big_short PPT HU22MGMT0700019sdfghjkjhgfds.pptx

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1. The big short a.Pramod goud (hu22mgmt0700019)

2. summary The movie follows multiple storylines that center around different groups of investors, all of whom come to realize that the U.S. housing market is built on a foundation of risky, subprime mortgages. Here are the key characters and their journeys: Dr. Michael Burry : Burry is an eccentric hedge fund manager at Scion Capital. He is the first to identify that the U.S. housing market is on the verge of collapse. After analyzing vast amounts of mortgage data, he finds that many mortgages are subprime (given to high-risk borrowers with a poor ability to repay). Burry decides to bet against these mortgage-backed securities by purchasing Credit Default Swaps (CDS) , which act as insurance against their failure. His investors doubt him, and he faces immense pressure, but he sticks to his belief that the market will collapse.

3. Mark Baum : Mark Baum is a cynical and morally driven hedge fund manager at FrontPoint Partners. His team investigates the mortgage market after being approached by Jared Vennett (Ryan Gosling), a trader at Deutsche Bank who realizes that the housing market is going to fail. Baum's team uncovers massive fraud within the housing market, including the reckless behavior of banks, rating agencies, and mortgage lenders. They also discover that Collateralized Debt Obligations (CDOs) , which are bundles of debt that include subprime mortgages, are being incorrectly rated as safe investments. Baum is horrified by the corruption but decides to bet against the system, leading to massive gains when the market collapses.

4. Charlie Geller and Jamie Shipley : These two young investors run a small fund and stumble upon a report detailing the potential housing bubble. With the help of retired banker Ben Rickert (Brad Pitt), they realize that the market is about to implode. They begin betting against the housing market by buying CDS on mortgage-backed securities. Like the others, they are frustrated by the greed and irresponsibility of Wall Street but also profit handsomely when the bubble bursts.

5. explain all the terms mentioned in it with examples 1. Subprime MortgageA subprime mortgage is a type of home loan given to borrowers with poor credit histories, low income, or other factors that make them high-risk for lenders. These borrowers have a higher likelihood of defaulting on their loans, which makes subprime mortgages risky.Example : Suppose a person with a low credit score applies for a mortgage to buy a house. Since they are considered a higher risk, they are given a subprime mortgage with a higher interest rate to compensate for the added risk of default. During the housing bubble, many subprime mortgages were given out to people who couldn’t realistically afford them, leading to widespread defaults when the economy slowed. 2. Mortgage-Backed Securities (MBS)A Mortgage-Backed Security (MBS) is a financial product made up of a pool of home loans (mortgages) that are bundled together and sold to investors. Essentially, the investor buys a share in the mortgage pool and earns returns from the interest and principal payments on those loans. MBS was a key component of the 2008 financial crisis because it spread the risk of subprime loans throughout the financial system.Example : Imagine a bank gives out 1,000 mortgages to homebuyers. Instead of keeping those mortgages, the bank bundles them together and sells them to investors as MBS. The investors get returns as the homeowners pay their monthly mortgage installments. However, if many of those homeowners default, the MBS loses value, and investors face heavy losses. 3. TranchesTranches refer to slices or segments of a financial product, typically a pool of debt like an MBS or CDO. These tranches are divided based on risk levels, with higher-risk tranches offering higher potential returns but also higher potential for losses. Lower-risk tranches have lower returns but are considered safer.Example : A bank creates an MBS with three tranches:Senior tranche: The safest, usually rated AAA, with lower returns.Mezzanine tranche: Moderate risk, with higher returns than the senior tranche.Equity tranche: The highest risk but with the highest potential returns.If homeowners start defaulting on their loans, the losses hit the equity tranche first, then the mezzanine tranche, and lastly the senior tranche. Investors in the senior tranche only lose money if defaults are severe.

6. 4. Credit Default Swap (CDS)A Credit Default Swap (CDS) is essentially insurance against the default of a financial asset like an MBS or a CDO. The buyer of the CDS pays premiums to the seller, and if the asset defaults, the seller compensates the buyer. CDS allowed investors to bet against the mortgage market or insure themselves against losses, but they were also used speculatively during the financial crisis.Example : Hedge funds in The Big Short, like the one run by Michael Burry (played by Christian Bale), bought CDS to bet against the mortgage market. They paid premiums to insurance companies (like AIG) on the assumption that the subprime mortgage market would collapse. When the market did crash, the sellers of the CDS (like AIG) had to pay enormous amounts to those who had bought the swaps, causing financial distress. 5. International Swaps and Derivatives Association (ISDA)The International Swaps and Derivatives Association (ISDA) is a global trade association that sets standardized guidelines for derivative contracts, like Credit Default Swaps (CDS). ISDA is responsible for establishing the legal framework and terms under which these contracts are traded, providing consistency in how they operate worldwide.Example : When two parties enter into a CDS contract, the terms are governed by ISDA guidelines. ISDA helps ensure that there is a common understanding and legal framework in case one party defaults, setting clear rules for settlement.

7. give the reasons for the failure of financial institutions from the the movie 1. Subprime MortgagesFinancial institutions invested heavily in subprime mortgages, which were loans given to people with poor credit histories. These mortgages were risky because many of the borrowers couldn’t afford to pay them back. When the housing market declined, defaults on these loans skyrocketed. 2. Mortgage-Backed Securities (MBS)Banks and financial institutions bundled subprime mortgages into mortgage-backed securities (MBS) and sold them to investors as safe investments. However, these securities were far riskier than they appeared because they were based on unstable subprime loans. When borrowers defaulted, the value of these MBS plummeted, leading to massive losses. 3. Collateralized Debt Obligations (CDOs)CDOs were created by further bundling MBS and other forms of debt into complex financial products. CDOs were sold as highly-rated investments, but in reality, they contained a significant amount of bad loans. The complexity of CDOs obscured their risk, and when the housing market collapsed, CDOs became toxic assets, causing financial institutions to suffer enormous losses. 4. Credit Rating Agencies’ ComplicityCredit rating agencies like Moody's and S&P played a significant role in the crisis by giving high ratings (AAA) to subprime mortgage-backed securities and CDOs. These ratings misled investors into believing the securities were safe. The agencies had a conflict of interest because they were paid by the banks issuing the securities, which incentivized inflated ratings. 5. High Leverage and Risky BetsMany financial institutions were highly leveraged, meaning they borrowed massive amounts of money to make risky bets on mortgage-backed securities and CDOs. When the housing market crashed, the value of these assets plummeted, and institutions found themselves unable to cover their losses, leading to insolvency .

8. 6 . Lack of RegulationThe financial system was poorly regulated at the time. Derivatives like CDOs and credit default swaps (CDS) were largely unregulated, allowing banks to take enormous risks without oversight. The lack of government intervention or adequate regulations exacerbated the crisis. 7. Credit Default Swaps (CDS)Credit default swaps were essentially insurance policies that banks and hedge funds purchased to bet against mortgage-backed securities and CDOs. When these securities failed, institutions that had sold CDS were required to pay out enormous sums of money. Companies like AIG, which sold large amounts of CDS, collapsed because they couldn’t cover the losses.

9. 8. Overconfidence and GreedThe film portrays Wall Street executives and traders as being overconfident in their models and driven by greed. Many financial institutions ignored warnings about the impending collapse of the housing market because they were making huge profits from the boom. The financial system was focused on short-term profits at the expense of long-term stability. 9. Ignorance of RiskMany people, including investors, regulators, and financial executives, failed to understand the full extent of the risks posed by subprime mortgages and the complex financial instruments built around them. As a result, they were blindsided by the scale of the collapse.

10. what could SEC\government could have done to safeguard the financial institutions 1. Stricter Regulation and Oversight of Mortgage LendingThe government could have enforced stricter regulations on mortgage lending, particularly for subprime mortgages. Banks were giving loans to people who couldn’t afford them, often with little to no verification of income or assets (liar loans). The government could have imposed tighter lending standards, ensuring that only borrowers with sufficient creditworthiness and ability to repay received loans. 2. Reining in Credit Rating AgenciesCredit rating agencies like Moody’s and S&P gave inflated ratings to risky securities, leading investors to believe they were safe. The SEC could have imposed stricter regulations on these agencies, requiring more accountability and transparency in how they rated complex products like MBS and CDOs. The government could have introduced reforms to remove the conflict of interest where agencies were paid by the very institutions they were rating.

11. 3. Regulating Credit Default Swaps (CDS)Credit Default Swaps (CDS), which allowed institutions to bet against MBS and CDOs, were largely unregulated. The SEC and the government could have imposed strict regulations on the CDS market, ensuring that institutions selling these products had sufficient capital reserves to cover potential losses. AIG, which collapsed under the weight of CDS obligations, might have been prevented from selling unbacked swaps had regulations required capital adequacy. 4. Leverage Limits on Financial InstitutionsMany banks and investment firms were operating with extremely high leverage, borrowing large sums of money to invest in risky assets. The government or the SEC could have imposed limits on leverage ratios, ensuring that institutions maintained sufficient capital reserves to withstand downturns in the market. If leverage had been limited, the collapse of MBS and CDOs would not have caused such catastrophic losses. 5. Enforcing Better Risk ManagementThe SEC and other regulatory bodies could have mandated stronger risk management practices across the financial sector. Banks and financial institutions failed to adequately assess the risks associated with subprime mortgages and complex securities. By requiring more rigorous risk assessments, stress tests, and scenario analyses, regulators could have forced institutions to be more cautious in their investments

12. can it happen in India if yes why if not why not , what precautions should SEBI take to avoid this situations India is Less Likely to Face a Big Short -like Crisis. Reasons: 1. More Conservative Lending PracticesIndian banks, particularly public sector banks, have traditionally followed more conservative lending practices compared to the highly aggressive lending seen in the U.S. during the subprime mortgage crisis. Loans in India typically have stricter requirements for creditworthiness and income verification, which reduces the likelihood of a large-scale housing bubble fueled by bad loans. 2. Tighter Regulation of Housing FinanceHousing finance companies and banks in India are regulated by multiple entities, including SEBI, the Reserve Bank of India (RBI), and the National Housing Bank (NHB). This multi-layered regulation ensures tighter control over the mortgage lending market. Additionally, India's homeownership culture tends to focus on primary residences rather than speculative real estate investments, which reduces the risk of a housing bubble.

13. 3. Relatively Underdeveloped Derivatives MarketThe derivatives market in India is not as complex or widespread as it was in the U.S. before the 2008 crisis. Products like Collateralized Debt Obligations (CDOs) and Credit Default Swaps (CDS) that amplified risk in the U.S. are less prevalent and less complicated in India. The relatively lower complexity and size of these markets in India reduce systemic risk. 4. Stronger Capital and Risk RequirementsIndian banks, under the supervision of the RBI, have stronger capital adequacy requirements. Indian regulations ensure that banks maintain adequate reserves to cover potential losses. In the U.S., many institutions were over-leveraged, while Indian regulations aim to prevent banks from taking on excessive debt relative to their capital. 5. Active Central Bank and Government OversightThe RBI plays a proactive role in overseeing the financial system and takes measures to curb excessive speculation or asset bubbles. India has witnessed instances where the central bank intervened to prevent overheating in certain sectors, such as real estate or non-banking financial institutions (NBFCs). This active oversight helps prevent risky practices from spiraling out of control.

14. Strengthen Mortgage and Housing Finance OversightSEBI , in coordination with the RBI and NHB, should ensure that lending practices in the housing market remain conservative and well-regulated. Continuous monitoring of loan quality, especially in the real estate sector, can prevent a subprime-like situation.Action : Ensure that housing finance companies and banks follow strict creditworthiness checks, income verification, and realistic loan-to-value ratios to avoid risky lending. Enhance Transparency in the Derivatives MarketSEBI should continue to keep a close watch on the derivatives market to prevent the creation of complex and opaque financial products like CDOs and CDS. Increasing transparency and simplifying derivatives will help ensure that financial institutions do not take on excessive risk unknowingly.Action : Require detailed disclosures for derivative products and impose limits on the complexity and volume of high-risk derivatives. SEBI should also ensure that any synthetic financial products are well-regulated. Precautions SEBI Should Take to Avoid a Big Short-like Crisis.

15. Stronger Stress Testing and Capital Adequacy NormsSEBI , along with the RBI, should ensure that banks and financial institutions undergo regular stress testing to assess their ability to withstand shocks, such as a sharp decline in the housing market. Banks must maintain sufficient capital reserves to cover potential losses from risky loans.Action : Require periodic stress tests for all financial institutions and NBFCs to evaluate their resilience in case of a market downturn or asset bubble burst. Regulate the NBFC Sector More StringentlyThe growth of NBFCs, which are not as tightly regulated as banks, poses risks similar to the shadow banking sector in the U.S. SEBI can collaborate with the RBI to ensure that NBFCs maintain sufficient capital buffers and follow prudent lending practices.Action : Strengthen regulations around NBFCs, ensuring they adhere to strict lending norms, have adequate capital reserves, and are subject to the same scrutiny as traditional banks.

16. Limit Leverage in Financial InstitutionsOne of the reasons for the collapse of financial institutions in the U.S. was their high leverage ratios. SEBI should ensure that Indian financial institutions maintain conservative leverage ratios and avoid overexposure to risky assets.Action : Impose limits on how much financial institutions, especially NBFCs and housing finance companies, can borrow relative to their assets. Enhanced Regulation of Rating AgenciesIn the U.S., credit rating agencies failed to accurately assess the risk of mortgage-backed securities. SEBI should enforce stricter guidelines for credit rating agencies in India to ensure they are not influenced by conflicts of interest and provide accurate, independent assessments of risk.Action : Ensure that credit rating agencies are held accountable for their ratings and impose penalties for inaccurate or biased ratings. Additionally, SEBI should promote competition and reduce conflicts of interest

17. Strengthen Consumer Protection and Financial LiteracyOne of the contributing factors to the U.S. crisis was that borrowers did not fully understand the risks of subprime mortgages. SEBI should promote financial literacy among the general public, particularly regarding housing loans and investments, to ensure that people make informed decisions.Action : Launch public awareness campaigns about the risks of taking loans with unrealistic repayment terms or investing in speculative financial products. Also, ensure transparent disclosures in all mortgage and financial products. Monitor Real Estate Bubbles and Take Pre-emptive ActionSEBI should work with the RBI and government authorities to monitor for signs of a real estate bubble. In the event of overvaluation in the housing market, SEBI and RBI could take pre-emptive measures to cool down speculative lending.Action : Implement policies such as higher down payment requirements, tighter lending criteria for real estate loans, or higher interest rates for speculative investments in property.

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