This guest article was written by Gavin Smith. With 25 years’ experience working in financial markets, Gavin Smith is First Global Credit’s CEO and the futurist guiding the company so that it will grow alongside the developing digital currency capital market. His experience developing and managing global risk for Trafigura, one of the world’s largest physical commodity traders, has given him the skills to build the risk management framework that underpins all First Global services.
As this year’s Academy Awards celebration draws to a close, it seemed an opportune time to take a closer look at the dysfunction on display in one of the nominees for Best Picture, “The Big Short,” which was based on Michael Lewis’ book of the same name. Lewis’ book, and the movie it inspired, related the story of the subprime mortgage crisis in the United States. Essentially, a series of opaque and illiquid financial instruments were sliced and diced into a series of increasingly complex derivatives, the notional value of which ended up being many times greater than the size of the underlying mortgages. When homeowners, who were the people responsible for paying the underlying mortgages, defaulted on those mortgages, investors in these derivatives (collateralized debt obligations (CDOs), CDOs-squared, synthetic CDOs, credit default swaps, etc.) lost a lot of money. Those who sold these derivatives short (Michael Burry et al) made a lot of money.
To understand this at a very high level, consider a pivotal scene in the movie: Steve Carrell’s character goes to see a contact at S&P (played by Melissa Leo). In the course of speaking with her, he learns that S&P basically gives an investment bank whatever rating it wants for a CDO issue, because if S&P did not cooperate with the bank, the bankers would simply go down the street […]
