Copyright 2011 by John T. Reed

I saw the movie Margin Call.

One reviewer said it was the best Wall Street movie ever. Bull! Too Big to Fail (HBO) was much better and far more accurate.

Some dialog at the beginning made me think it was going to be a caricature of investment bankers written by know-nothings like the Gordon Gekko Wall Street movies. But it turned out to be pretty realistic.

Not Lehman, maybe Bear or Goldman, probably a composite

A couple of other reviews said it was loosely modeled after Lehman Brothers. Sounded more like Bear Stearns to me. Mainly because they were trying to be the first to sell off their subprime mortgages. Lehman was not until about seven months after Bear and FNMA and FHLMC came in between. Also, Too Big to Fail was accurate and talked about Lehman by name and had actors playing actual Lehman execs. Finally, Margin Call was so much fiction that there were no government officials from Treasury, the NY Fed, or the SEC. They were all over the place in reality as shown quite well in Too Big to Fail.

Also, it sounded like Goldman Sachs. Goldman was among the first to figure out the problem (because of a long firm habit of marking all of their assets to current market value daily, not the goofy Value at Risk formula cited in the movie) and decide to sell most of their subprime stuff. I am not sure Bear ever did figure it out. Lehman was clueless always figuring out that they should have accepted the last offer to buy them months after it had been withdrawn.

No government involvement—Ha!

Margin Call would have you believe a bunch of Wall Street execs of one firm never called the Fed or Treasury to tell them about their plight. They tried to unwind all their long positions in subprime mortgages in one day and not let anyone know other than by trades appearing gradually on the ticker as the day went on. It doesn’t work that way. You can criticize Wall Street a bunch, but not for that. They all called the government for help.

No margin calls in Margin Call

Actual margin calls were a big problem for Bear. But after the title, Margin Call never mentions margin calls at all even by other phraseology. There was one reference to being highly leveraged—having borrowed many times their equity in the firm—but that was it. The movie producers seemed to have just selected the title Margin Call out of thin air because it sounds vaguely Wall Streetish and sinister.

That’s dopey. Margin call is defined at If you understand mortgages, it is as if your mortgage lender had the right to, and did, call you every time your equity fell below your original down payment percentage of the value of the property and demanded that you put up more cash so that your loan-to-value ratio never got worse than it was the day you first got the mortgage.

Margin calls are extremely dangerous and risky and were a big part of the subprime crisis financial collapse in 2008, so the choice of that phrase for the movie title was not inappropriate. But there simply are no margin calls in Margin Call.

Value at risk

They talk about VaR (value at risk) in the movie. That was a stupid risk-measuring formula used by Wall Street in the run up to the 2008 financial collapse. It basically assumes that asset values in the future will behave as they did in the past—home prices and mortgage defaults in the subprime case. But the assumption is wrong. When you make millions of idiotic mortgages to people who cannot afford them with loan-to-value ratios of 100% and such, the values of the homes will rise in bubble fashion, and when the home prices fall, even a little bit, you have a zillion home mortgage borrowers under water meaning they will default. Past history meant nothing because past history had no such mass of deliberately bad loans being made.

VaR relies on the bell curve also called normal distribution or Gaussian distribution. It assumes that the patterns of past data, including worst cases, will remain the same. That is nonsense. The bell curve only applies to randomly-selected, naturally-occurring data, like the heights of 100 randomly-selected humans. Home prices and mortgage default rates are human will events, not naturally-occurring events. Human will events are almost the opposite of naturally-occurring ones. They are capable of fat tails—everything suddenly being way above or below average at the same time—like the mid-2000s home price bubble collapsing and the resulting massive number of mortgage defaults.

Think of it this way. The heights of people in a theater will vary in a bell-curve shaped way—a few below average and a few above average but most average. But if someone yells “Fire!” every single person in the theater will make the same human-will decision to run out the exits. VaR says that the people will not all try to leave the theater at the same time because they never did in the past. But that was only because no one ever yelled “Fire!” in the past. You can read more about that sort of analysis in my book How to Protect Your Life Savings from Hyperinflation & Depression.

If you read my book How to Protect Your Life Savings from Hyperinflation & Depression or my web article about my five-day backpacking trip in the Grand Canyon, you know that

Low probabilty is not a risk management technique.

The problem with VaR and Black-Scholes described below is that they caused so-called risk managers to not manage the risk of the subprime crisis because they felt the probability of it happening was too low. As I explain in my book and the Grand Canyon article, low probablity is something for actuaries to worry about when setting insurance premiums. If the probability is low, the premium can be low.

But for risk managers as opposed to premium setters, the only question is CAN this happen? If so, how do we protect ourselves from it? The guys in Margin Call and the real guys on Wall Street chose not to protect themselves because the risk was deemed too unlikely to worry about. In other words, they committed the cardinal sin of using low probability as a risk management technique.They used it to excuse themselves from managing that risk. It is not a risk-management technique. It is only an insurance-premium-seting technique.

Just weak ordinary people

Fundamentally, the movie’s message is that Wall Street guys are just regular people—with more money to spend—but just going along with the crowd trying to keep their jobs. That is partly true but the Wall Street guys have a far more numb conscience than most people. And they are far more status-conscious with the huge amounts of money being more status than greed.

I reject that message of Margin Call. I am honest. It’s not a brag. Being honest is a minimum standard, not laudatory. Same as my saying I never committed burglary is not a brag. My brothers, wife, and kids are the same. It is a congenital condition, not something we achieved like big muscles from weight lifting.

You simply must have a personal code to help anchor you against peer pressure, boss pressure, keep-up-with-the-Jonses pressure and so forth. Here is mine:

Tell the truth.

Keep your promises.

Treat others as you want to be treated.

Also, in the investment world, which I am in as a writer, I also say

Thou shalt not sell a sophisticated asset to an unsophisticated person.

That is called the “know-your-customer rule” or “suitability” in the investment business.

My first job was being an Army officer. The U.S. government in general and the U.S. military in particular is a corrupt, dishonest organization. I had learned that before I graduated from West Point, and decided because of it that I would just do my five-year commitment then get out. I resolved that I would not lie—typically that is done in the Army by signing false reports like daily motor vehicle maintenance status reports.

I figured my superiors would not be thrilled with that, but that they would not dare doing anything about it.


Boy, was I wrong about that!

I also figured that if my superiors did dare retaliate against me for refusing to sign false documents, that the Pentagon would immediately call up and say, “What the hell is going on with you and Lieutenant Reed!? The guy is a West Point airborne ranger who volunteered for Vietnam and you’re saying he is not up to the high standards of being an officer—in a Vietnam war time army with a zillion OCS (technically 115 days then I’m told) day wonder officers. The standards at West Point are about ten times higher than ROTC and about 100 times higher than OCS. Who the hell do you think you are kidding and what the hell is really going on here!?”

Double ha!

You can read more about it in my Web article “Is military integrity a contradiction in terms?

In particular, look in that article for the standard “counseling session” I got from the colonelsand generals in command over me. It is how Army officers rationalize the fact that they are corrupt scum bags. If you see Margin Call and read my “counseling session” description, you will see the similarities. Wall Street has a slightly different line of bullshit about why it’s okay to be dishonest and unethical. I have not read Liar’s Poker by Michael Lewis, but my impression is that it is the Wall Street equivalent of my “Is military integrity a contradiction in terms?” article. But the Wall Street rationalization for choosing routine daily corruption over career is the same general theme as the Army rationalization:

Everybody does it.

You can’t change it.

Pick your battles.

Be a team player.

If you do not go along with this, things may not go so well for you.

The screen writer and director seem sympathetic to that bunch of ways to rationalize corruption. I am not and I do not appreciate the power of Hollywood being harnessed to help future Wall Street people rationalize their own misbehavior.


Margin Call makes a lot of cinematic hay out of the drama and emotion of being laid off. Powerful stuff, only there was virtually none of that in the Wall Street subprime crisis of 2008. People were videoed carrying file boxes of their belongings out of the offices of Enron when it went bankrupt. Ditto Lehman Brothers in 2008 when that company went bankrupt. But I do not recall any Wall Street firm where there were lots of layoffs before the big explosion. Certainly Goldman Sachs did not discover their excessive risk exposure by a bunch of layoffs promoting some new guy rocket scientist up to a level where he could discover too much risk through VaR analysis.

So the whole layoff thing, which pervades the movie from start to finish, is almost total bullshit. The only connection to the real world of 2008 was that Lehman did fire a top female executive late to try to convince the market that their problems all stemmed from her and that now that she was gone everything would be all right.

There were plenty of layoffs on Wall Street in 2008 and thereafter, but almost all after the whole house of cards collapsed, not while some firm was trying to sell off its subprime assets to unsuspecting customers.


Margin Call makes a big deal out of a Wall Street phenomena called quants. Those were highly trained academics from science and engineering who, because they were good with numbers, were able to help finance guys figure out how to make a lot of money—for a while. Sort of like the Moneyball where a quant Ivy Leaguer figures out that traditional baseball stats are not of much use in choosing which players to draft or which free agents to hire. The word “quant” is short for “quantitative” which refers to very spohisticated numerical analysis. The two quants in Margin Call are the former civil engineer who gets fired in teh opening scene and urges his subordinate who did not get laid off to look at a flash drive of analysis he was working on. The subordinate, trained literally as a rocket scientist, does look at it and sees the excesive risk they have been taking.

As with Moneyball, the quant story is an interesting one, but it’s largely over and has been for a wile. The heyday of the quants was in the 1980s and 1990s. Margin Call claims to take place in 2008. The Waterloo of the quants was the collapse of a hedge fund called Long Term Capital Management in 1998. Talk about quants; Long Term Capital Management had two Nobel Prize in economics winners: Myron Scholes and Robert C. Merton. Those two guys, along with Fischer Black created the Black–Scholes option-pricing formula. Black did not get a Nobel Prize because hedied before the Nobel committee got around to it and you have to be alive to get a Nobel Prize.

That option pricing formula is sort of an ancestor of the VaR formula. They both rely too much on past price movements being predictive of future price movements and limits on how much prices can move.

Anyway, Long Term Capital Management lost its ass in 1998 in a collapse so big—at the time—that it almost brought down the world financial system. It turned out to be a very important dress rehearsal for the subprime crisis of 2008 because many of the same big shots were involved in each. Long Term Capital Management was atually Waterloo 1.0 for the quants. The subprime crisis was their Waterloo 2.0. Waterloo was an 1815 battle between Napoleon Bonaparte of France and Britain’s Duke of Wellington with much help from the Prussian Army. It has come to mean the event where a stellar winning streak ends. Napoleon Bonaparte was perhaps the greatest general ever. I think we spent more time studying him at West Point than we did any other general in world history including the American generals. Before Waterloo, Napoleon was the military champ of Europe (although he did not do so well in Russia either). Merriam Webster’s dictionary defines Waterloo as a “decisive or final defeat or setback.”

The quants are still around and should be especially now that they have learned the limitations of their formulas, but they were not the ones who solved the 2008 risk-analysis puzzle as Margin Call would have you believe. Rather, they were the ones who got it wrong and caused the problem. Those on Wall Street who diagnosed the problem—other than the shorts described in Michael Lewis’s book The Big Short—were guys at places like Goldman Sachs and J.P. Morgan who simply saw the mounting losses relatively early.

I understand they are going to make a movie of Liar’s Poker. Good. Its author, Michael Lewis, has turned out to be a pretty good writer of books that make good movies including Blindside and Moneyball. I expect it will be more like Too Big to Fail and less like Margin Call. I also did not care much for the Academy-Award-winning movie Inside Job.

John T. Reed