Monthly Archives: December 2015

“The Federal Reserve has kept short-term interest rates near zero for seven years and bought trillions in bonds to push all bond rates down—in a deliberate effort to encourage investors to seek out higher rates and accept the risk that goes with them. Investors obliged…

…According to Dealogic, U.S. junk-bond issuance hit a record $361 billion in 2013, after $355 billion in 2012. Those totals were more than double the volumes in the years before the financial crisis. Investors also began to see junk bonds as less risky, judging by the spreads. This is the interest paid on the bonds over and above what investors can receive holding U.S. Treasury bonds. According to Bank of America Merrill Lynch, which maintains a popular measure of this spread, the long-run average since 1990 is 558 basis points. But with the Fed encouraging risk-taking, it fell below 340 in June of 2014. Investors weren’t demanding much extra compensation for the extra risk…..on Monday the high-yield spread over Treasurys had climbed to 710 basis points—more than twice the level of late June 2014, and investors are getting whacked. The risk of any illiquid market is that a mild correction can turn into a larger panic if sellers can’t find buyers. One place to watch in particular is the energy industry, where borrower fundamentals do look bad thanks to the Fed-inspired commodity-price boom and bust. The post-crisis meddling in markets was done in the name of reducing risk, but it has created new risks of its own.”, The Wall Street Journal Editorial Board, December 15, 2015

Opinion

The New Bond Market

Encourage record sales of bonds, while telling banks not to buy them.

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PHOTO: GETTY IMAGES/ISTOCKPHOTO

The good news about the junk-bond selloff shaking financial markets is that taxpayer-backed banks generally aren’t absorbing the losses. The bad news is that with America’s new financial architecture it doesn’t take much to trigger a steep decline.

Junk or high-yield bonds are loans to companies of questionable credit quality. And a popular exchange traded-fund that tracks the junk-bond market is down nearly 8% since early November and about 12% on the year. The Federal Reserve has kept short-term interest rates near zero for seven years and bought trillions in bonds to push all bond rates down—in a deliberate effort to encourage investors to seek out higher rates and accept the risk that goes with them. Investors obliged.

According to Dealogic, U.S. junk-bond issuance hit a record $361 billion in 2013, after $355 billion in 2012. Those totals were more than double the volumes in the years before the financial crisis. Investors also began to see junk bonds as less risky, judging by the spreads. This is the interest paid on the bonds over and above what investors can receive holding U.S. Treasury bonds.

According to Bank of America Merrill Lynch, which maintains a popular measure of this spread, the long-run average since 1990 is 558 basis points. But with the Fed encouraging risk-taking, it fell below 340 in June of 2014. Investors weren’t demanding much extra compensation for the extra risk.

Meanwhile, the Fed and other regulators were also limiting the ability of large banks to buy these instruments. So while the junk-bond supply was expanding, the demand among big banks has been constrained by regulations in the wake of the 2010 Dodd-Frank law.

The result is that these bonds are now more likely to be held by corporate treasuries and mutual funds—institutions that carry less leverage and aren’t backed by taxpayers. This is good for bank stability in a systemic crisis (assuming the assets regulators tell banks to hold aren’t even worse). But many on Wall Street have been wondering what will happen when a market downturn occurs and banks are largely not available as distressed-bond buyers when investors wish to sell.

Well, here we are. It’s tempting to call this a stress test of the new markets that Washington has created, but the underlying economic conditions aren’t all that stressful—yet. Through November the default rate on junk bonds was 2.6%, not all that high considering defaults spiked to nearly 12% after the financial crisis. Defaults exceeded 12% after a recession in the early 1990s and were beyond 14% in the early 2000s.

Yet on Monday the high-yield spread over Treasurys had climbed to 710 basis points—more than twice the level of late June 2014, and investors are getting whacked. The risk of any illiquid market is that a mild correction can turn into a larger panic if sellers can’t find buyers. One place to watch in particular is the energy industry, where borrower fundamentals do look bad thanks to the Fed-inspired commodity-price boom and bust.

The post-crisis meddling in markets was done in the name of reducing risk, but it has created new risks of its own.

“It is simply not true that we are forced to choose between one system dominated by Fannie Mae and Freddie Mac and another dominated by a few huge banks…

…The argument is at best ill considered, and at worst a red herring that will undermine any attempt to achieve significant reform. There is no reason we can’t create a dynamic mortgage market with plenty of competition, free of an unhealthy dependence on institutions we cannot afford to let fail. As we consider reforming the role of Fannie Mae and Freddie Mac, we should settle for nothing less.”, Jim Parrott and Mark Zandi, “Fixing Fannie and Freddie for Good”, The New York Times, December 15, 2015

The Opinion Pages

Fixing Fannie and Freddie for Good

By JIM PARROTT and MARK ZANDI

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Credit Michael Reynolds/European Pressphoto Agency

IN the longstanding debate about what should be done to overhaul Fannie Mae and Freddie Mac, the mortgage behemoths that taxpayers rescued at the height of the financial crisis, a growing number of groups, including several hedge funds and other investors, as well as civil rights groups and consumer advocates, are offering a surprising answer: Go back to the very system we just bailed out.

In September 2008, after the two institutions had racked up tens of billions in losses that had wiped out their capital, and amid fears about what their insolvency might mean for the American housing market and the wider economy, the then newly created Federal Housing Finance Agency stepped in to place Fannie and Freddie in conservatorship. Taxpayers have backstopped the two institutions and their mortgage securities ever since.

Yet, hard as it is to imagine, given the colossal scale of this bailout and the dramatic effect that their failure had on the broader economy, many are arguing that we should now resurrect Fannie and Freddie as the privately owned but taxpayer-backed oligopoly whose collapse contributed mightily to the financial turmoil and resulting Great Recession.

More surprising still, one of the primary reasons offered by many proponents of this view is that we cannot end their stranglehold without decreasing competition in the mortgage market.

This view isn’t merely counterintuitive; it’s wrong.

Fannie Mae and Freddie Mac are among the largest financial institutions in the world, currently purchasing roughly one-half of the mortgages issued by lenders in the United States. They package and create securities out of these loans, and provide guarantees to the investors that they will be paid their principal and interest under any economic scenario. They thus act as critical gatekeepers in determining what kinds of mortgage loans lenders can make, and who gets a loan and under what terms.

The concern is that any move to reform Fannie and Freddie by diminishing their dominance of the housing finance system will inevitably mean that the nation’s biggest banks will swoop in to take over their gatekeeping role. If they do, then these banks will use that power to their advantage, squeezing out smaller competitors.

This would indeed be a bad outcome. We would simply be swapping one dysfunctional system dependent on too-big-to-fail institutions for another with the same problem.

If this were what reforming Fannie and Freddie was all about, then the critics of reform would be right. But it’s not.

The point of the kind of reform that we support is to end the system’s dependence on too-big-to-fail institutions. It is critical to ensure that no institution central to the system has an incentive to take on excessive risk, knowing that taxpayers will bail them out if things go wrong, as happened with Fannie and Freddie and could happen in a system overly dominated by other too-big-to-fail institutions.

One of us, Mark Zandi, is on the board of a mortgage insurer; the other, Jim Parrott, advises several financial institutions in the housing finance industry. Some of these institutions could benefit from Fannie and Freddie reform, while others may suffer. But our focus is not the interests of these institutions, any more than it is those of the big banks or the shareholders of Fannie and Freddie. The aim of reform should be to create a healthier housing finance system, which means, among other things, one with greater competition.

In winding down Fannie and Freddie’s duopoly, Congress could and, we have long argued, should explicitly prohibit institutions that make mortgage loans from also playing the role of gatekeeper to the secondary market of mortgage-backed securities. Congress could also cap the market share of any single gatekeeper at a low enough level to preclude market concentration, or it could even create new gatekeepers to ensure that smaller lenders never are locked out of making mortgage loans.

Legislative reform could be a long time coming, however, given the complex politics of the issue. In the meantime, the F.H.F.A. should work to ease the mortgage giants’ unhealthy hold on the market.

The agency has already taken two steps that hold great promise: requiring that Fannie and Freddie share the risk they take when guaranteeing mortgage securities with a broad range of private financial institutions, and that they develop a common platform for offering securities on mortgage loans.

Done right, these steps could eventually open up the market to greater competition, reducing the dominance of Fannie and Freddie without enabling other too-big-to-fail institutions to take their place.

It is simply not true that we are forced to choose between one system dominated by Fannie Mae and Freddie Mac and another dominated by a few huge banks. The argument is at best ill considered, and at worst a red herring that will undermine any attempt to achieve significant reform.

There is no reason we can’t create a dynamic mortgage market with plenty of competition, free of an unhealthy dependence on institutions we cannot afford to let fail. As we consider reforming the role of Fannie Mae and Freddie Mac, we should settle for nothing less.

Jim Parrott is a senior fellow at the Urban Institute and the owner of Falling Creek Advisors, a financial consulting firm. Mark Zandi is the chief economist at Moody’s Analytics.

A version of this op-ed appears in print on December 15, 2015, on page A35 of the New York edition with the headline: Fixing Fannie and Freddie for Good.

 

“And those $0 down (home) loans? They are primarily drawn from the U.S. Department of Agriculture’s Rural Development Guaranteed Loan program. Unlike mortgages guaranteed by the Federal Housing Administration, or those from most private lenders, the USDA offers 100% financing…

…While meant to be limited to rural areas, many of the places it covers are in the exurbs LGI focuses on. Tom Lawler, a Fannie Mae veteran who is now an independent housing economist, says he isn’t a fan of LGI’s practice of promoting USDA loans. Nor is he enamored by it advertising its houses by monthly payments rather than price.”, Justin Lahart, “Why This Home Builder Doesn’t Have to Slip on Oil”, The Wall Street Journal, December 15, 2015

“The USDA offers no-down payment home loans, VA offers 100% LTV cash-out mortgages and FHA isn’t far behind with only 3% or so down (and to subprime FICO score borrowers). Why post-crisis, now that we all know that nominal housing prices can fall not only regionally, but nationally, is our government continuing to offer these risky mortgages that can easily result in hundreds of thousands, if not millions, of borrowers being underwater on their mortgage and billions in taxpayer losses? And why should a for-profit firm like LGI be allowed to make big profits with “no skin in the game” (The risk of the 100% mortgages is fully taken on by the American taxpayer.)? LGI’s business model doesn’t exist without USDA’s 100% financing!”, Mike Perry, former Chairman and CEO, IndyMac Bank

Markets

Why This Home Builder Doesn’t Have to Slip on Oil

LGI Homes’ focus on first-time buyers is helping it outstrip rivals

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LGI Homes closed on 934 homes in the third quarter, up from 557 a year earlier. An LGI-built home in Hockley, Texas. PHOTO: LGI HOMES INC.

By Justin Lahart

LGI Homes has been growing so quickly investors could be forgiven for thinking they had been transported back in time to the housing boom. The way the home builder’s stock has fallen this month, they could also be forgiven for thinking they are back in the housing bust.

It doesn’t help, either, that LGI’s home state of Texas represents a big chunk of its business, exposing it to the oil-price rout. Or that LGI builds its houses on “spec”—that is with no identified buyers. Or that it is focused on the exurbs and touts the chance to own a new home “for $0 down.”

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Even so, with a focus on first-time buyers, the company is filling a void left by an industry that may be overly risk averse. And December’s 25% drop in LGI’s stock gives investors more compensation for risks around the high-growth company.

LGI closed on 934 homes in the third quarter, up from 557 a year earlier. That 68% gain compares with an overall rise in new single-home sales of 10%. Its revenues grew 88%, and its gross profit margin of 26% is well above most peers. With the drop in its stock price, the company now trades at just 8.4 times expected earnings. That is below most large builders’ multiples despite its much higher growth profile.

Investors’ immediate concern is that with oil below $40 a barrel, LGI’s exposure to Texas, which accounted for more than half its closings in the third quarter, will hurt it. So far, though, its Texas business isn’t showing signs of flagging. And its business outside the state has grown quickly, representing 47% of closings in the third quarter versus 30% a year earlier. Communities scheduled to open in five new markets will further diversify it away from Texas.

Meanwhile, its building on spec is looking more like a feature than a bug lately. This has allowed LGI to offer subcontractors steady work. As a result, while other large builders have struggled with a dearth of available labor, LGI didn’t experience such shortages.

And those $0 down loans? They are primarily drawn from the U.S. Department of Agriculture’s Rural Development Guaranteed Loan program. Unlike mortgages guaranteed by the Federal Housing Administration, or those from most private lenders, the USDA offers 100% financing. While meant to be limited to rural areas, many of the places it covers are in the exurbs LGI focuses on.

Tom Lawler, a Fannie Mae veteran who is now an independent housing economist, says he isn’t a fan of LGI’s practice of promoting USDA loans. Nor is he enamored by it advertising its houses by monthly payments rather than price.

But he thinks it is a plus that LGI is focused on building exurban homes that are affordable to first-time buyers. This is an underserved area after the housing bust sent many mom-and-pop builders out of business and led large public builders to retrench.

LGI will be reaching more of those buyers in the year ahead, and yes, there are risks in that. But a home builder willing to take on some risk may be a welcome thing these days.

 

“All of these markets saw historic highs during the Fed’s quantitative-easing, near-zero heyday. The Fed wanted investors to lift financial-asset prices, chasing risk along the yield curve. That’s exactly what they did, pouring into the likes of emerging-market debt, commodity plays and riskier corporate bonds…

…The high-yield-bond washout is worth watching in particular, as we note below. Normally junk investors would deserve no special attention because their investments are called junk for a reason. But some investors unaccustomed to the risks may have been enticed into the market when junk spreads narrowed to historic lows against Treasurys while the Fed was urging everybody on.Now the junk bubble is bursting, and the extent of the damage is hard to predict. This is precisely why many of our friends warned about the excesses that near-zero rates might produce in asset markets.”, “The Fed at the Brink”, The Wall Street Journal Editorial Board, December 15, 2015

Opinion

The Fed at the Brink

After seven years of near-zero, financial markets are nervous.

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The Federal Reserve Building in Washington D.C. on October 27, 2014. PHOTO: GETTY IMAGES

What goes down must come up, and so after seven long years the Federal Reserve is finally poised this week to get off its near-zero interest-rate bound. Along with this come the financial tensions of unwinding the Fed’s long gamble with unconventional monetary stimulus.

The big news in financial markets in recent weeks has been the return of anxiety, led by commodities, junk bonds and emerging markets. All of these markets saw historic highs during the Fed’s quantitative-easing, near-zero heyday. The Fed wanted investors to lift financial-asset prices, chasing risk along the yield curve. That’s exactly what they did, pouring into the likes of emerging-market debt, commodity plays and riskier corporate bonds.

The returns were fun while they lasted, but these have been rolling back as the Fed has signaled a gradual return to normalcy. As the dollar has climbed while Japan and Europe devalue and emerging economics like China slow, commodities have plunged.

Crashing oil prices are punishing energy companies, which is also rippling through the credit markets. Chesapeake Energy’s bonds traded below 30 cents on Monday amid a bond swap to reduce debt. Banks have been carrying many energy companies for months in anticipation that oil prices might rebound, but the pain will build the longer prices stay low.

The high-yield-bond washout is worth watching in particular, as we note below. Normally junk investors would deserve no special attention because their investments are called junk for a reason. But some investors unaccustomed to the risks may have been enticed into the market when junk spreads narrowed to historic lows against Treasurys while the Fed was urging everybody on.

Now the junk bubble is bursting, and the extent of the damage is hard to predict. This is precisely why many of our friends warned about the excesses that near-zero rates might produce in asset markets.

One question is whether this case of market nerves is merely an inevitable and temporary adjustment or a sign of deeper credit distress. The former is certainly possible. The markets threw their famous “taper tantrum” of 2013 when the Fed was reducing its monthly bond purchases, only to calm down when the Fed followed through. This expansion had two of its strongest quarters of growth after the Fed purchases ended.

Perhaps the oddest feature of this pending rate hike is how conflicted Fed Chair Janet Yellen and her colleagues seem to be. Even their own leaks to the Fed press corps are full of self-doubt. Fed officials seem to be looking at the economy through the usual Phillips Curve model based on the trade-off between inflation and unemployment. The Fed’s Keynesians see a moderately tight jobs market with a 5% unemployment rate, at least for those still looking for work, and so they worry about wage-push pressure on prices coming around the corner.

We thought the Phillips Curve was discredited amid the stagflation of the 1970s, and our preferred inflation guides are actual prices and price expectations. On that score, nearly every leading commodity market is signaling lower future prices, which suggests lower demand expectations. The rising dollar is a factor here, but these markets could also be signaling slower global growth in 2016.

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All of which leaves the Fed with a dilemma of its own making. If it stays at zero this week, it will raise more doubts about the economy and cause markets to wonder about the Fed’s competence. If the Fed does follow through and raise rates, it courts catcalls from the political class and Wall Street if the economy slows or there is larger financial turmoil.

Our own view, oft-expressed, is that the Fed would be better positioned now if it had begun raising rates earlier in this expansion, returning to normal amid a stronger, more confident investor outlook. If the fed-funds rate were closer to 2% or 3% now, the Fed would have room to pause its rate increases and might have less financial turmoil to navigate.

Instead, the Ben Bernanke-Yellen Fed argued year after year that a little more time at zero would pave the way for an economic breakout to 3% or faster growth. That faster growth has never arrived, even as the Fed’s rate reckoning apparently has. The transition had to happen sooner or later, and it might be a bumpy ride.

“The preachy, hectoring tone writer and director Adam McKay takes at the end of the ‘The Big Short’ is not only discordant, it’s also hugely misleading…

…McKay thinks one of the main takeaways from the crisis is this: The banks “blamed poor people.” No one blamed poor people, but McKay seems unaware of the major role the federal government played in nudging poor people to buy houses they couldn’t afford. . . .McKay’s movie essentially tells us that the big banks like Goldman had ensured that the fix was in—they had criminally rigged the system. How so? You can hardly yell “People should have gone to jail” when you can’t point to a single individual and explain what crime he committed. Betting that AAA-rated securities are in fact sound investments may sometimes be stupid, but dumb isn’t the same as fraudulent. And justice isn’t supposed to work on lynch-mob principles in which anger and a noose are all you need to deliver a satisfying conclusion. “The Big Short” is already getting praise in Hollywood for its “powerful message.” Critics and award voters won’t care that it doesn’t tell the whole story. They’d rather be righteous than right.”, Notable & Quotable: The New York Post’s Kyle Smith on ‘The Big Short’, The Wall Street Journal, December 15, 2015

Opinion

Notable & Quotable: Kyle Smith on ‘The Big Short’

The New York Post critic and columnist writing about the new movie ‘The Big Short.’

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Steve Carell in a scene from ‘The Big Short.’ PHOTO: JAAP BUITENDIJK/ASSOCIATED PRESS

Dec. 14, 2015 7:06 p.m. ET

The New York Post’s Kyle Smith writing about the new movie “The Big Short,” Dec. 6:

The story is everything, and that story is: Evil bankers in an unregulated Wild West of capitalist depravity crippled the economy, cost us taxpayers billions of dollars in bailouts and carried on in a lawless spree that should have resulted in jail time for everybody.

To say the least, it’s an imprecise view, which raises the question: When it’s time to make a movie dealing in complex material about contemporary financial instruments, is the guy who brought us “Anchorman 2” really the best available option?

Longtime Will Ferrell collaborator, former “SNL” head writer and director Adam McKay, whose work usually isn’t even on the smart end of the comedy spectrum, co-wrote and directed “The Big Short,” an inept and frequently idiotic take on Michael Lewis’ deeply engaging book, and it will largely be remembered for three things: bad haircuts, overacting and Margot Robbie in a bubble bath. . . .

The preachy, hectoring tone he takes at the end of the film is not only discordant, it’s also hugely misleading. McKay thinks one of the main takeaways from the crisis is this: The banks “blamed poor people.” No one blamed poor people, but McKay seems unaware of the major role the federal government played in nudging poor people to buy houses they couldn’t afford. . . .

McKay’s movie essentially tells us that the big banks like Goldman had ensured that the fix was in—they had criminally rigged the system. How so? You can hardly yell “People should have gone to jail” when you can’t point to a single individual and explain what crime he committed. Betting that AAA-rated securities are in fact sound investments may sometimes be stupid, but dumb isn’t the same as fraudulent.

And justice isn’t supposed to work on lynch-mob principles in which anger and a noose are all you need to deliver a satisfying conclusion.

“The Big Short” is already getting praise in Hollywood for its “powerful message.” Critics and award voters won’t care that it doesn’t tell the whole story. They’d rather be righteous than right.

 

“Never let anyone say that Wall Street history lacks irony. Remember those “toxic” mortgage bonds at the epicenter of the 2008-09 financial crisis? Turns out they’ve been nothing but tonic to a select group of mutual fund managers’ portfolios ever since…

…Since its inception in June 2011, the Angel Oak Multi-Strategy Income fund (ticker: ANGLX)—the oldest retail fund to invest primarily in such bundles of residential and commercial mortgage loans—has delivered a 9.2% annualized return, almost triple the Barclays Aggregate Bond Index’s 3.1%. That a beaten-down asset class should rally during an economic recovery is not remarkable. What is surprising is how stable the once-distressed sector has been. Since inception, the Angel Oak fund has had volatility identical to its Barclays benchmark, which holds only high-quality corporate and government bonds. Even better, the fund has had more upside and less downside—82 positive and 18 negative months since its launch, compared with 65 and 35 for Barclays. How is this possible with once-toxic assets? “We don’t call this sector toxic or distressed anymore,” says Sreeni Prabhu, chief investment officer of Angel Oak’s management firm. “Today, I call it opportunistic fixed income.” That may sound like the worst Wall Street euphemism ever, but Prabhu insists that it’s accurate.”, Lewis Braham, “’Toxic Mortgages’, Healthy Gains”, Barrons, December 5, 2015

“Yet the FDIC-R sold IndyMac Bank (a large RMBS issuer and investor) right at or near bottom, at a time in early 2009 when its Chairperson Sheila Bair herself was quoted in The New York Times saying “asset prices were irrational.” And despite this fact, they sued me and falsely alleged I was a negligent banker, because I could not foresee in early 2007 the crisis coming and/or successfully manage massive and unprecedented external economic events, beyond any individual financial institution’s control. (The FDIC approved our non-conforming mortgage business model for federal deposit insurance in 2000. Prior to then, we were a mortgage REIT.)That’s not right. In late 2008/2009, the FDIC-R didn’t need any foresight and their decisions and actions were all within their control. All they had to do was act like any other prudent receiver/conservator (like the Fed did with Bear and AIG assets, like Treasury did with GM and others, and like the Lehman BK Trustee did with its assets) and not fire-sell assets at or near the bottom of a panicked marketplace. I think this might be why the U.S. Treasury’s material loss report on IndyMac Bank never reconciled the components of the deposit insurance fund’s losses, as required by law?”, Mike Perry, former Chairman and CEO, IndyMac Bank

Fund of Information

“Toxic” Mortgages, Healthy Gains

Subprime mortgages, once scorned, are producing nice returns for some mutual funds

By Lewis Braham

Never let anyone say that Wall Street history lacks irony. Remember those “toxic” mortgage bonds at the epicenter of the 2008-09 financial crisis? Turns out they’ve been nothing but tonic to a select group of mutual fund managers’ portfolios ever since.

Since its inception in June 2011, the Angel Oak Multi-Strategy Income fund (ticker: ANGLX)—the oldest retail fund to invest primarily in such bundles of residential and commercial mortgage loans—has delivered a 9.2% annualized return, almost triple the Barclays Aggregate Bond Index’s 3.1%. Newer mortgage-related funds, such asSemper MBS Total Return (SEMPX) and Voya Securitized Credit (VCFAX), have also topped the charts.

While many giant funds such as Vanguard GNMA (VFIIX) own mortgage bonds, these are mainly invested in low-yielding bonds backed by government agencies such as Ginnie Mae. Currently, only 14 funds invest primarily in the other forms of securitized credit called nonagency residential mortgage-backed and commercial mortgage-backed securities, or RMBS and CMBS, respectively. These funds specialize in the higher-yielding prime and once-dreaded subprime loans, which the agencies deemed too risky or unusual to back.

That a beaten-down asset class should rally during an economic recovery is not remarkable. What is surprising is how stable the once-distressed sector has been. Since inception, the Angel Oak fund has had volatility identical to its Barclays benchmark, which holds only high-quality corporate and government bonds. Even better, the fund has had more upside and less downside—82 positive and 18 negative months since its launch, compared with 65 and 35 for Barclays.

How is this possible with once-toxic assets? “We don’t call this sector toxic or distressed anymore,” says Sreeni Prabhu, chief investment officer of Angel Oak’s management firm. “Today, I call it opportunistic fixed income.” That may sound like the worst Wall Street euphemism ever, but Prabhu insists that it’s accurate. “The fraud in the sector is gone,” he says. “The average mortgage borrower who was struggling has already defaulted out. What you’re left with is a good pool of borrowers.” That said, Prabhu largely avoids the subprime, lowest-quality securities.

One misunderstanding about RMBS is that they don’t default like a conventional bond. With a corporate bond, for instance, the end result is binary: Either the bond pays income until it matures or it defaults. But since an RMBS is a bundle of mortgage loans, some borrowers can default and the bond can still continue to pay income from its remaining loans. Since there has been little issuance of RMBS post-crisis, most of the securities today are of an earlier vintage with now-stable borrowers.

“Now we have borrowers who have made several years of payments into the trust, and the average loan to value of their homes is below 80%,” Prabhu says. “So they are eligible for refinancing their mortgages.” Refinancing is good because that means the borrower must first repay her previous mortgage loan. Loan repayments cause RMBS’ credit quality and prices to improve.

Consequently, Prabhu expects RMBS to deliver 7% to 8% total returns going forward—5% to 5.5% yields plus the remainder in price appreciation. And that’s with less credit risk than competing junk bonds: “These securities should be compared with high-grade corporate credit now.”

Of the retail funds in the sector, perhaps Semper MBS Total Return is the most interesting. That’s because it has only $427 million in assets, and its management firm runs a total of $1.1 billion. It also has no load and a lower expense ratio, 1%, than the $4.8 billion Angel Oak, at 1.24%. “Our size allows us to be extremely nimble and opportunistic,” says Semper Capital CEO Gregory Parsons.

BEING NIMBLE HELPS, as RMBS liquidity has been drying up since the crisis. “Roughly $700 billion of legacy nonagency debt still exists,” says Parsons. “The supply is shrinking 10% to 15% a year as securities mature.” Consequently, Parsons plans to close the fund to new investors at about $2.5 billion.

There is hope for new issuance, however. Since the crisis, some new nonbank lenders have gradually emerged to issue loans that are structured similarly to RMBS but have more-stringent lending standards. “This year, these new loans will be a $2 billion marketplace,” says Prabhu. “We think it will be a $200 billion marketplace in the next five years.”

One of the biggest problems during the crisis was that banks seemed ignorant of RMBS’ credit risks. Since then, their transparency level has improved. “These are still complex instruments,” says David Goodson, manager of Voya Securitized Credit. “But a number of companies have emerged offering data that help make the analysis easier.”

Still, given the sector’s complexity, having an experienced money manager is paramount. The cruelest irony: Top managers often come from the banks that originally issued the toxic loans. Goodson used to work at Wachovia. Prabhu’s team worked at the infamous Washington Mutual. But then, who better to dissect these securities than someone who watched them collapse firsthand?

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LEWIS BRAHAM is a free-lance writer, based in Pittsburgh.

“But it is an incomplete picture. By dwelling so intensively on mortgage finance, “The Big Short” underplays the more complex economic forces that produced the bubble and intensified the crisis…

…By laying the bulk of the blame on Wall Street venality, it brushes off less nefarious but more compelling reasons why so many on and off Wall Street didn’t see it coming. The idea that mortgage-industry insiders systematically profited by selling mortgages they knew would fail is at odds with what actually happened. A 2012 paper by three Federal Reserve economists noted insiders such as Bear Stearns and its executives had their wealth and their companies tied up in the mortgage market. Trader Mark Baum (played by Steve Carell) concludes the banks knew what they were doing but assumed they would be bailed out. This is a strange sort of logic: What bank would knowingly make itself a candidate for a bailout, by which point shareholders are often largely wiped out and management fired? In fact, as the Fed paper notes, insiders took on so much exposure because they, like most home buyers, thought housing prices would never go down. This is also why underwriting standards collapsed: Proof of income didn’t matter if the loan could always be repaid by selling off the appreciated collateral. The movie nods to this at times. “No one can see a bubble,” an investor tells Mr. Burry. “That’s what makes it a bubble.” But it never answers the bigger question: how the bubble, and the belief it would never collapse, formed. The reason lies in broader macroeconomic and societal forces that are barely mentioned: low interest rates engineered by the Fed after the Nasdaq bubble’s collapse; the glut of foreign savings from China and elsewhere pouring into the U.S. bond market; the complacency nurtured by years of economic calm; the financial innovations—well beyond mortgages—and lax regulatory standards bred by that calm. These forces were global: Many countries had housing bubbles and bank bailouts. Perhaps no movie could do justice to all those questions.”, Greg Ip, “What the ‘Big Short’ Movie Gets Right—and Wrong—About the Financial Crisis”, The Wall Street Journal, December 12, 2015

Markets

What the ‘Big Short’ Movie Gets Right—and Wrong—About the Financial Crisis

Film details financial crisis well but gives an incomplete picture

Adam McKay, known for directing the comedy blockbuster “Anchorman,” stops by the WSJ Cafe to talk about taking on the 2007 financial crisis in his new film “The Big Short,” which co-stars Brad Pitt, Steve Carell, Christian Bale, and Ryan Gosling. Photo: Paramount Pictures

By Greg Ip

The global financial crisis has inspired hundreds of books, but only a handful of movies. It’s hard to make mortgages telegenic.

The Big Short” hopes to change that. Based on Michael Lewis’s best-selling book by the same name, it tells the story of a handful of traders who made a fortune betting against the mortgages behind the housing bubble.

Director Adam McKay is better known for making comedies. “The Other Guys,” a 2010 action comedy he directed that revolves around a financial fraud, piqued his interest in finance, and led him to Mr. Lewis’s books. When he landed the “The Big Short,” he immersed himself in books and articles about the crisis and visited a bond-trading company.

“I feel there’s a giant gap between the professionals and experts, and average people” when it comes to finance, he says. “Average people feel they’re too dumb, or banking is boring.”

His movie goes a long way toward narrowing that gap. Viewers get an entertaining lesson in the financial engineering behind the mortgage bubble, such as how mortgage-backed securities are constructed and how vulnerable they were to default.

But it is an incomplete picture. By dwelling so intensively on mortgage finance, “The Big Short” underplays the more complex economic forces that produced the bubble and intensified the crisis. By laying the bulk of the blame on Wall Street venality, it brushes off less nefarious but more compelling reasons why so many on and off Wall Street didn’t see it coming.

The movie, which opens in limited theaters Dec. 11 and more broadly on Dec. 23, begins by depicting how in the 1970s Lewis Ranieri of Salomon Brothers began packaging mortgage loans into mortgage-backed securities. The MBS was “simple and valuable,” but it “mutated into a monstrosity that collapsed the world’s economy,” declares trader Jared Vennett, a fictionalized version of Deutsche Bank trader Greg Lippmann played by Ryan Gosling.

By the 2000s, billions of dollars in subprime loans made to customers with low credit scores, no verified income and low “teaser” rates that adjusted upward after just a few years were being packaged into MBS. In 2005, a handful of traders who examined the actual mortgages and homes backing the securities concluded they were far likelier to default than the triple-A-ratings implied. So they devised tools for betting against—i.e. “shorting”—them.

There is a lot of dry finance at work, which is why it was ignored for so long. Mr. McKay finds clever ways to explain it: actress Margot Robbie in a bubble bath describes why banks began filling MBS with riskier mortgages. Mr. Vennett explains how securities are sliced into “tranches” with a tower of toy Jenga blocks.

If there were an Oscar for best dramatization of a derivative, it would surely go to behavioral economist Richard Thaler and singer Selena Gomez, playing themselves, at a blackjack table. The crowd lays bets on Gomez’s hand, then on each other’s bets. It’s just like a “synthetic CDO”—a derivative priced off complex mortgage securities that itself contains no mortgages.

A central question hovering over the movie is what motivated the Wall Street establishment against whom the traders are betting: stupidity or criminality? Says Mr. Vennett: “Tell me the difference between stupid and legal and I’ll have my wife’s brother arrested.”

The movie, ultimately, sides with criminality. Mr. McKay says that some bankers were clearly stupid, but that isn’t an excuse. “ Tony Soprano’s model is not a good business model. He’s stupid. But he’s a criminal.”

Such moral clarity will resonate with a public still sickened over the crisis-era bailouts. But it is also simplistic.

The idea that mortgage-industry insiders systematically profited by selling mortgages they knew would fail is at odds with what actually happened. A 2012 paper by three Federal Reserve economists noted insiders such as Bear Stearns and its executives had their wealth and their companies tied up in the mortgage market. It was their losses “that nearly brought down the financial system in late 2008.” It was outsiders, such as hedge-fund manager Michael Burry (played in the movie by Christian Bale) and John Paulson, another hedge-fund manager not profiled in “The Big Short,” who made a killing.

Trader Mark Baum (played by Steve Carell) concludes the banks knew what they were doing but assumed they would be bailed out. This is a strange sort of logic: What bank would knowingly make itself a candidate for a bailout, by which point shareholders are often largely wiped out and management fired?

In fact, as the Fed paper notes, insiders took on so much exposure because they, like most home buyers, thought housing prices would never go down. This is also why underwriting standards collapsed: Proof of income didn’t matter if the loan could always be repaid by selling off the appreciated collateral.

The movie nods to this at times. “No one can see a bubble,” an investor tells Mr. Burry. “That’s what makes it a bubble.”

But it never answers the bigger question: how the bubble, and the belief it would never collapse, formed. The reason lies in broader macroeconomic and societal forces that are barely mentioned: low interest rates engineered by the Fed after the Nasdaq bubble’s collapse; the glut of foreign savings from China and elsewhere pouring into the U.S. bond market; the complacency nurtured by years of economic calm; the financial innovations—well beyond mortgages—and lax regulatory standards bred by that calm. These forces were global: Many countries had housing bubbles and bank bailouts.

Perhaps no movie could do justice to all those questions. There is “only so much you can do” in a two-hour movie, Mr. McKay says. “I’d love it if this movie gave a kick in the pants to the conversation about the economy and finance, the collapse, and regulation, and made people a little less intimidated by the subject.”

Corrections & Amplifications:
Margot Robbie is an actress. An earlier version of this article misidentified her.

“(In 2000), Realty Times was having none of it. The bank campaign (against Fannie and Freddie), it said, posed a direct threat to the “U.S. Department of Housing and Urban Development’s vow to boost home ownership to 70 percent this decade.” So important was this initiative,…

…a “national coalition of home builders, community bankers, community developers, civil rights groups, real-estate brokers and secondary mortgage market leaders will help make it so.” You know how that ended: A government-sponsored subprime lending boom was eventually transmuted by Wall Street into a global crash and a deep recession. Not that any of this context found its way into the New York Times piece, whose apparent impetus was entirely reactionary: Fannie and Freddie must be restored to their antediluvian status because, because, because . . .”, Holman W. Jenkins Jr., “Fannie and Freddie’s Propaganda War”, The Wall Street Journal, December 12, 2015

“Fannie and Freddie don’t have a business, without the government’s backing of its mortgage guarantee business. As I have said many times on this blog, any “profit” derived from this activity belongs to the American taxpayer. Better yet, get the government out of the business of guaranteeing most mortgages and student loans, except for maybe first-time home buyers, first-generation college students, and the poor.”, Mike Perry, former Chairman and CEO, IndyMac Bank

Opinion

Fannie and Freddie’s Propaganda War

A newspaper’s ‘investigation’ of the battle over the housing giants’ fate may be nonsensical but that’s OK by certain hedge funds.

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Fannie Mae headquarters in Washington, D.C. PHOTO: KEVIN LAMARQUE/REUTERS

By Holman W. Jenkins, Jr.

Seven years since they were seized by the federal government, Fannie Mae and Freddie Mac’s fate is still up in the air, and a “convergence of conditions could undermine the foundation of the American Dream.”

Oh wait. That quote doesn’t come from Monday’s big New York Times “investigation,” painting as sinister a lobbying effort by big banks and private mortgage lenders to have the government-sponsored housing giants gradually shut down, which also happens to be the position of many Republicans and the Obama administration.

The quote comes from the Oct. 4, 2000, edition of the real-estate industry publication, Realty Times, reacting to a similar effort, known as FM Watch, begun in the 1990s and backed by J.P. Morgan Chase, Wells Fargo and others. Well before the housing bubble and the 2008 crash, these banks were lobbying to roll back Fannie and Freddie’s role in housing finance, especially their pending spread into subprime lending. In this, they were ably assisted by then-Clinton Treasury Secretary Larry Summers and Federal Reserve Chairman Alan Greenspan, both longtime critics of the housing behemoths.

Realty Times was having none of it. The bank campaign, it said, posed a direct threat to the “U.S. Department of Housing and Urban Development’s vow to boost home ownership to 70 percent this decade.” So important was this initiative, a “national coalition of home builders, community bankers, community developers, civil rights groups, real-estate brokers and secondary mortgage market leaders will help make it so.”

You know how that ended: A government-sponsored subprime lending boom was eventually transmuted by Wall Street into a global crash and a deep recession.

Not that any of this context found its way into the New York Times piece, whose apparent impetus was entirely reactionary: Fannie and Freddie must be restored to their antediluvian status because, because, because . . .

Well, actually, the reason is never explained, leaving the reader to suppose that if the big banks are hostile to Fannie and Freddie’s resurrection, their resurrection must be desirable.

Back on earth, there is nothing nefarious or unusual about interested parties seeking to influence government policy. A free and pluralistic society cannot work otherwise. And Fannie and Freddie’s status is naturally up for grabs because they have been under federal conservatorship as bankrupt entities since 2008.

Unmentioned is that the American dream of homeownership would still be subsidized eight ways from Sunday via the tax code, federal housing aid and “community reinvestment” standards. Unmentioned too, except for an obscure, passing reference to hedge funds, is that the fight isn’t a one-sided battle of bankers vs. the natural order, mom and apple pie.

There is lobbying on the other side. By far the loudest voice raised against Fannie and Freddie’s long-discussed liquidation comes from big-time fund managers Bill Ackman of Pershing Capital, Richard Perry of Perry Capital, and Bruce Berkowitz of Fairholme Capital Management.

Why? After noticing that the government’s stated, bipartisan intention to wind them up had driven down their shares to penny-stock levels, these fund managers opportunistically began buying great gobs of their stock. These funds were able to score large, instant profits for their investors simply by mounting a visible campaign to suggest the government’s intended outcome might be in doubt.

The hedge funds claim they are committed to a long-term fight to see the companies recapitalized and set free, and have filed lawsuits to that effect. But they undoubtedly have also earned millions from the gyrations in Fannie and Freddie’s thinly traded shares as the penny-stock enthusiasts pile in.

Indeed, it’s tempting to see Monday’s New York Times piece, with its strange lacunae, as a classic plant (and not the first) aimed at stirring up action in Fannie and Freddie shares. Which it certainly did: Both were up handsomely Monday morning. And Mr. Berkowitz of Fairholme, one of their backers, soon jumped on the Times piece with a letter to his own shareholders, decrying what he called a “surreptitious campaign spearheaded by the ‘Too Big To Fail’ banks to assume control over the mortgage market and usurp the assets of Fannie Mae and Freddie Mac.”

Of course, the fillip to their share prices didn’t last long. Fannie and Freddie now are trading back where they started before the New York Times weighed in with its 4,700-word “investigation.” The market, not being stupid, was able to digest the deficiencies in the paper’s lengthy but myopic account of the Fannie-Freddie policy debate.

“Federal Reserve officials participating in a “war game” exercise this year came to a disturbing conclusion: Six years after the financial crisis ended, the central bank remained ill-equipped to quell the kind of dangerous asset bubbles…

…that destabilized the savings-and-loan industry during the late 1980s, tech stocks in the 1990s and housing in the mid-2000s. The five officials—gathered at a conference table in Charlotte, N. C.—had to determine if hypothetical booms in commercial real estate and corporate borrowing risked collapse and damaging fallout for the broader economy. The group was asked what to do about it. Fed officials said afterward they saw they lacked clear-cut tools or a proper road map of regulatory measures to help stem the simulated booms. They also disagreed on whether to use higher interest rates to stop bubbles, a blunt instrument affecting the entire economy. “I walked away more sure about the discomfort I originally had,” said Esther George, president of the Federal Reserve Bank of Kansas City and a participant in the June exercise. She and others believe the Fed’s low-rate policies might have played a role in booming asset prices.”, Jon Hilsenrath and David Harrison, “As Commercial Real-Estate Prices Soar, Fed Weighs Consequences”, The Wall Street Journal, December 12, 2015

Economy

As Commercial Real-Estate Prices Soar, Fed Weighs Consequences

The Federal Reserve would act only if the market risked a sharp reversal that would hurt the U.S. economy

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Construction projects in Boston caught the eye of Boston Fed President Eric Rosengren, who wondered if the central bank’s low-interest rate policies were heating up the commercial real-estate market too rapidly. PHOTO: STEPHAN SAVOIA/ASSOCIATED PRESS

By Jon Hilsenrath and David Harrison

Federal Reserve officials participating in a “war game” exercise this year came to a disturbing conclusion: Six years after the financial crisis ended, the central bank remained ill-equipped to quell the kind of dangerous asset bubbles that destabilized the savings-and-loan industry during the late 1980s, tech stocks in the 1990s and housing in the mid-2000s.

The five officials—gathered at a conference table in Charlotte, N. C.—had to determine if hypothetical booms in commercial real estate and corporate borrowing risked collapse and damaging fallout for the broader economy.

The group was asked what to do about it. Fed officials said afterward they saw they lacked clear-cut tools or a proper road map of regulatory measures to help stem the simulated booms. They also disagreed on whether to use higher interest rates to stop bubbles, a blunt instrument affecting the entire economy.

“I walked away more sure about the discomfort I originally had,” said Esther George, president of the Federal Reserve Bank of Kansas City and a participant in the June exercise. She and others believe the Fed’s low-rate policies might have played a role in booming asset prices.

The worry has turned more concrete. Commercial real-estate prices are soaring and Fed officials face the conundrum of what, if anything, to do.

“Signs of valuation pressures are emerging in commercial real-estate markets, where prices have been rising at a solid clip and lending standards have deteriorated, although debt growth has not yet accelerated notably,” Stanley Fischer, vice chairman of the Fed, said in a speech Thursday.

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Central bank officials would feel an urgency to act only if they believed the commercial real-estate market could suffer a sharp reversal that destabilizes the financial system or hurts the U.S. economy. That isn’t clear. Commercial real estate is a relatively small segment of the overall economy, and unsustainable debt hasn’t emerged as a problem.

But financial bubbles have been root causes of the past three recessions and is a consideration as the Fed nears a decision on interest rates. Officials have signaled they will raise short-term interest rates from near zero at their policy meeting next week with the economy and job market improving. For some officials, the commercial real estate boom—and other financial sector froth—could be an added incentive.

“It is certainly one of the things that I am considering,” said Eric Rosengren, president of the Boston Fed, in an interview last month.

Mr. Rosengren arranged the war-game exercise, joined by New York Fed President William Dudley, Cleveland Fed President Loretta Mester and Minneapolis Fed President Narayana Kocherlakota and Ms. George. Some of them, including Ms. George, said rates weren’t the right instrument to use against bubbles. She favored demanding banks hold more capital.

Mr. Rosengren had noticed more building cranes in Boston. It conjured memories of the New England real estate boom in the late 1980s, which led to a regional banking crisis that played a role in the U.S. recession that followed.

“Given our low interest rates, given that it is an interest-sensitive sector, it is probably worthwhile to start thinking about at what point do we become concerned that is growing too rapidly,” he said. “And if it were to reverse course at some point in the future what would be the consequences of that?”

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Boston Fed President Eric Rosengren said rapidly rising prices in the commercial real-estate market were a consideration in a coming decision on interest rates. PHOTO: JESSICA RINALDI/BOSTON GLOBE/GETTY IMAGES

The Fed’s low interest-rate policies have helped drive investors into such assets as commercial real estate as they search for higher returns.

“I don’t think there is an imminent threat,” Ms. Mester said in an interview last month. “But I want to keep looking at it.”

Demand for giant tower cranes leased from Morrow Equipment Co. of Salem, Ore., has grown to nearly 500 from less than 200 after the financial crisis, said Peter Juhren, the company’s vice president of operations. His best markets, he said, are New York, Miami, Seattle, San Francisco and Los Angeles.

Overall U.S. spending by businesses on new buildings is modest, at an annual pace of $456.7 billion in the third quarter, compared with more than $500 billion during the previous boom, the Commerce Department said.

But U.S. commercial real-estate prices are up 93% from a low in 2010 and 16% above the previous peak in 2007, according to Moody’s Investors Service. Among the hottest properties are apartment buildings, which have more than doubled in price since their November 2009 low and are 34% above their 2007 peak.

“In the back of your mind you’re asking yourself, ‘How far and how fast can I go?’” said Dan Lofgren, president of the Utah-based real-estate development firm called Cowboy Partners, which is building a 176-unit residential project in downtown Salt Lake City, another market dotted with building cranes.

Such rapid price increases sometimes signal trouble. Another important measure is how investors and buyers use debt. Booms fueled by heavy borrowing can backfire on investors and their lenders.

Bank commercial real-estate loan portfolios are up 10% from a year earlier to $1.76 trillion in late November, a record high, according to Fed data. Nearly two-thirds of these loans are on the books of smaller banks, Fed data show, and foreign banks hold a growing proportion. Private-equity funds and real-estate investment trusts also have jumped in the game, reaching for high-yield returns.

Despite the action in commercial real estate, debt levels across the broader financial system are still modest. Overall U.S. financial sector debt— $15.2 trillion in the second quarter—was down 16% from the third quarter of 2008. Financial sector debt has fallen to 84% of economic output from 125%, a sign the economy is less prone to a financial crisis on the scale of 2008.

“Our quantitative measures indicate a subdued level of overall vulnerability in the U.S. financial system,” Fed economists said in an August research paper that sought to assess risks of banks and markets overheating.

A boom that also surfaced in junk bonds now shows signs of fizzling. Outstanding debt in that market has grown to more than $1.2 trillion from less than $700 billion in 2007. But junk bond prices are now tumbling, while borrowing costs and defaults on this debt rise.

Not every sharp increase in asset prices ends in recession. Iowa farmland prices rose 28% between the fourth quarter of 2010 and the fourth quarter of 2011, igniting fears of a dangerous bubble. That boom has since faded.

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Other countries emerged from the financial crisis with powers that made it easier for their central banks to battle bubbles using regulatory measures. The U.K.’s Bank of England, for example, has a Financial Policy Committee with the power to set minimum requirements on bank loan down payments.

Even though many Fed officials favor using regulatory powers over interest rates to stop bubbles, the U.S. was a “long way” from establishing a regulatory system that could achieve that, Mr. Dudley said in September.

U.S. regulatory powers after the 2010 Dodd-Frank overhaul law remain dispersed in Washington, Mr. Rosengren said, making them slow-moving and subject to disagreements. For instance, Fannie Mae and Freddie Mac are big players in commercial real estate debt but aren’t regulated by the Fed.

“These tools are not things you just pull off the shelf and say, ‘Now I’m going to use them,’” Ms. George said. “They tend to be things that require policy analysis, discussion with other agencies or politicians even. By the time you identify the issue you are already too late in many respects.”

—Peter Grant contributed to this article.

“Of course a drop in the housing market would bring the whole thing crashing down like a Jenga tower. It was obvious. We knew it all along. In fact, almost none of us did…

…Certainly not the government officials and banking executives who remain at liberty and in positions of power to this day.”, A.O. Scott, “Review: In ‘The Big Short,’ Economic Collapse for Fun and Profit”, The New York Times, December 10, 2015

Review: In ‘The Big Short,’ Economic Collapse for Fun and Profit

The Big Short

By A. O. SCOTT

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From left, Hamish Linklater, Jeremy Strong, Steve Carell and Rafe Spall, with Ryan Gosling in the background, in “The Big Short,” directed by Adam McKay. Credit Jaap Buitendijk/Paramount Pictures

A true crime story and a madcap comedy, a heist movie and a scalding polemic, “The Big Short” will affirm your deepest cynicism about Wall Street while simultaneously restoring your faith in Hollywood.

Written by Adam McKay (“Anchorman,” “Anchorman 2”) and Charles Randolph, and directed by Mr. McKay and released in the midst of “Star Wars” advent season, the film sets itself a very tall order. It wants not only to explain the financial crisis of 2008 — following the outline of Michael Lewis’s best-selling nonfiction book — but also to make the dry, complex abstractions of high finance exciting and fun. Celebrity cameos (from Margot Robbie, Anthony Bourdain and Selena Gomez, among others) are turned into miniseminars on the finer points of credit-default swaps and collateralized debt obligations. The story swerves and swings from executive suites and conference rooms to hectic Manhattan streets and desolate Florida subdivisions. The performances, the script and the camera itself seem to be running on a cocktail of Red Bull, Adderall and mescaline.

It’s a trip. At the end, your brain hurts and you feel sick to your stomach, as can happen when too much adrenaline has been surging through your system. But that queasy, empty feeling is the point: This is a terrifically enjoyable movie that leaves you in a state of rage, nausea and despair. What is to be done with those feelings is the great moral and political challenge Mr. McKay has set for the audience, which I hope is vast and various. I don’t condone mob violence and I’m supposed to keep my political opinions to myself, but as soon as I’m done writing this I’m going out to the garage to look for a pitchfork.

“The Big Short” is not the first movie to reckon with the fraud and stupidity that brought the world economy to the brink of collapse not so long ago and that continues to exact a heavy toll in social misery and political alienation. Charles Ferguson’s 2010 documentary “Inside Job” remains the definitive cinematic account of the regulatory, intellectual and ethical failures that led to the crisis. J .C. Chandor’s superb “Margin Call” (2011) depicts the minute-by-minute bursting of the mortgage-backed-securities bubble, while Ramin Bahrani’s excellent “99 Homes,” released this year, dramatizes some of the long-term consequences of the crash. But rather than rehash familiar ground, “The Big Short” achieves a fresh and brilliant synthesis of knowing insiderism and populist incitement.

Back in 2010, when Mr. Lewis’s book came out, it was as ubiquitous an accessory for business-class airline passengers as the “Twilight” novels were for adolescent girls. Part of the book’s appeal — a side effect of its author’s smart, breezy, plain-spoken style — was that it offered readers the illusion of retroactive prescience. You could read about the insanity of bundling subprime mortgages into highly rated investment products and think: Well, of course that was a recipe for disaster. Of course a drop in the housing market would bring the whole thing crashing down like a Jenga tower. It was obvious. We knew it all along.

In fact, almost none of us did. Certainly not the government officials and banking executives who remain at liberty and in positions of power to this day. Or if they did know, they didn’t care. The truth about what the banks and their enablers were doing was obvious only to a handful of people (one of whom, in the movie, is shown demonstrating the Jenga tower metaphor I just borrowed). Mr. McKay, with a comedy writer’s eye for archetypes, sorts them into an amusing array of strongly defined characters.

There is the antisocial numbers guy, Dr. Michael Burry (Christian Bale), a fund manager who sits in his office wearing a T-shirt and flip-flops, blasting death metal, beating on his desk with drumsticks and betting his client’s money on financial catastrophe. There is the righteously angry crusader, Mark Baum (Steve Carell), a disaffected Wall Streeter who sees a similar wager as the perfect expression of his contempt for the big banks (including the one he technically works for). And there are the young indie upstarts, Jamie Shipley (Finn Wittrock) and Charlie Geller (John Magaro), college buddies whose “garage band” fund was started with their own money and who want to show that they can play in the big leagues.

Linking these motley iconoclasts, and serving as our guide to the apocalypse unfolding around them, is Jared Vennett, a silky cynic played, with all the seductiveness that has made him a beloved Internetmeme, by Ryan Gosling. From time to time Vennett will cast his baby blues toward the camera to tell us that something didn’t really happen in quite the way it’s being shown — or that, incredibly enough, it actually did. His slick, winking wit inoculates the movie against excessive earnestness and allows us to think that “The Big Short” is going to be one of those boisterous, amoral rich-guy movies, complete with geysers of Champagne and visits to strip clubs.

Which, to some extent, it is. Mr. McKay is not above using paid-for female nudity as a signifier of capitalist excess, nor acknowledging, more generally, the hedonistic aspects of greed. He is a naturally exuberant director, and his antic energy matches the rhythms of the story. The teams conspiring to short the market are impossible not to root for, and the work of the movie’s sprawling ensemble is never less than delightful. (This is the place to appreciate the contributions of Rafe Spall, Hamish Linklater and Jeremy Strong, who play Baum’s baffled minions; Adepero Oduye, who plays his liaison to the bank that houses his fund; and Marisa Tomei, who as Baum’s wife is like the only civilian in a combat picture.)

But when we root for Baum and Burry to be proven right, for Shipley and Geller to hit pay dirt and for Vennett to earn the right to be smug in perpetuity, we are also hoping for ruin to be visited on millions of ordinary people. Houses, nest eggs, jobs and lives will be lost. Brad Pitt, in a gravelly turn as Ben Rickert, Shipley and Geller’s paranoid guru, makes this point explicitly when he scolds his protégés for celebrating their good fortune. He says what needs to be said, but the achievement of “The Big Short” is that Mr. McKay doesn’t only underline the moral of the story in dialogue. The film’s final images, its abrupt shift in tone from exhilaration to exhaustion, its suddenly downbeat music (by Nicholas Britell) all combine to trigger a climactic wave of almost unbearable disgust.

Because, as we know — and as we can stand, from time to time, to be reminded — there is no happy ending to this story, no punishment for the crime. A movie is unlikely to change that, and “The Big Short,” in many ways a startlingly ambitious film, is modest about what it can do. It offers no solutions, and no comfort. The best it can do is put down a marker.

“The Big Short” is rated R (Under 17 requires accompanying parent or adult guardian). All that is solid melts into air; all that is holy is profaned. Running time: 2 hours 10 minutes.

A version of this review appears in print on December 11, 2015, on page C1 of the New York edition with the headline: Economic Collapse, for Fun and Profit