The Big Short and The Black Swan

Did you hear the one about “the number that killed us?” That’s actually the title of a book by quant professor Pablo Triana. I’m reading it now to see how he dissects and attacks the VAR (value-at-risk) models – that broke Wall Street and the US economy in 2008 – any better than Nassim Nicholas Taleb began to do so in his seminal The Black Swan in 2007.

But that’s a lot of dry reading. Much more colorful and entertaining is the book-turned-film by Michael Lewis, The Big Short. Directed by Adam McKay, the film has an all-star cast and does a fantastic job of not only explaining complex Wall Street finance shenanigans, but of bringing them to life with a captivating story and believable characters.

Hollywood’s Best Brings Out Wall Street’s Worst

Even the real life characters portrayed in the film thought their personalities and stories were well represented. Christian Bale was excellent as Michael Burry, the protagonist savant who discovered fatal flaws in the US mortgage market and committed large sums of money to the idea, much to the displeasure of his investors.

And comedian Steve Carell surprised me with his powerful and convincing range to play fictional hedge fund manager Mark Baum, the co-protagonist curmudgeon. Baum’s character was based on the real Steve Eisman, another hedge fund manager who also saw the wheels falling off of Wall Street and housing.

Also worth noting is Ryan Gosling's excellent performance as the character Jared Vannett, who is based on Greg Lippman, a Deutsche Bank trader at the center of the real story. Gosling’s shark-like charm added that element of cold Wall Street indifference we would expect from many players involved in such a house of cards.

But instead of a house of cards, Gosling’s character used Jenga blocks to create a beautifully simple analogy of the subprime housing skyscraper about to collapse. I didn’t read the Lewis book, so I don’t know if this part is fiction or not. If you know, fill me in. In any case, the use of Jenga in the movie was priceless.

How Taleb Tried to Warn Us about Super Models and Black Swans

In the video that accompanies this article, I run through ten specific talking points to answer this question:

How well did the Michael Lewis book and Adam McKay film explain the subprime housing implosion?

I’ve already stated that I thought they did “a fantastic job.” But in going through the complexities of the story, and beyond mere greed and ignorance, I am inevitably led back to the fundamental cause of the financial crisis: statistical models based on standard deviation, normal probability distributions, and derivative tools like VAR.

And for this fundamental story of the flawed math behind the crisis, we must go back to Taleb who greatly simplified matters for us in early 2007 with The Black Swan. Before the first Bear Stearns CDO hedge funds blew up that summer, he told us in very clear language and examples that the statistical models based on bell curve standard deviation were a “great intellectual fraud.”

For more on Taleb’s point of view, and why you should listen to him, watch the video where I provide five key ideas from the man who predicted the collapse of Wall Street. And here’s another article I wrote to explain where the banks go wrong in handling risk…

Super Models With Fat Tails

Kevin Cook is a Senior Stock Strategist for Zacks Investment Research where he runs the Tactical Trader portfolio. He can be reached @KevinBCook on Twitter.

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