The Big Short

by

Michael Lewis

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The Big Short: Chapter 2 Summary & Analysis

Summary
Analysis
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.
Unlike Eisman’s chapter, which began with an explanation of his background, Burry’s chapter begins in media res, when he first starts looking into shorting subprime mortgage bonds. Aside from being a logical follow-up to the ending of the previous chapter, this introduction also centers Burry’s analytical side and reflects the fact that he erects more personal barriers around himself than Eisman. He’s not really comfortable with people knowing much about him as a person.
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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 is depicted doing what he does best—perusing seemingly insignificant details to discover information that other people overlook. It’s clear to him that lenders are offering home loans to people who have absolutely no way to pay for those homes—including people who don’t have an income.
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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.
Lewis deliberately sets out to demystify Wall Street because he doesn’t like the way some people in finance have turned investment banks into “black boxes” where no one knows what’s going on inside, which is why he explains complicated—but crucial—concepts like credit default swaps. Once again, Lewis compares the practices of finance firms to gambling, implying that people in finance are reckless degenerates, making irresponsible bets to try to profit off of other people’s suffering.
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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.
Lewis shows how Burry is an innovator, able to see ways to make money that don’t even exist yet. It’s certainly cynical to come up with a way to profit off of bad mortgage loans—readers may wonder why he’s not instead sounding the alarms about how this will destroy both high finance and everyday Americans. But Eisman’s chapter did show that sounding the alarm is sometimes not very effective when dealing with a complicated, powerful system.
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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.
Once again, Lewis emphasizes how unique Burry was by showing that his idea was so unconventional that most banks weren’t willing to take him seriously.
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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.
As with Eisman, Lewis reveals Burry’s back story in a way that causes the audience to reconsider Burry’s previous actions. The fact that he has a glass eye and that he overcame childhood cancer help to illustrate how he grew up to be such a tough loner.
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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.
Burry’s enthusiasm is amazing—he is able to make a name for himself as an investor even while working insane hours at the hospital.
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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.
The downside of Burry’s enthusiasm, however, is that he can’t control it, and that he always feels obligated to take his interests to the extreme.
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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 is lucky to have been born when he was—just in time to be there for when the internet revolutionized how people communicate. His experience shows how online communication differs from face-to-face interactions, and how the internet might help people who are very skilled at their jobs but less comfortable socially.
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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.
The fact that Burry turns investors away suggests that he is both an idealist and a pragmatist—he wants to do things with his choice of investors and without getting in over his head.
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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.
Though Burry makes himself a lot of money, he does so in a way that is more favorable to investors than similar firms, suggesting again that he has an idealistic streak. (Or maybe he just decides it’s good business.)
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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.
Burry may be analytical, but he’s also adventurous. Lewis shows that Burry isn’t afraid to take long shots if the odds are good enough. However, while Burry begins his career very optimistic about the future of the stock market, he’s troubled enough by the real estate bubble to change his strategy.
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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 flexes his creativity by finding an unconventional solution to a problem that at first seems insurmountable. Also, the complexity of this process shows how the finance industry has gotten so complicated that even a professional like Burry struggles to navigate it.
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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.
Burry’s response from Goldman Sachs suggests that the major banks are still a step behind him. The people at the big banks are too arrogant to consider the possibility that perhaps Burry actually knows what he’s talking about. In this way, Burry uses his outsider status to his advantage, allowing others to underestimate him so that he can get the deals he knows will pay off.
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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.
Though credit default swaps are a promising investment option, Burry botches the rollout of Milton’s Opus, showing once again that his lack of interpersonal skills can sometimes hold him back. Burry is clearly a genius, but his inability to build his investors’ confidence in his plan is a serious career obstacle.
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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 fact that big banks are catching on to Burry’s idea provides evidence that it’s a good one—but it also highlights how big institutions are slower to accept innovation, whereas someone working independently can adopt new ideas sooner. The notion that all these banks are looking to buy credit default swaps foreshadows the enormous crash to come.
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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.
Though Lippmann and Burry have similar investment strategies, they are also opposites in many ways. Lippmann is more of a self-promoter, which leads him to be covered in news stories, while equally accomplished traders like Burry (who lack the same PR skills) are left out. While Burry expects that the newspaper reporting on defaulted mortgages will bring new regulations to the industry, he’s about to learn—as Eisman did in the previous chapter—that the regulators aren’t doing their job.
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