5 Crucial Lessons from “Margin Call”

Margin Call is a 2011 thriller that serves as a case study of how investment firms might react to a crisis. The movie is set on the eve of the Great Recession, depicting the last night of good times on Wall Street when the company discovers its portfolio could become worthless, potentially resulting in a firm’s collapse due to speculation in the mortgage markets. Consequently, the senior executives and risk analysts gather to decide their next course of action – whether to hold and try to mitigate the damage or sell everything before everyone on the market learns the same and prices fall.

The movie’s director and screenwriter found inspiration for Margin Call in his own experience in real estate investment. This helped give the movie a realistic, though high-stakes, plot with razor-sharp wit and pertinent lessons for investors today. Its Oscar nomination took the movie to Wall Street cult classic status.

Similar to almost any classy investing book, this movie contains crucial insights into how individuals should and should not act during turbulent times that they can build upon.

1. Beware of fire sales

“Buy low, sell high” is a mantra many investors utilize. Yet, there is an inherent danger in buying low: fire sales. A fire sale is when an asset sells at a heavily discounted price so that it is difficult to resist. In Margin Call, the fictional firm’s CEO ordered his company to start dumping worthless holdings before word of their value spread.

This brings to light a vital question investors should ask before purchasing in turbulent times: Why are the assets being sold in a hurry and for a bargain? Undervalued assets are only worth purchasing when the company has competitive advantages to overcome a crisis, not because the asset has no value, as then no discount will make it a sound investment.

There are three ways to make a living in this business: be first, be smarter, or cheat.
— John Tuld, CEO and Chairman of the Board of the fictional company in Margin Call

2. Be careful when using leverage to invest

Some experts might recommend borrowing to invest. Under the right circumstances – for example, potentially higher return on investment (ROI) – the tactic can bear fruit. On the other hand, it might turn much riskier than using equity capital because it is a loan.

Using loan capital, called leveraging, might be useful for long-term investments in companies with a high growth potential instead of capitalizing on short-market movements, inherent in trading. Problems arise when the investment does not perform well and investors owe more than they are worth.

In Margin Call, the firm made a critical error in not diversifying its investment type and compounded its problems by borrowing to snap up even more of these assets.

The moral investors can take from this is to focus on the long-term and avoid taking these ‘traders’ trying to figure out how to back peddle, navigating the storm they created as role model.

You know, the feeling that people experience when they stand on the edge like this isn't the fear of falling; it's the fear that they might jump.
— Will Emerson, Head of Trading of the fictional company in Margin Call

3. Crises can be weathered

A key lesson from Margin Call is that uncertainties can be weathered in the long term. In one scene, the CEO said, “It wasn’t brains that got me here, I assure you that.” He was referring to having gumption and a stomach for making tough calls. This distinguished him from other intelligent, competent traders. He was focused on the long game and knew better than to act on impulse. Circumstances can – and do – change, so making tough calls when the time comes is part of the job.

A takeaway for investors is to focus on long-term horizons and to invest knowing that the market will change, prices will fluctuate, and losses will happen. Yet, over time, the market has a history of correcting itself. For instance, from 1957 through 2022, the S&P 500 fell by 15% or more five times. The index rebounded by 15% or more in the following year only three times. Nevertheless, the market has historically recovered from these crises.

1637, 1797, 1819, ‘37, ‘57, ‘84, 1901, ‘07, ‘29, 1937, 1974, 1987, 92, 97, 2000 […] It’s all just the same thing over and over, and you and I can’t control it, or stop it, or even slow it.
— John Tuld, CEO and Chairman of the Board of the fictional company in Margin Call

4. Diversify and verify your assets

“Diversification is a protection against ignorance,” Warren Buffett once said, and his words are widely considered inviolable. In Margin Call, one of the cardinal mistakes made by the fictional firm was its disregard for diversification, which left it overexposed to subprime assets. As a result, the executives in the film then decide they must sell their entire position in a single day.

If the firm’s analysis and due diligence had been more thorough and its investment strategy more sound, it might have avoided the situation it found itself in. Diversifying would have mitigated losses, and due diligence would have helped them better understand what they were investing in.

Therein is the fourth lesson: Do as much research as possible before buying, and don’t put all your eggs in one basket. This can help investors weather storms and avoid certain pitfalls.

Maybe you could tell me what is going on. And please, speak as you might to a young child. Or a golden retriever. It wasn't brains that brought me here; I assure you that.
— John Tuld, CEO and Chairman of the Board of the fictional company in Margin Call

5. Discuss crucial decisions with your team, community, or advisor

Rounding out our list of takeaways from Margin Call is a reminder of the importance of discussing crucial decisions with knowledgeable team members. In the movie, the firm complies with reality and makes a call. By taking action, they avoided a spiraling demise. The final call was the CEO’s, but his decision was not made in a silo. He brought in many stakeholders, including the analyst who made the initial discovery of the valueless assets.

This scene serves as a reminder that a community of investors, advisors, and experienced managers of successful companies can offer advice in making a “margin call.” Done right, it is not only about minimizing losses but also about identifying potential opportunities together.

If you're first out the door, that's not called panicking.
— John Tuld, CEO and Chairman of the Board of the fictional company in Margin Call

Conclusion

While Margin Call is fictional, it has roots in the Great Recession, and the lessons distilled in its stories apply to investors to this time. Be wary of fire sales – always ask why someone is selling the asset for so low – and don’t borrow to invest unless you have done extensive due diligence and have a fallback plan. Remember that storms can be weathered, and it is better to take a long-term horizon position when investing. Diversify investment types and, lastly, seek to turn adverse situations into opportunities. There is a lot to learn from Margin Call, both regarding mistakes to avoid and lessons to apply.