The Big Short

In early 2004, Michael Burry is another stock market investor looking into bonds for the first time. He performs a lot of research with one goal: to find out how to short subprime mortgage bonds.

Burry combs through the fine print on dozens of mortgage bonds. He notices that lending standards have fallen—to the very bottom, in his view. Even people with no income are getting loans. Burry decides to look into why lenders would do this, and he determines that they have basically lost all restraint in their quest to increase lending volume.

Burry wants to short the subprime market, but the problem is that there’s no direct way to do so. Earlier, however, he discovered something called a credit default swap, which is an insurance policy where you lay down annual premium payments on a debt. If the debt doesn’t default, you get nothing, but if it does, you get a return several times larger than your investment. Lewis compares credit default swaps to a roulette game: one side puts money on the table with a chance to lose it all but also a chance to increase the investment significantly.

Burry is already involved in corporate credit default swaps, but he realizes that credit default swaps on subprime mortgage bonds could be an even more direct way to profit off an upcoming market downturn. This system would allow Barry to make his bet while at the same time limiting the maximum amount he could lose. The only problem is that this particular market for subprime credit default swaps doesn’t exist yet.

Burry calls lots of major financial institutions and finally gets Deutsche Bank and Goldman Sachs to hear him out. No one else on Wall Street seems to be looking at things the way Burry is.

Burry realized he was different at a young age. A battle with childhood cancer cost him his left eye, and for years afterwards, he struggled to look people in the eye. He attributes his awkwardness in social situations to his glass eye. He grew up isolated, more comfortable living in his own head. Initially, he went into medicine, but he soon found himself more interested in the stock market.

Burry starts commenting on a message board about value investing (picking stocks that seem to be trading for less than they’re worth). Eventually, he creates his own blog, which he writes between 16-hour hospital shifts. Big companies start to notice his blog.

As Burry gets more involved watching the markets, he finds it harder to pretend he is interested in medicine. Eventually, his father’s life insurance policy provides Burry with enough money to start his own business, Scion Capital.

As Scion Capital, Burry continues to be anxious about face-to-face encounters with people—he finds that they only ever go well with people who already like him because they know his writing. Eventually, Burry gets his first million from Joel Greenblatt, an investor who wrote a book that Burry read and admired. From there, Burry begins getting more and larger investments.

Burry decides to attract investors by writing his thoughts online and waiting for people to approach him—and it works. By late 2004, he is managing $600 million and has to turn investors away.

Burry takes an unusual approach to managing Scion. Instead of taking two percent of assets, like most hedge fund managers do, he only charges investors expenses. Basically, the only way for him to make money is for his investors to make money. Luckily for him, Scion is instantly successful, growing 242 percent by the middle of 2005.

Burry makes risky bets that pay off. One investor describes a classic Mike Burry trade as one that “goes up by ten times but first it goes down by half.” He likes investors who are long on the stock market (believing stocks will ultimately go up). But as time goes on, Burry begins to see the bubbling real estate market as a disaster in waiting that could disrupt the whole market.

In early 2005, Burry runs into a problem with this credit default swap plan: the big Wall Street investment banks aren’t treating the matter as urgently as he is. He knows he needs to create some sort of standard contract that will be acceptable to everyone in the industry, so that dealers won’t try to get out of paying him. Eventually he comes to a solution by working out an agreement with an organization called International Swaps and Derivatives Association (ISDA)—a process that takes the lawyers months.

Burry arranges things carefully so that he’ll get paid even in the event of a total market collapse. He sets out to find the very worse mortgage bonds and is surprised when Goldman Sachs offers him the information to do just that. He begins pestering investment banks to sell him credit default swaps—and eventually some do. He plays dumb but secretly believes that he’s right and the rest of the world is wrong.

In August, Burry writes a proposal for a fund called Milton’s Opus, which involves credit default swaps. None of his investors understand it, however, and it dies quickly. Later he confesses in a letter to investors that a lot of the fund’s money has already gone into credit default swaps, causing a backlash. Burry contends that he isn’t losing money, just looking at longer term returns.

In October 2005, a subprime trader at Goldman Sachs becomes the first of Burry’s Wall Street contemporaries to take a closer look at what he’s doing. Later, in November, Burry gets an email from a subprime trader at Deutsche Bank called Greg Lippmann who is offering to buy a billion dollars in credit default swaps. Burry declines. He looks into it and finds out other major banks are suddenly looking to buy his default swaps and won’t sell them to him anymore.

The next morning, a Wall Street Journal article exposes how many mortgages have been defaulting across the country. Burry expects there will be big changes and greater regulations. He gets an email from an investor who saw Greg Lippmann the other day: Lippmann was bragging about how he was about to make “oceans” of money off $1 billion in shorts on subprime mortgages.