Random Thoughts – Randocity!

Film Review: The Warning – PBS / Frontline Documentary

Posted in bailout, banking, bankruptcy, botch, economy, insurance, scam, tanking by commorancy on November 26, 2010

Rated: 4/5 stars.

PBS’ The Warning Documentary

The Warning is a PBS documentary discussing a warning from Brooksley Born, an attorney and a former Commodity Futures Trading Commission (CFTC) chairperson. She explained that derivatives were extremely risky insurance vehicles and sent a warning that these vehicles needed regulation during her tenure as CFTC chairperson, but her warnings went unheeded. She resigned in 1999 from the CFTC position after legislation was passed preventing her agency from regulating derivatives.

Vision of this Documentary

While I would like to rate The Warning higher, its take is pretty much tunnel vision on the derivatives markets. While the derivatives markets did melt down and did, to a large degree, spur the meltdown onward, the meltdown was not started because of derivatives. The derivative meltdown was a casualty of and was exacerbated by the sub-prime mortgage meltdown. Had the mortgage industry bubble not burst, the derivatives market might have gone unchecked for many more years. The warning was and should have been about placing regulations onto mortgage lending practices. The mortgage lending industry is the industry that failed and sent the economy into a tailspin, let’s make that perfectly clear. The derivatives (insurance) market, which speculated on the mortgage industry, single-handedly sent Wall Street into a tailspin (along with several large insurance companies like AIG).

Derivatives and the Mortgage Meltdown

Anyone with half a brain in their head could see that using questionable lending vehicles like interest only loans for the first two years or adjustable rate mortgages were ticking time bombs. When the actual monthly payments came due years later after rates went up to where they should have been, people couldn’t afford pay. This was especially true when lenders were handing these loans to people who could barely afford the ‘introductory period’ payments. So, loans came due, people defaulted and the rest is history. The derivatives (insurance policies) that were issued also came due because of the en masse foreclosures. Insurance companies that issued derivative policies speculating people wouldn’t default en masse began to fail because their speculation was wrong. So then, these insurance companies couldn’t pay off on the insurance claims. So, when consumers defaulted, so did the insurance companies offering derivatives.

It wasn’t as if warnings weren’t being issued regarding the inevitable mortgage meltdown, it’s just that Brooksley Born (the focus of this film) was not one of the people issuing the mortgage warning. Her warning was strictly about the highly risky derivatives. More specifically, the black box non-transparent nature of them. The danger, of course, is that derivatives can be placed on any speculative and risky investment as insurance. The reason derivatives need to be regulated is to prevent companies the size of AIG from making stupid decisions about such risky vehicles. However, from a consumer perspective, banks should never have gotten into the position of issuing such risky mortgages like water to people who couldn’t afford them. This was the single mistake that led to where we are today and that mistake has nothing to do with derivatives and everything to do with Government and the Federal Reserve making stupid decisions.

Overall, the movie is worth watching, but also understand its information’s place in the larger meltdown that was at work in our economy.

3 Responses

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  1. charles henderson animal rescue said, on November 27, 2017 at 5:51 am

    The review about derivatives not being the instigator of the Meltdown is not exactly correct. In fact, it was because of the massive amount of derivatives that were in play and provided off the back of all of the collateralized debt obligations created from the mortgage back securities and the credit-default swaps that were created to cover all of those various derivatives that precipitated the “Meltdown” that actually occurred. AIG, Lehman Brothers, Merrill Lynch as well as many of the other investment banks and commercial banks from Goldman Sachs, Morgan Stanley to JPMorgan Chase and Citigroup were all very heavily overextended with collateralized debt obligations and credit default swaps because of the massive amount of derivatives that were sold on those off the balance sheet, black box SIVs(derivatives). The collateralized debt obligation and credit default swap exposure was in the hundreds of billions but when all the derivatives sold were laid over top of the CDOs & CDSs, the exposure was in the 10’s of trillions.

    In fact, right now, in 2017, JPMorgan Chase alone, according to a Fortune and Atlantic Monthly article in 2013, is exposed to over 75 trillion dollars in derivatives – four times the the annual US GDP and higher than the GDP of the whole world. If a match catches those derivatives on fire, it will melt down the entire world economy as we know it. That’s why Warren Buffett refers to derivatives as “financial weapons of mass destruction”. Yes, what started the fire was all of the subprime mortgages that were being defaulted on but it was the exposure to the trillions of dollars of derivatives that were placed as bets against mortgage-backed securities that caused the meltdown in 2009 and that’s what Brooksley Born was fighting with Congress, the Secretary of the Treasury, the Chairman of the Federal Reserve and the President of the United States about. She saw it coming a decade before it actually happened and she was shamelessly and unconsciously marginalized and unceremoniously and thanklessly basically run out of office. Yes, she resigned after a courageous fight taking on the system and having everyone turn on her like a brood of vipers but that’s because she realized it was the end of that run and there was nothing more she could do. She had no support from anyone in government in Washington DC. She is a modern day hero and should be lauded as such. She put her reputation, her career and everything she had achieved on the line in order to take on the entire system to warn them about the potential danger of derivatives and that they needed to be regulated. And she was proved 100% correct in 2009, 10 years after she had left Commodity Futures Trading Commission… to the tune of several trillion and counting. Tens of millions of people lost their homes; tens of millions of people lost their jobs, pensions and retirement savings because of derivatives but the worse is yet to come..buckle up because history repeats itself and another bigger meltdown is coming that will make us forget all about 2009.

    According to a variety of different sources, the financial services industry is overexposed to between 100 trillion and 500 trillion dollars worth of derivatives as of December 2017.

    Financial armageddon for sure.


    • commorancy said, on November 27, 2017 at 6:52 am

      Hi Charles,

      Thanks for your detailed comment. Though, I’d like to point out that derivatives only exist because of another vehicle to place the derivative (i.e., bet) on. Without another financial vehicle (i.e., subprime mortgages), the derivatives wouldn’t have existed. If the home loans issued had been 10, 20 or 30 year fixed terms instead of effectively 5 year balloon notes, the then meltdown likely wouldn’t have occurred. The reason the ‘match was lit’, or really more appropriately, ‘the fuse was lit’, were the creative, but highly volatile and fragile mortgage vehicles being issued at the time to people who couldn’t afford them. On top of that, the home market also then doubled down as an investment vehicle for many who ended up way overextended buying two, three and four other homes putting themselves massively in debt. These loan vehicles were, in fact, the catalyst that lit the fuse. The derivatives themselves weren’t the cause of the meltdown. They were the fallout.

      Obviously, it ended as a domino effect. A smallish number of people defaulted because their balloon note came due. This, in turn, caused home prices in those areas to plummet. This, in turn, caused mortgages around those foreclosures to go under water and caused banks to call those notes due when the home value sank below the note value. More dominoes fell as a result of yet more foreclosures. It snowballed into what became the mortgage meltdown until the government stepped in and bailed out the banks. AIG’s derivatives became a secondary casualty because of the massive numbers of failed mortgages. Unfortunately, it also exposed a huge problem in the banking industry with regards to these ‘side bets’. The thing is, derivatives are built to withstand a few failures spread out over longish period of time. However, they are not built to withstand the domino effect in a very short period of time, which at the time was caused by the creative loan vehicles that should have never been issued.

      What this all really points out in the financial industry is that all pieces must work together as a cohesive whole for the financial system to stay afloat. When one part of the industry makes their own independent decisions about how to run their piece, domino effect meltdowns occur. Could it occur again? Most definitely. As you’ve pointed out, the amount of outstanding derivatives is immense. The question is, are these derivative bets being made on such volatile investment vehicles as those balloon note mortgages? Only time will tell.

      As a side note, I would like to say that the mortgage meltdown underscores why balloon loans suck. I would never consider purchasing anything using a balloon loan. I was given that financing option once when I attempted to buy a new car. After the terms were explained to me, I turned it down. Yes, it offers much lower monthly payments, but at the end of the payment term you’re stuck shelling out a massive wad money (up to half) to pay the loan off (or attempting to find another loan to cover the remaining amount — usually at much higher interest). For this reason, no one should ever say yes to a balloon or variable rate loan unless they already have sufficient liquid capital to pay that massive balloon payment. It’s also worth noting that some loans penalize you if you pay them off early. It may not be worth refinancing a loan that has a payoff penalty. You gotta read the terms closely and then do the math before signing the loan agreement.


  2. Sangeeta said, on November 8, 2014 at 5:00 pm

    Great review! And very helpful to understanding how to place the information outside of the filmmakers direct intentions. Thank you.


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