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Michael Burry’s Sad Success Story

A med school grad turned fund manager, was blessed with the ability to dig into mortgage-backed securities, he discovered that the global financial system was on the path to disaster.

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Dr. Michael Burry, founder of investment fund Scion Capital, is one of a handful of individuals who grasped the destructive nature of the subprime mortgage backed securities market and saw the approaching economic train wreck some three years before the 2008 crash, making himself and his clients rich as a result. As he characterizes it, “I had bet against America and won.”

In this week’s video selection, Burry speaks to the 2012 graduating class of the University of California Los Angeles Department of Economics. While it is hardly the typical, uplifting college commencement speech, it is typical Burry—uncomfortably blunt, honest and pessimistic.

In my letters to investors, I described a downturn that would be unprecedented, with no counterpart in the modern era. Wall Street’s risk models would fail all at once, and every single CEO and every single politician would be disastrously wrong.
I put my money where my mouth was, and at peak I was short $8.4 billion worth of subprime mortgages and certain financial companies. The most we could lose was less than $100 million, thanks to credit derivatives. And at first we did lose; it was a negative carry trade. Investors, business partners and even employees questioned strategy. Lawsuits were threatened, our distress was reported in the press, and Wall Street looked to squeeze our short. Besides all this, I had to stomach what I knew was coming—a tragic end to the folly. This was not fun. I did not tap dance to work. But the firm survived, we turned the tables on Wall Street, and I became the 1% in a way I never imagined when I was sitting where you sit today.

As described by Michael Lewis in his 2010 book The Big Short: Inside the Doomsday Machine, Burry became rich by delving deeply into the exotic, almost unbelievably risky new securities that were composed of thousands of bad mortgages, sold by the original lenders to financial firms, then bundled and “sliced” into tranches and sold to investors. The resulting product, the composition of which only the bond desk at the financial firms understood, was rubber-stamped by the ratings agencies, who work for the financial firms, and sold to investors, with the financial firms raking in the fees. The appetite for the new products incentivized the lenders to make increasingly shady loans, loans with low teaser interest rates that would reset in two or three years. Once the rates reset, the lenders thought, they would make more money refinancing the loans. Incredibly, once the market for the sub-prime mortgage bonds was booming, the worst-performing loans—those made with no or fraudulent borrower documentation, zero down payments and zero interest for the initial loan period—were lopped off the bottom of the sub-prime bonds, repackaged into yet another product called a CDO, or collateralized debt obligation, the top tranches of which, incredibly, were given AAA ratings. If it all sounds unbelievable and surreal, it is, and The Big Short is worth reading just to get an idea of how far off the rails the financial industry run and how incredibly unworthy they are of the taxpayer-funded rescue they received—funded by the very pensioners and mutual fund clients whose personal wealth was decimated when the whole house of cards collapsed.

But back to Burry. Unlike most investors, Burry had the obsessive nature that made tasks like reading financial prospectuses and ferreting out the obscure details of all these strange new securities fun. Burry lost an eye to cancer as a child and was consequently ostracized and bullied growing up. As an adult he was socially awkward and had difficulty with interpersonal interactions, a fact he always attributed to his glass eye. It was not until his son was diagnosed with Asperger’s syndrome, a form of autism, that Burry recognized the same characteristics in himself that his son was exhibiting. Among those characteristics was the ability to be singularly, obsessively devoted to research of specific topics, and even to be emotionally comforted by the intense research. A med school graduate, Burry began investing small sums and blogging about his trades during his medical residency, as he far outperformed the S&P. Although he couldn’t tell exactly who was reading him, he began to notice some readers from the big financial firms. He quit medicine and decided to become a fund manager. He inherited a little money upon his father’s death, and other family members gave him a few tens of thousands more. He launched Scion Capital. Almost immediately, he got calls from a couple of funds offering to invest in Scion and give him a few million to manage to boot.

When Burry encountered subprime mortgage-backed securities, he was initially incredulous. He began searching for a way to short the market. At that time, although credit default swaps—basically insurance products designed to allow investors to purchase insurance on their bets for pennies on the dollar—had been invented back in the 1990s, no one was selling CDSs on the subprime mortgage bonds. Burry started going from financial firm to firm asking to purchase them. Eventually he found someone willing to sell them. In time a lot of them were sold, to folks like Steve Eisman and a small investment firm called Cornwall Capital, and a few others who saw what was happening and bought as many as they could afford. Those holding CDSs on subprime mortgages subsequently profited immensely.

In 2010, Burry wrote a New York Times op-ed piece in which he asked, if he saw the crisis coming, why didn’t the Federal Reserve? It was not well received by the financial establishment.

Never did any member of Congress, any member of government for that matter, reach out to me for an open, collegial discussion on what went wrong or what could be done. Rather, within two weeks, all six of my defunct funds were audited. The Congressional Financial Crisis Inquiry Commission demanded all my e-mails and lists of people with whom I had conversed going back to 2003. And a little later, the FBI showed up. A million in legal and accounting costs and thousands of hours of time wasted, all because I asked questions.
It seemed they would pump me at gunpoint or not at all. That summer the Federal Reserve put out a paper that concluded that nothing in the field of economics or finance could have predicted what happened with regards to the housing bust and subsequent economic fallout. Ben Bernanke continues to backfill this logic, and I fear that history is being written wrong yet again. The ignorance is willful. As we move forward as a country it is worth considering mainstream economics and finance in light of recent events. Our nation’s economic policies are born of a synthesis of theories on how to deal with the great depression of the 1930s yet seem unable to examine the most recent one.

Having said all this, if one believes Dr. Michael Burry has a pretty straightforward and realistic view of the financial system, his UCLA commencement speech is not too uplifting. In fact, you may say to yourself, they asked this guy to speak to the graduates why? It was an education doubtless few of them got in school.

Sadly, at the highest levels of economic thought in government, questions are not tolerated. It is as if we are dealing with a binary judgment of a fundamentalist religion. Finance theory and practice are no better. The continuing process makes a mockery of the principles which have guided credit policy and risk management since the 1960s. As it turns out, information is not perfect; volatility does not define risk; markets are not efficient; the individual is adaptable. But the dark ages of finance allow no such light. Mainstream economists and finance practitioners, please check your premises. You have contradictions before you.
Truthfully, I do not expect much to change. Practically speaking, history has demonstrated the ability of sovereign nations to justify themselves and to postpone the moment of crisis. This will be even more acute for the United States, with the largest economy by far, with the strongest central bank. As a result over the course of your lives, you will experience withering but stealthy attacks on your quality of life. As government attempts to manage its faltering finances, you will see declines in the quality of health care, quality of education, quality of public safety and the quality of our currency. Of course, this is a false prophesy; I am simply describing what is already happening.

“You started your term at UCLA in the midst of a financial panic,” Burry told the grads, “the global consequences of which are far from settled.

As a result of what happened while you were growing up, you now face a future that will feature either another great recession during your 20s or during your 40s a U.S. debt-to-GDP ratio exceeding 200%...

The projection comes not from him, Burry clarifies, but from the Congressional Budget Office. “Me, I think they’re ignoring reflexivity,” he says, “and I think you face both.”