True, to keep Fred awake and on-message, the film comes with some oddball idiosyncrasy; such as the cameo appearance of the star of behavioural economics, Richard Thaler, teaming up with Selena Gomez - Fred's grandchildren told him who - to explain the phoney logic that persuaded punters that synthetic collateralised debt obligations (CDOs) would be a sure bet.
Such diversions are understandable because the subject matter is obscure, indeed, for a movie on general release. Until he saw The Big Short, based on Michael Lewis's eponymous book, Fred thought that 'securitisation' was something to do with the bored young guard standing at the entrance of his local Asda store. However, the film does a first-rate job of conveying the simple truth that, to get a financial bubble, you start with innovation, add success, leaven the mix with greed, gullibility and connivance in equal measure, then add a pinch of dishonesty - well, maybe more than a pinch. What applied to the Credit Crunch applied to John Law's Mississippi Company in 1720, the Wall Street Crash of 1929 and any other financial crisis you care to mention. It's always the way.
However, as one truth was stated, the film sidestepped another equally important one. That was a pity because - esoteric though it is - this truth is based on sound economics and it's the one that drives all valuation - whether it's an obscure CDO, the price of houses or the price of all shares, from, say a fast-growing FTSE 100 company such as Arm Holdings (ARM) to a minnow such as AEC Education (AEC).
This is the truth that stems from the principle of the 'conservation of value'. It is particularly important to securities of all sorts because with these instruments - whether debt or equity - it's fairly easy to estimate the future cash flows from which value will be derived.
The starting point is to understand that the only thing that creates value today is cash flows in the future. If I examine the prospects for a security - say, a company's shares - and see no chance of ever receiving cash disbursements then I'll give it a value of zilch. As soon as cash disbursements become possible then value is created. After that, the more that cash returns look like exceeding the costs of financing my investment - 'cost of capital', in the jargon - the more that value will be created. So companies become valuable by generating cash for the owners of their capital and the more they generate for a given slug of capital, the more valuable they will be.
From that arises a vital corollary - assuming the cost of capital remains unchanged and nothing happens to increase the likely cash flows, then the value cannot change. Given that, the sources of a company's capital don't affect its value; nor do changes in the mix of debt and equity. So, for example, the bosses of Arm are using spare cash to buy in the company's shares. That may cause Arm's share price to rise, but no extra value has been created. All that's happening is that the same quantity of residual cash is being spread across a narrower base of equity. Or - had Arm borrowed money to fund its share buybacks - the same cash flow would be redistributed between more debt and less equity.
Similarly, when mortgages were bundled together and securitised in mind-boggling quantities 10 or so years ago, no extra value was created - it couldn't be because the cash flows from the underlying mortgages remained unchanged. All that altered was that risk was passed around. Multiple tranches of debt, each with different claims on the cash flow, meant that more was left over for the holders of those tranches with the residual claims - but only while the going was good.
Simultaneously, the use of short-term debt to finance long-term obligations - the mortgages - meant that when 'teaser' loans expired and interest payments rose loans would go into default, as Michael Burry, the hero of The Big Short first sussed out. As the ensuing defaults multiplied, the whole CDO market froze because - due to the mind-boggling complexity of layer upon layer of mortgages, CDOs and more CDOs - no banks knew which of their trading partners were infected with financial plague and which were disease-free.
That something similar is happening in China today is a dark fear that spooks the world's financial markets. Certainly, the expansion in the domestic balance sheets of China's banks relative to growth in the economy implies that an awful lot of easy money is chasing fewer opportunities - since 2008, banks' balance sheets have expanded four times while the rise in China's nominal output is less than three times.
There may not be a happy ending and the best that investors can do to protect themselves is to remember - and, more important, to apply - the fundamental rules of valuation. I'll be showing how starting here next week, perhaps while humming the theme song to The Big Short - Led Zeppelin aptly telling us that "if it keeps on rainin', levee's goin' to break".
