A Contrarian by Nature
Burry was a contrarian. He sized up value and had no hesitation in going against popular sentiment. He typically bought stocks on the way down that would go up ten-fold. Not many investors can play this game well.
Contrarians are often early. Burry was early in spotting the housing bubble. In May 2003, Burry wrote "I am extremely bearish, and feel the consequences could very easily be a 50% drop in residential real estate in the U.S...A large portion of current [housing] demand at current prices would disappear if only people became concerned that prices weren't rising." Michael Lewis, The Big Short: Inside the Doomsday Machine, page 47.
What I find interesting is that Burry felt a sense of urgency even as most professionals continued to believe in the Housing Bull Market. In early 2005, Burry felt he had to place his bet now. Id. Jim Rogers has talked about seeing a new trend before the market sees the change in trend. Anticipating before the crowd is the best way to make money, however, it is also a lonely path. Being ahead of the herd isn't fun at times.
On May 19, 2005, Burry did his first subprime mortgage deals. He bought $60 million in credit default swaps from Deutsche Bank. Deutsche Bank seemingly had no interest in the mortgage backed securities Burry had bet against. Then, Burry bought $5 million in credit default swaps from Bank of America. Then, he executed a $100 million deal with Goldman Sachs. By July 2005, Burry owned $750 million in credit default swaps on subprime mortgage bonds. By October 2005, Burry's bet against sub-prime mortgages approached $1 billion.
I began this blog with the post "Opportunity is a Powerful Force." I cannot improve upon Burry's eloquence about the power of opportunity:
Markets erred when they gave America Online the currency to buy
Time Warner. They erred when they bet against George Soros and for the British pound. And they are erring right now by continuing to float along as if the
most significant credit bubble history has ever seen does not exist. Opportunities
are rare, and large opportunities on which one can put nearly unlimited capital to work at tremendous potential revenues are even more rare. Selectively shorting
the most problematic mortgage-based securities in history today amounts to just
such an opportunity.
Id. at 54.
Resistance from Investors.
Investors in Scion Capital didn't get it. Why was their ace stock picker betting against macro trends in real estate? How could anyone call the top of a seventy-year housing cycle? Why was Burry bearish on real estate while everyone was bullish? The investors had signed up for a nice return in stocks, not a leveraged bet against a red-hot housing market.
Burry stuck to his guns. In the face of veiled threats of financial withdrawals, Burry wrote that his mission was a global search for value. And that included credit default swaps on subprime mortgage bonds.
Them, the insiders began to catch on. On November 4, Deutsche Bank offered to buy back the credit default swaps. Burry said, no. Three days later, Goldman Sachs came a calling; i.e. "Could Mike Burry sell them $25 million of the stuff, at really generous prices, on the subprime mortgage bonds of his choosing?" Id. at 59. Burry said, no.
So Close and Yet So Far.
By mid-2006, Burry was stressed. Scion was down 18 percent on the year. Investors began to pull their money out of the fund. Potential clients lost interest in Burry. Many investors questioned Burry's competence to invest in (or against) mortgages at all.
Late in 2006, Burry sold 1/2 of the protection he held on $7 billion of corporate debt of companies like Countrywide, Washington Mutual, AIG, and other exposed players in the subprime mortgage industry. It was probably the worst time to sell. The market was still in denial about the credit bubble. Burry took a "substantial loss" on the sale of his insurance. Gregory Zuckerman, The Greatest Trade Ever: The Behind the Scenes Story of How John Paulson Defied Wall Street and Made Financial History, page 166.
At the end of 2006, Burry wrote "A money manager does not go from being a near nobody to being nearly universally applauded to being nearly universally vilified without some effect." Id.
Vindication.
The real estate market peaked in early 2007. But it didn't matter. Investors wanted out. They continued to stress Burry about his involvement in complex subprime derivatives. Burry continued to sell but now he was doubling his original investment upon the sales. The market was proving Burry right but his triumph was joyless. He was selling because he had to and in order to keep his firm together.
By the Summer of 2007, it was clear to the outside world that Burry had foreseen the greatest trade ever. Inside Scion, the mood was gloomy.
In August of 2007, Burry's firm had gained 60 percent for the year. This rate of return was one of the best in the world. Burry finished the year with a gain of over 150 percent. The subprime trade had quadrupled in value. Burry's personal net worth increased $70 million in two years.
It amazes me that Burry was dead on right in his trade. But his investors deserted him a year before the trade proved itself. By all rights, Burry should have been celebrating and feeling good at the end of 2007. Instead, he was hollow inside and bitter.
He had not aced his Soros trade.
Conclusion.
I consider Burry to be a Hall of Fame Contrarian. He saw the trade of a lifetime in 2003. He followed through by betting against subprime mortgages in 2004 and 2005. He knew he was right, however, he was too far ahead of his investors. And so we are reminded that one can be dead on right about the market, have the market move in your favor, and not be able to celebrate or feel good about the outcome.
Burry's trade is a cautionary tale for all of us.
Wink
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