Margin Call the Movie Margin Call Recounts

Margin Call

The movie Margin Call recounts a fictionalized version of the fall of Lehman Brothers in the autumn of 2008. The story centers around the trading floor, the company's exposure to toxic mortgage-backed securities and its responses to these challenges. The movie discusses and provides a framework for analyzing a number of financial concepts. This report will use Margin Call to discuss a number of different microeconomic concepts that are seen in the movie.

Market Failure

Lehman Brothers is ultimately a story of market failure, so this is a natural starting point for this analysis. Marker failure occurs when the "quantity of a product demanded by consumers does not equate to the quantity supplied by suppliers" (Investopedia, 2013). Market failure is evident in a number of ways, based on the story of the movie. For example, the traders are instructed to unload their positions in the toxic assets, but they fear that to do so would cost them the relationships with their clients. They must offload these positions because the positions are going to cause the company to go bankrupt, but must do so in a 'fire sale' manner because there is no market for them.

This situation bears several hallmarks of market failure. The first is that the fire sale implies that there is a mismatch between demand and supply of these MBS products. The market at present is in a state of equilibrium but if Lehman begins selling, that equilibrium state will be disrupted. This market failure causes several problems. There are social costs to the traders, who will lose their relationships in the industry. Such costs are not priced into the transaction and they are large enough that they factor into the market failure. Further, the market failure is brought about by information asymmetry. Lehman has knowledge about how bad these products are, and how they will bankrupt the company. Other firms in the industry do not have this information yet. Thus, they will buy the products not realizing this. When they do realize it, there will be market failure because nobody will want to buy the products and everybody will want to sell them. The result is that Lehman must unload the products as quickly as possible, before the inevitable market failure occurs. When the company cannot do this, it goes bankrupt. Thus, market failure occurs because of information asymmetry, and has strong social costs attached to it.

Supply, Demand and Efficiency

The opposite of market failure is an efficient market. In the beginning, the MBS market was efficient. Demand and supply were aligned, and the prices and volumes reflected this. However, the demand for MBS products was actually based on information asymmetry. Basically, these products were marketed as AAA products when they were nothing of the sort, being highly exposed to changes in interest rates, real estate prices and the unemployment rate. When Lehman's traders learn this about the products, that is when they realize that they need to sell these products. Thus, unloading Lehman's position would take the supply out of line with the demand. Prices will be suppressed and the market will become inefficient. The change in supply will not result in a new equilibrium position in the market, however, because the massive selloff by Lehman will trigger questions at other firms, causing the information asymmetry to be revealed. This will bring the market back to equilibrium at a point where these products have very little value on the market, a status which is equivalent to their intrinsic value. The market had grown on the basis of being inefficient, and its actual efficient frontier was at quite a bit lower, since this is a niche product with a high risk level. However, firms had stockpiled this product, and that was going to cause a major economic collapse. The collapse itself was not the subject of the film, which instead highlighted some of the ways that market inefficiency created by information asymmetry resulted in banks taking excessive positions in these instruments.

Rationality

The movie also touches on the issue of rationality. Efficient market hypothesis argues that markets are efficient, and that market participants behave rationally. The behavior of the characters in Margin Call highlights some instances that can be analyzed for rationality. The first is interesting, in that when Eric is fired, he passes Peter the memory stick. At this point, Eric is an ex-employee, but he still performs this act seemingly in defiance of having any rational incentive to do so. Dale is then brought back on board later, but he needs to be coaxed both my carrot and stick. Dale is thus subjected to economic motivation. At that point, he still has no motivation to help, but the company persuades him to help by appealing to his sense of economic rationality.

The same approach is used with the traders. They are instructed to sell the MBSs aggressively, even though it will erode their trading relationships. Thus, they have no rational incentive to engage in such trades, because it will cost them money down the road. The company again must focus on providing rational economic incentive. This means that the offer must outweigh the utility of maintaining those relationships. For the traders, they must evaluate whether the promise of massive bonuses and no career is worth more to the than maintaining those trading relationships. In the end, most decide that the offer has sufficient utility and they begin selling the mortgage-backed securities, destroying the trading relationships that they have established.

Moral Hazard

Moral hazard is a concept maybe a bit tangential to the field of microeconomics, but given that some moral hazards (like the ones in Margin Call) can lead to market failure, it is important to consider the role that moral hazard plays in this story. There was considerable incentive for the bank to acquire the mortgage-backed securities, because they were offering a rate of return better than their risk level implied. The risk level had been understated. The company then faced the dilemma where it had to determine if it was wise to sell these securities, that they risk causing further damage to the economy by spreading this risk around the entire financial sector. One of the executives argues against this, knowing that Lehman might well fail anyway and that it might be better to keep the failure in house and not take the entire economy down as well. This represents the moral hazard with agency theory -- the executive's position conflicts with the maxim that the bank must seek to enhance shareholder wealth. Enhancing shareholder wealth demands offloading these positions to try to avoid bankruptcy but this creates moral hazard because in this situation the actions that are in the firm's best interests are not in the interests of the public at large.

Opportunity Costs