In the land of the blind, the one-eyed man is king. This saying and its many forms are over a thousand years old. It has never been truer than in the trading world, with Michael Burry.
Michael Burry’s Early Life
Michael Burry was born in 1971 in NYC. He had a rare disease as a baby, and he had his left eye removed. He grew up with a glass eye instead, which affected how people treated him. So much that it became part of Burry’s personal narrative. He always had trouble dealing with people, instead preferring solitude and his own specific interests.
The interest that dominated his early life was the study of medicine. He went to medical school and earned an M.D. from Vanderbilt University School of Medicine. This led to a neurology residency at Stanford Hospital and Clinics. Burry would work long days and spend the sliver of his remaining time writing about trading online. He was focussing on value investing during the dot-com bubble, making him an outlier once more.
It didn’t take long before Burry felt that he had learned everything he could from the forums online. He started his own blog, though it was looser than what most people recognize as a blog. This took up his night time, around 3 hours per night from midnight to 3am.
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From Medicine to Investing
He quickly noticed people were following his blog more and more. At first, his readers’ source was random, but they increasingly showed traffic from big Wall Street firms. His sway would become obvious when he spoke ill of Vanguard’s index fund and got a letter from their lawyers.
As Burry got more involved and visible in the trading world, he was also getting less interested in medicine. He was coming to terms with the truth that although he wanted to help people, he did not like dealing with them personally. Michael even became disgusted with medicine at times. He realized that he was in medicine because it was easy for him, not because he liked medicine.
This led to the inevitable. He left medicine to start managing money. Between his own savings and what his family gave him, he had about $40,000. He owed $145,000 in student debts by comparison. He decided his investors should have $15 million in net worth to join his fund. Although this may sound ridiculous, he saw things clearly.
Setting Up His Hedge Fund
As he was setting up his office, he got an interesting phone call. It was from a man by the name of Joel Greenblatt. He was the founder of the investment fund Gotham Capital. Joel had also written a book called You Can Be a Stock Market Genius. Joel told him he had been waiting for him to leave medicine and invited Michael and his wife to come to New York to meet.
The meeting caused some anxiety for Burry, which is typical of him when meeting new people. Thankfully, this meeting was nearly impossible to screw up. At Gotham’s office, they offered him a million dollars to buy into ownership of Michael’s newly created firm, Scion Capital. This stunned Burry, but he accepted. This was the first time that Gotham had ever done such a thing.
They were not the only ones to do this. An insurance holding company named White Mountain also contacted Burry. Its manager was Jack Byrne, who was close to Warren Buffett. Byrne had discovered the deal with Gotham, and he wanted a piece as well. By the end of the discussion, White Mountain had bought into co-ownership for $600,000 and pledged $10 million to let him invest. Just like Gotham, they had not done such a thing before they met Burry.
Michael Burry and Scion Capital
At this point, Scion was born. Not just that, it had started in a completely unprecedented way.
Michael Burry had just over a million dollars to play with. His first full year was 2001, and the return on the fund was 55%. This is a large percentage, especially when you consider that the S&P had fallen by about 12% that year.
This return was not an anomaly. 2002 the fund was up 16%, with the market down 22%. 2003 the market went up again, by 28%; Scion was up 50%. By 2004, Scion had around $600 million in it and was turning away further investors. This is amazing by industry standards. Burry made Scion for investors, not for profit. He had a strong sense of the right way to do things he lived and conducted business by.
Michael Burry described his style as “Ick investing.” Burry described this as follows:
Ick investing means taking a special analytical interest in stocks that inspire a first reaction of ‘ick’.”
– Burry, in a 2001 letter to his investors
Basically, Burry would find investments that would turn people off on their current reputation but actually good value. Investments like this would often first go down as the market sold off the stock, then go up strongly soon after as the trouble settled and the value was noticed by the market.
Investing in Credit Default Swaps
This idea of Ick investing would take Scion to a whole new level and into fame. The next level came in the form of credit default swaps (CDSs). A CDS is essentially insurance on a loan. If the loan goes bad, the holder of the CDSs gets a payout. They see use by loan holders to hedge risk or by an investor who thinks the loans will go bad. Their creation dates back to the mid-1990s and they were not common investments at the time.
Michael Burry started with $60 million in CDSs from Deutsche Bank, $10 million each on 6 different bonds. He would search out the bonds with the worst underlying mortgages, those most likely to default. It also surprised him that Deutsche Bank didn’t care to differentiate these loans. They simply accepted Standard & Poor’s rating, despite a large variance within the rating categories.
When Burry bought his first CDS on mortgage bonds from Goldman Sachs for $5 million, they applauded Burry for being the first to ever buy them. Burry, in typical form, responded with, “I am educating the experts here.” This is never a truer quote, but this would not be a clue in Goldman Sachs (or anyone else) until the market proved Burry correct.
Of course, Burry did not stop buying CDSs at this amount. By July, he had $750 million worth of CDS sitting in the fund. This was unlike any other hedge fund.
A Different Approach
The use of CDSs can be seen as an interesting twist on Burry’s “ick investing.” It flips the typical pattern of investing against undue negative perception. CDSs on subprime mortgage bonds were reverse ick investments, in that they made money off of undue positive perceptions. In the typical language of traders, this could be called shorting a bubble.
That idea is not new, so why was it so surprising to the market and his clients that he was shorting this subprime bubble?
The simple answer to that question can be seen in the reactions of Burry’s clients. Not only could they not see the bubble, but they also could not imagine housing would ever bubble like this. This might be considered a realistic viewpoint since real estate has been one of the most reliable historical investments. However, this was not just a matter of real estate. It was a matter of subprime loans, which were never before seen en masse. Burry could see their instability easily and was willing to place a giant bet on it.
Unease Among Investors
Though his clients did not like what he was doing, they were stuck keeping their money in his fund. Scion had a rule that you had to keep the money in for a minimum of one year if you invested in the fund. This did not stop clients from complaining heavily. This put Burry in the exact position he tried to avoid from the start: dealing directly with his clients. He had specifically told these clients that he made unorthodox bets, and they should not simply evaluate him in the short term, only the long term.
As is often the problem, people did not listen. Or, as Michael Burry is often quoted:
Early on, people invested in me because of my letters. And then, somehow, after they invested, they stopped reading them.”
Michael Burry and The Subprime Crisis
Here we have Scion, piloted by Burry, full of CDSs. To him, they are precious as gold, but this gold is on a ship, and the seas are choppy. Michael Burry is a true captain, though, only the port in his sights.
He even tried to take this strategy to a new level by opening a second fund devoted to CDSs. It could take this bet into the billions of dollars. He called this second fund Milton’s Opus, after Paradise Lost. This — again — was lost on people. People didn’t invest in this second fund, and for that matter, did not even understand the name.
On top of this, people found it difficult to understand why firms such as Goldman Sachs would even sell these CDSs in the first place if they were such a good buy. People could not understand that Burry was ahead of the game in seeing the value here. This was reflected in June 2005, when Goldman Sachs asked Burry if he wanted to increase his trade size to $100 million.
In October 2005, Michael had officially told all of his investors what he was doing (not that it was much of a secret). Within a few weeks, everything started to bust wide open. People started asking Goldman Sachs how to short housing like Scion did.
The Turning Point
The tide had turned fully when Deutsche Bank got in contact with Scion. They had broken ties with him due to his aggression in buying swaps, and now they wanted to buy back the first 6 swaps he had bought from them. He did sell them back for a profit. They immediately asked for more and were even willing to take the full billion of CDSs he had.
Goldman Sachs was next to call Burry, asking to buy some of his CDSs as well. To test the waters, Burry called Bank of America to see if he could buy some more. They were not selling. Like the others, they only wanted to buy.
The market had flipped. The common perception was moving in Burry’s direction. Now all he had to do was wait for the inevitable avalanche of money.
The Peak of the Crisis
By early 2007 the predictions were becoming facts. The subprime mortgages were coming out of their “teaser rates.” Teaser rates were low payments early in the mortgage that later skyrocketed, causing many defaults. At the same time, Burry was struggling. To maintain his position, he let go of some of his staff and a fraction of his positions. This is significant because these CDSs are becoming sure-fire wins, so having to sell them in the market eats up the gains that would have come when they paid off.
By mid-2007, Bear Stearns and Goldman Sachs were falling apart in front of everyone. When Burry contacted firms he was trading with, suddenly people were out sick or came up with other excuses, such as power failures. By late June, they conferred with Burry to correctly mark these CDS’ value since their reports had been underestimating them more and more each month.
By July’s end, reports were popular about those who saw the subprime crash coming. This included Greg Lippmann, a trader from Deutsche Bank. He was the trader who had re-initiated contact with Burry. He had copied Burry’s plan and gotten money and fame from doing so. Burry’s name was not heard.
Michael Burry After the Crisis
Despite not getting fame for his visionary trading, Burry still did very well. By the end of this long journey, Burry had made about $100 million for himself. Even more impressive is what he made for his clients, $725 million. Removing fees and expenses, a client who stayed with Scion the whole time made around a 500% return on their money.
The one sour note that came with this was the lack of anyone thanking Burry or apologizing for all the doubt they had shown him. No wonder Mr. Burry didn’t like people.
He did end up gaining his fame after all, though. Michael Lewis wrote a book about the subprime bubble in 2013 called The Big Short. The movie version came out in 2015, and Michael Burry was portrayed by Christian Bale. The moral of the story? Stick to your principles, and you too can be Batman. Or at least you can have a slice of Bruce Wayne’s money.
