The Flaw

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EFL Movie Study Guide for: The Flaw

Markets, Money, Mortgages and the Great American Meltdown



Story: The Flaw: Markets, Money, Mortgages and the Great American Meltdown. What caused the world's biggest economy to crash and burn? And why is it so slow to recover? This documentary tells the story of the credit bubble that caused the financial crash. It includes interviews from leading economists, housing experts, Wall Street insiders and victims of the crash. At a time when economic theory and public policy is being re-examined, this documentary reminds us that we need to address root causes, lest it happen again.
(excerpted from the DVD's back cover; Dartmouth Films; 2010; 120 minutes; closed captioned, but no subtitles)

Note 1: I highly recommend that English-learners read the following notes and quotes before you watch this film. Some/many of these words will be unfamiliar, so be sure you understand them before you watch!


Many of the key people speaking or shown in the film:

Dr. Alan Greenspan (former Chairman, Federal Reserve Board, 1987-2006)

R Shiller, Yale University Prof. of Economics.

L Hyman, Harvard University, Economic Historian

G Cooper, Blue Crest Capital, Fund Manager

R Frank, Cornell University, Prof. of Economics

N Minow, The Corporate Library, corporate watchdog

J Stiglitz, Columbia University, Nobel Prize for Economics

R Wade, London School of Economics, Prof. of Political Economy

Luan (an Asian-American MIT grad, “Wall Street tour guide” who used to be a bond trader)

Going Places (1948 educational cartoon)

It's Everybody's Business (1954 educational cartoon about economics)

What Makes Us Tick (1952 educational cartoon)

E Andrews, New York Times, Economics Correspondent (now way behind in his mortgage)

A Coffi-Ahibo, Optician (with a terrible mortgage in foreclosure)

S Nahas, Real Estate Investor (“underwater”)

S Ludwig, NEDAP (Neighborhood Economic Development Advocacy Project), Co-director

The documentary starts with quotes from TV broadcasts:
...the bursting of the nation's housing bubble adds up to... government takeover of bankrupt mortgage giants Fannie Mae and Freddie Mack (top mortgage insurers)... meltdown on Wall Street, the worst since 9/11...warning Congress to approve a $700 billion bailout or face dire consequences...

Sort of summarizing: It's a crisis of wealth, of debt, of economic theory; it's a total failure of markets. The crisis was caused (in large part) because banks (including “the Central Bank”/Greenspan) encouraged us to borrow and spend more and more (for decades). This “encouragement” benefited those who own things already (the rich). 


*flaw: imperfection; mistake, mark, or defect (often, that cause problems or weakness)

*bubble: a temporary ball made from soapy water and air; (economics) a speculative price increase that is not justified

*asset: sth that can be sold to help you pay your debt

*mortgage: the legal agreement you make (usually with a bank) to buy property or a home, and then pay for this purchase over a period of years (the bank earns money through the interest you pay)

*equity: the money you would have if you sold your house and repaid the balance of your mortgage loan

*income inequality: the gap between the rich and the poor

*to trickle: to flow slowly in drops; to move slowly in small amounts

*to escalate: to become much worse (referring to a bad situation, e.g., a war or crisis)

*bankruptcy: inability to pay your debts

*collateral: sth you promise to give sb if you cannot pay back borrowed money

*predator: an animal who kills/eats weaker animals (like a lion who kills an injured zebra); a person/company/etc. that hurts others, esp. by taking advantage of their weaknesses


Sentences/ideas from the film:

1. In a congressional interview:

Politician: “Dr. Greenspan, were you wrong?”

Greenspan: “Partially, but let's separate this problem into it's component parts.... Yes, I found a flaw [in the model I used, based on my ideology favoring free competitive markets]. I don't know how permanent or significant it is, but I've been very distressed by that fact.”

Greenspan believed that the financial system was a self-stabilizing system. He didn't see the need to influence maximum prices, but felt that the Board should keep prices from dropping too much (by encouraging people to borrow more and buy more).


2. Efficient Markets Hypothesis: You have a value of something in the market; if it is too low, people would bid the price up; if it is too high, people would bid the price down. The “wisdom of the crowd” is always the correct price of the item (within a short span of time)—theoretically, there's no way to have a “bubble.”

This works when people buy things to use them; goods markets are relatively stable. But when people buy things/houses/stocks as “financial assets,” these asset markets can become very unstable. There's added danger when people pay for “financial assets” with borrowed money (a mortgage), and that's what was happening in the US. People borrowed money to buy a house; soon thereafter it was “worth more” so they borrowed more money (based on their increased equity) in order to buy another house, and then another... As long as the prices kept rising, these investors looked richer and richer (based on the supposed value of the things they had borrowed money to “buy”). But when prices started to go down, then no one wanted to buy their “asset.” Then the prices kept falling, but the “investor” had to keep paying the bank based on what was actually borrowed, not based on the (now much lower) value of the “assets (houses).” When they couldn't pay their credit debts, many people went bankrupt; they lost the “asset” and whatever money they had “invested” in it, and the bank was stuck with a house they didn't want and couldn't sell. [Now, Chinese investors are buying some of these unwanted houses, because the bank offers them for a relatively low price. These new investors hope that someday, someone will want to buy the house for more than they are paying (including all of the property taxes!).]

Pres. Ronald Reagan (the most “conservative” president in recent decades): “Government is not the solution to our problems; government is the problem.”

3. Prof Shiller (Yale) explains the crisis in cultural, not economic, terms. Capitalism became prominent under Pres. Reagan/Prime Minister Margaret Thatcher, then it moved on with the break up of the Soviet Union (USSR), and the advent of capitalism in China. It was an intellectual revolution: people believed in markets, and thus that “private property reigns.” This caused fear in those who didn't “own” anything (property or stocks), and thus they felt they needed to become “investors” (even though they didn't know how to invest). They “bought internet companies” (stock), but they were then embarrassed when the stock market bubble burst, and turned to physical property (real estate).

“In goods markets, when the price rises, the demand drops; in asset markets, when prices rise, demand often rises as well.” G Cooper, Blue Crest Capital, Fund Manager
Stop first day at 18:20

4. By the 1950s, workers earned twice as much in 40 hours as workers earned in 1900 after working 60 hours. This produced a very high standard of living. Any man could get a good job and support a wife and kids, in a way that isn't possible for most people today. “And fortunately, we have been able to raise our standard of living without sacrificing the spiritual side of life, which means so much to the American family.” [see endnote1]

The 1950s was also the time when there was the least “income inequality” in US history (i.e., the smallest gap between rich and poor). In 1929, the top 1% earned 22% of the income. Inequality fell until the 1970s, when the top 1% were getting only 9%. The gap widened in the 80s and 90s. By 2007, the top 1% were getting about 25% of the total income. These ultra-rich people, once they spend millions on themselves, have billions more to invest in financial assets, which tends to ignite asset bubbles. Furthermore, as the rich build bigger houses, this trickles down to all levels (e.g., in 1970, the “median family” wanted a 1600 sq foot “median house”; now they want 2400 sq feet). Though bigger houses cost more, people sacrifice (other budget needs) to live in a “nice neighborhood,” in part because schools are funded by local property taxes, so there's a strong link between how good the schools are in an area, and how much the houses cost.

Credit levels were also at their lowest in the 1950s. Then, as more people went into debt (esp in the 90s and early 2000s), bankers and investment brokers got richer. (In discussing “Compensation strategy”, a banker says their million-dollar salaries are justified because they are competing to attract the smartest people in the world. Then an economist says that if they were really that smart, we wouldn't have ended up in this mess!)

Two other important economic factors are the rise of globalism and the de-industrialization of America, starting in the 1970s but escalating in the 90s. Although workers' wages were stagnant (didn't change), prices kept rising. To keep up their standard of living, people went deeper into debt. When American factories were busy (1950s/60s), unionized workers could strike for better wages and benefits. But as many jobs “went overseas,” union power decreased and workers “took what they could get” (for even low wages were better than no wages).

5. “On the one hand you have home buyers, struggling to make ends meet, looking for the only way they know how to make money in our economy. They can't make money through their labor, but maybe they can make it through buying a house and seeing the value of that house increase. So people look to mortgages, these easy-to-get mortgages, as a way to finally get their share of the American dream. And on the other hand, the income inequality produced a ready supply of capital at the top to be invested as well in these kinds of mortgages. So, while the top was not willing to pay the bottom wages, they were willing to lend them money.” L Hyman (Harvard)

See Discussion section 1 (about 40 minutes into the film)

6. Part of what caused the Great Depression (1929+) was not only that people lost their jobs, but that investors fled the mortgage investment market. To solve this problem, a federal program was created (FHA) that made it easier for investors to buy and sell mortgages (i.e., to treat mortgage loans as assets). Meanwhile, criteria was set for “a good loan”, including “no class or race mixing in a neighborhood.” This, in turn, lead to the creation of both “middle class suburbs” and “the lower-income ghetto.” Investment money went to the suburbs, and the inner-cities deteriorated. Then, in the mid 1990s, credit money started to flood into the inner cities. This investment money (for mortgages) came from the ultra rich, those “newly rich” because of the bubble (i.e., there was so much money being made that they were looking for new places to invest it), as well as investment money from China and other places overseas.

CDOs. Banks didn't want to “hold” mortgages for the full 30-years of the loan, and someone created CDOs (Collateralized Debt Obligations)--a group of mortgages or credit-card loans (grouped according to the borrower's “risk of bankruptcy” factor), sold into the Wall Street capital markets as “assets” (and later called “toxic assets”).

7. To illustrate how easy it was to borrow money (at the height of the bubble), one man said he didn't even have to disclose (tell the bank) what his income/pay was. They didn't care, as long as he had a job and the house was worth the amount of the loan. He said he wasn't buying an investment; for him, it represented “normalcy” after a traumatic divorce and remarriage; it was a “ticket to continued membership in the middle class” (a place for his family, school for the children, etc.).

A woman wanted to expand her business, and banks kept telling her she needed a house for collateral (i.e., they said that if you are paying the mortgage for a house, it will be easier to borrow money for your business). Bankers talked her into buying an expensive duplex (two houses under one roof), and said that those who rent the other part will be helping her pay for her part, and that “after a year you can refinance the mortgage and get lower payments.” But “refinancing” costs the borrower money (up front—in the beginning), and many people (especially minorities) were pressured (lied to?) into getting mortgages that they couldn't afford (because the “loaner” would make money up front, and then sell the mortgage to Wall Street investors, via CDOs). Some called this “predatory lending” (a “predator” is a big animal who lives by killing/eating weaker animals, like a lion who kills an injured zebra). Unfortunately for this woman, “a year later” was after the bubble burst, and no one allowed her to refinance because the “value of the house went down.” Then she tried to get a “loan modification” but it was denied “because you've been paying your mortgage on time” (i.e., she had been honoring her agreement with the bank!). But even after she stopped paying on time, the loan was denied. She is now stuck with a mortgage she can't afford.

(continued in the other column)

(main ideas--continued from the other column)


In Miami, investors and builders constructed large high-rise blocks of homes (because they were not expensive to build, but could be sold for a lot of money). Then the bubble burst. Many of these houses have remained empty (“...there's 400 units and there's 50 people in it right now...”). To explain, a man said: “Banks get the financing to build, so they have to keep building” (regardless of whether anyone want to buy the homes or not). A banker said that, not only was he making a million dollars per year, but when they helped people refinance, those people were extremely grateful that we had “saved” their home, “so we felt like we were helping people. It seemed like win-win for everybody.” But after the bubble burst, lots of people lost their homes and savings.

“The fatal flaw was the assumption that real estate values would always go up, and I think even a fourth grader would be able to tell you that's impossible.” N Minow


See Discussion section 2


8. Another huge part of the crisis came from people's decisions to borrow too much money, and then spend it as if it were income. Wages were stagnant, and in order to keep their high standard of living and pay their bills, people borrowed money from the equity in their homes (which looked like they were becoming more and more valuable). The result was the transfer of 1.5 trillion dollars each year from “working people” to the top 1% of Americans. “This enormous upwards redistribution of American income took place in a stable democracy with governments (that were promoting this upwards redistribution) being re-elected time and time again.” R Wade (London)

“We've masked a lack of income growth by the fact that people have been supporting their living standards with debt.” G Cooper


9. As the bubble grew, investors knew the simple math: a dollar put into home mortgages, makes you more money than a dollar invested in a factory.

After the bubble burst, homes lost equity, people lost their homes and their retirement savings (which was personally devastating), and there was a “ripple (涟漪?) through the economy.” Since these loans had been bundled and sold as assets, investors never considered that the “thing” they were trading was a house loan which (to be blunt) was ruining someone's life, wiping out people's life savings, and making families “homeless.” But even the bankers and brokers say they “felt like cogs in the wheel of a much larger piece of machinery.” Even Dr. Greenspan said that “all those extraordinarily capable people” at one of the best economic organizations in the world (The Federal Reserve Board) couldn't foresee the problem because “we're not smart enough.”

The meltdown happened very quickly. Sophisticated investors (i.e., those who manage the wealth of the very rich) saw the first signs when large numbers of people couldn't pay their mortgage for three months in a row. Although financial “experts” on TV kept saying things are “OK” (to the common investor), banks “lowered the ratings on hundred of sub-prime mortgage-backed securities.” “Investors knew that the game was up” (due to these “downgrades”) and “they now knew that all of the other securities couldn't hold up either, [] they bailed out very, very quickly.” By the time others caught on, there was no way to get out (no one would buy the “assets” you needed to sell).

J Stiglitz (Nobel Prize for Economics) says, “What we are doing in effect is transferring money from people who would spend it, to people who don't need all that money and don't spend it.... When you have growing inequality, typically, your level of consumption goes down...” (and telling normal people to 'continue to spend, using borrowed money' is a broken model).

L Hyman (Harvard) says that the “evil bankers” and predatory lending pales in comparison to the real problem: “the way in which capital moves in the economy, and the way in which wage inequality has caused this capital to move so inefficiently in our economy.” “We need to have capitalism work for us, not work us over.” Profits need to create jobs for everybody, “not profits create just some wealth for the very few.” After working well for hundreds of years, “the capitalism in the last 30 years has decreased the standard of living for everyone except those at the very top.”

Discussion Section 1:

Compare the situation described in this documentary with conditions in China. In particular, comment on bank interest rates, stock market values, housing prices, etc. Where do "smart investors" put their money? How do cultural values help keep the demand up for housing? (Marriage? Family pressure? Others?) Compare the cost of renting with the cost of buying (remember that in China, you are really only leasing the land for a period of years, not buying the land). How long do you think housing prices continue to climb, and to what level? What are some of the crucial differences between China and American (related to these issues)?


Discussion section 2:

Do you think that Ms. Minow's comment applies to the situation in China? Why or why not? I see a lot of empty apartments around Xiamen, with more under construction. Who is building them, and why? Many Chinese investors are also buying property abroad. Can foreigners participate as easily in China's economy? What do you think of this? If you had money to invest today, where would you invest it, and why?


Discussion Section 3:

The banker in Miami said he thought he was helping people, but later realized that he was part of the reason why so many people lost their homes and savings. Tell your partner about a time when someone thought they were helping you (or sb else), but actually were not.

Discussion Section 4:

A lot was said about debt, and the problems caused by people borrowing money (on credit cards, as well as through mortgages). How do you feel about “borrowing money”? Who would you borrow from, and how much might you be willing to borrow? Give your partner some advice about using a credit card or other forms of credit.

Discussion Section 5:

In the end, we saw that the economic crisis had many factors. With your small group, make a list. Then decide if any of these factors could also affect China? Comment on “income inequality.” Is that really a problem? Why or why not? This film is called “the flaw”--why? (What is “the flaw”?)



The picture shows blocks that represent main values; they say: Privacy in the home, Right to own property, Religious freedom.

[The film doesn't mention this, but several factors should be considered for the “high point” of the 1950s. Many men had died in World War 2, and few women were in the work force, so there were enough jobs for the men, and children received more attention/care from moms at home (resulting in more stable families). Women had time to be “smart shoppers”, which kept prices reasonable. There was plenty of fear in WW2 and the early Cold War, which meant that the government was spending a lot on weapons, research, space exploration, and other expensive things—paid for by growing taxes under Democratic administrations; Roosevelt, Truman. In the late 1940s and early 50s, Americans enjoyed the good will of people in many countries (except Communist countries), due in large part to the technology unleashed in war and the generosity given to war victims; this good will, plus the low wages in Asia, boosted imports and exports, which also affected the US Standard of Living. The UN was calling upon America to become the world's policemen, which meant more government spending/jobs (esp. military and defense industry). There was also a spiritual revival in America in the 1950s (Billy Graham and others), as individuals found comfort in a deeper faith, which came with an emphasis on forgiveness, selfless giving, considerate behavior, and widespread trust/honesty. Christianity also teaches that greed, coveting, dishonesty, and immorality are vices, while patience, contentment, loving your family and obeying your government are virtues. The 1960s “values revolution” turned educators and thus young people from Christianity to social Darwinism—characterized by an emphasis on "living the good life" (even if it meant borrowing money or cheating to do so), selfishness/personal happiness over family stability, and the desire to “get rich quick” instead of reaping the benefits of hard work and sound investments. Debt levels grew from their lowest point in the 1950s, back to the 1920s levels and beyond. (Interestingly, the “roaring '20s” were also characterized by many of the same “60s” values.) In the 60s & 70s, sensationalistic news/music/films filled homes with stories of violence, sex, corruption, dishonesty and rags-to-riches stories; as people grew to believe that “everyone else” was acting like what they saw on TV, moral standards dropped, crime increased, and ethical seeds were planted that grew into the greed and speculation of the 1990s and 2000s. Those raised in the post-Christian environment of the 1960s and 70s were in positions of power (economic and otherwise) when the dot-com and housing crises hit decades later.]


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