.
Financial implications
1. MBS had no value because they cannot be collected.