Inside Job

In 2008, Iceland’s three largest banks, Glitnir, Landsbanki and Kaupthing collapsed under debt roughly six times the nation’s Gross Domestic Product of €14 billion (US$19 billion).  Deregulation and privatization are said to be key factors that led to the banking system’s collapse.  Matt Damon, the film’s narrator, informs us that a third of Iceland’s regulators went to work for the banks.

Despite Iceland’s failure, and our own savings and loan crisis of the 1980’s (some 747 S&L’s went under) followed by the tech and housing bubbles, it would appear that America has yet to learn the hard lesson that Iceland did.

The filmmakers argue that the current economic crisis has been brewing steadily for at least thirty years including, notably, the Gramm-Leach-Bailey act of 1999 which effectively repealed the Glass-Steagall Act that kept commercial and investment banking separate.  The film does go a little further to explain, poignantly, that investment banks were once private partnerships in which each participant knew and understood the risk of the operation, but this changed as numerous investment banks started going public and complicated derivative instruments made it nearly impossible for shareholders or customers to understand the risks being undertaken by management.  Strangely, the filmmakers fail to underscore President Nixon’s 1971 abolition of the gold standard as another piece in this bubbling morass.

Bringing in various interview subjects, including billionaire investor George Soros, the International Monetary Fund’s former chief economist Raghuram Rajan and IMF Managing Director Dominique Strauss-Kahn, the film does a commendable job of explaining, as best as humanly possible, the esoteric financial instruments that contributed to the current financial crisis in America.  These mortgage-backed securities include collateralized debt obligations and credit default swaps—securitized hodgepodges of various debt instruments, typically mortgages.  Only now is popular opinion beginning to lean toward Berkshire Hathaway Chairman and CEO Warren Buffett’s view—once famously describing OTC derivatives as “Financial weapons of mass destruction.”

There are perhaps a handful of people in the world who can explain very specifically the internal mechanics of these debt packages (Mr. Soros admits he isn’t one of them), but a sufficient bird’s-eye view is presented here with graphic animations for clarity to illustrate the flow of debt and insurance against debt.

The film’s weak points, almost concealed by the tightness of the narrative and graphics charting the flow of money, lie in close proximity to Michael Moore’s failings as a documentary filmmaker.  While the film does consult academic professors, such as Nouriel Rubini of New York University’s Stern School of Business, it also seems to vilify academic “elites” such as Columbia University’s Alfred Lerner Professor of Banking Frederic Mishkin, and Columbia Business School Dean Glen Hubbard—both of whom have less-than-stellar interview skills.

What we don’t see amidst all the jump cuts a number of segments that may have led to these interviewees’ irritation.  Additionally, some logical threads of conversation are totally abandoned either because the filmmakers wanted to steer your perception or because they weren’t themselves intelligent enough to call out the professors on financial specifics.  One of the points argued is that professors should disclose any potential conflicts of interest, and it leads into the larger issue of cross-pollenization between academia, investment banks and government.  But I asked myself the question: In economics and finance, can you think of any field other than banking, government or academia from which to draw the intellectual capital for regulatory oversight?

The larger problem, one can argue, amounts to varying levels of self-interest.  The film doesn’t examine the difference between self-interest and greed, or rather at what point self-interest graduates to greed.  The filmmakers could have clarified how, esoteric financing schemes aside, the self-interests of borrowers have limited catastrophic implications for themselves and perhaps their immediate neighbors (every foreclosure affects neighboring appraisal values).  That contrasts with the handful of individual decision makers who, after much deregulation and consolidation, could single-handedly capsize the whole ship.  Additionally, an information gap exists which implicitly places more responsibility on the realtors, mortgage brokers, lenders, investment bankers and other professionals who knowingly and willingly engage in tremendously risky behavior.

Mr. Rajan notes that one major contributing factor to this risky behavior is a lopsided compensation model in which bonuses are not risk-weighted.  That is to say if I borrow $35 million to make a $1 million return, versus borrowing $5 million to make the same return, there’s a significant difference in how much I’ve exposed the company and its shareholders to risk.  Also, negative consequences should exist to penalize poor performance and risk-taking.  This combination would encourage longer-term thinking and planning.

Because the banking industry elected to undertake such massive risk, leveraging themselves out at 20-30 times their deposits on hand, the only institution capable of bailing them out when the rats chewed up the ship was, of course, our government.  The film makes the argument, and rather well, that the private banks of the world are so interdependent upon each other, the economies they support and the federal banking systems that back the currency they use, that large investment houses such as Goldman Sachs and a number of other corporates which failed wield too much influence on our economy.

To wit, because of their steep leverage ratios even a three percent decline in the value of their assets could have catastrophic impact.  Imagine, for example, that you have $10,000, and you borrowed $30,000 more to invest a total of $40,000 in a company’s stock.  Now imagine that company was vastly overvalued and accounting irregularities came to light.  One morning you wake up and find your stock lost half its value.  You only invested $10,000, so what’s the problem?  Since the value of your securities are now $20,000, but you borrowed $30,000, the sale of those securities leaves you $10,000 short.  Now imagine what happens if an even more convoluted OTC derivatives market worth about $610 trillion collapses in a society whose entire Gross Domestic Product is $13.4 trillion.

Inside Job • Dolby® Digital surround sound in select theatres • Aspect Ratio: 2.35:1 • Running Time: 120 minutes • MPAA Rating: PG-13 for some drug and sex-related material.• Distributed by Sony Pictures Classics

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