Find the investment everyone else read past.
In 2005, Michael Burry was buying protection against mortgage bonds. The physician who had left medicine to run the hedge fund Scion Capital had read the public filings behind those bonds. He found loans that would become harder to afford when their low introductory rates expired. Rising house prices gave borrowers a chance to refinance. Burry wanted to know what happened when that escape route closed. [1]
When the cheap payments ended.
The initial low rates generally expired 20–24 months after a mortgage pool was issued.
Scion had bet against pools created in spring and summer 2005. Burry expected their greatest strain in:
The second half of 2007.
He chose which bonds to bet against.
The date was only part of the trade. Burry studied how much protection stood between each bond and a loss. He chose vulnerable slices of the mortgage pools, so the bet could pay without a total collapse in house prices. As lenders added protections to newer deals, he found many of those deals less attractive to short than the mid-2005 ones. [2]
Being early nearly broke the fund.
Burry bought credit default swaps, contracts that would gain value as the mortgage bonds suffered losses. The wait brought demands for investors’ money back and threats of lawsuits. He cut salaries, laid off staff and considered liquidating the fund in December 2006. He sold other positions and held the mortgage bets he could. [1]
He found $725 million in documents anyone could read.
Burry kept trusting the loan data he had studied. By early 2006, early defaults on the summer 2005 mortgages had reached record levels, even as market pricing suggested less risk. [1] In summer 2007, the banks began marking his positions up. The trade ultimately made $725 million for his investors and $100 million for Burry himself, according to Michael Lewis’s reporting for The Big Short. [3]
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