The Long Quiet
The day Steve Eisman became the first man ever to take almost sexual pleasure in an essay in Grant's Interest Rate Observer, Dr. Michael Burry received from his CFO a copy of the same story, along with a jokey note: "Mike--you haven't taken a side job writing for Grant's, have you?"
"I haven't," Burry replied, seeing no obvious good news in the discovery that there was someone out there who thought as he did. "I'm a bit surprised we haven't been contacted by Grant's..." He was still in the financial world but apart from it, as if on the other side of a pane of glass he couldn't bring himself to tap upon. He'd been the first investor to diagnose the disorder in the American financial system in early 2003: the extension of credit by instrument. Complicated financial stuff was being dreamed up for the sole purpose of lending money to people who could never repay it. "I really do believe the final act in play is a crisis in our financial institutions, which are doing such dumb, dumb things," he wrote, in April 2003, to a friend who had wondered why Scion Capital's quarterly letters to its investors had turned so dark. "I have a job to do. Make money for my clients. Period. But boy it gets morbid when you start making investments that work out extra great if a tragedy occurs." Then, in the spring of 2005, he had identified, before any other investor, precisely which tragedy was most likely to occur, when he made a large, explicit bet against subprime mortgage bonds.
Now, in February 2007, subprime loans were defaulting in record numbers, financial institutions were less steady every day, and no one but him seemed to recall what he'd said and done. He had told his investors that they might need to be patient--that the bet might not pay off until the mortgages issued in 2005 reached the end of their teaser rate period. They had not been patient. Many of his investors mistrusted him, and he in turn felt betrayed by them. At the beginning he had imagined the end, but none of the parts in between. "I guess I wanted to just go to sleep and wake up in 2007," he said. To keep his bets against subprime mortgage bonds, he'd been forced to fire half his small staff, and dump billions of dollars' worth of bets he had made against the companies most closely associated with the subprime mortgage market. He was now more isolated than he'd ever been. The only thing that had changed was his explanation for it.
Not long before, his wife had dragged him to the office of a Stanford psychologist. A preschool teacher had noted certain worrying behaviors in their four-year-old son, Nicholas, and suggested he needed testing. Nicholas didn't sleep when the other kids slept. He drifted off when the teacher talked at any length. His mind seemed "very active." Michael Burry had to resist his urge to take offense. He was, after all, a doctor, and he suspected that the teacher was trying to tell them that he had failed to diagnose attention deficit disorder in his own son. "I had worked in an ADHD clinic during my residency, and had strong feelings that this was overdiagnosed," he said. "That it was a 'savior' diagnosis for too many kids whose parents wanted a medical reason to drug their children, or to explain their kids' bad behavior." He suspected his son was a bit different from the other kids, but different in a good way. "He asked a ton of questions," said Burry. "I had encouraged that, because I always had a ton of questions as a kid, and I was frustrated when I was told to be quiet." Now he watched his son more carefully, and noted that the little boy, while smart, had problems with other people. "When he did try to interact, even though he didn't do anything mean to the other kids, he'd somehow tick them off." He came home and told his wife, "Don't worry about it! He's fine!"
His wife stared at him and asked, "How would you know?"
To which Dr. Michael Burry replied, "Because he's just like me! That's how I was."
Their son's application to several kindergartens met with quick rejections, unaccompanied by explanations. Pressed, one of the schools told Burry that his son suffered from inadequate gross and fine motor skills. "He had apparently scored very low on tests involving art and scissor use," said Burry. "Big deal, I thought. I still draw like a four-year-old, and I hate art." To silence his wife, however, he agreed to have their son tested. "It would just prove he's a smart kid, an 'absentminded genius.'"
Instead, the tests administered by a child psychologist proved that their child had Asperger's syndrome. A classic case, she said, and recommended that the child be pulled from the mainstream and sent to a special school. And Dr. Michael Burry was dumbstruck: He recalled Asperger's from med school, but vaguely. His wife now handed him the stack of books she had accumulated on autism and related disorders. On top were The Complete Guide to Asperger's Syndrome, by a clinical psychologist named Tony Attwood, and Attwood's Asperger's Syndrome: A Guide for Parents and Professionals.
"Marked impairment in the use of multiple non-verbal behaviors such as eye-to-eye gaze..."
Check.
"Failure to develop peer relationships..."
Check.
"A lack of spontaneous seeking to share enjoyment, interests, or achievements with other people..."
Check.
"Difficulty reading the social/emotional messages in someone's eyes..."
Check.
"A faulty emotion regulation or control mechanism for expressing anger..."
Check.
"...One of the reasons why computers are so appealing is not only that you do not have to talk or socialize with them, but that they are logical, consistent and not prone to moods. Thus they are an ideal interest for the person with Asperger's Syndrome..."
Check.
"Many people have a hobby.... The difference between the normal range and the eccentricity observed in Asperger's Syndrome is that these pursuits are often solitary, idiosyncratic and dominate the person's time and conversation."
Check...Check...Check.
After a few pages, Michael Burry realized that he was no longer reading about his son but about himself. "How many people can pick up a book and find an instruction manual for their life?" he said. "I hated reading a book telling me who I was. I thought I was different, but this was saying I was the same as other people. My wife and I were a typical Asperger's couple, and we had an Asperger's son." His glass eye no longer explained anything; the wonder is that it ever had. How did a glass eye explain, in a competitive swimmer, a pathological fear of deep water--the terror of not knowing what lurked beneath him? How did it explain a childhood passion for washing money? He'd take dollar bills and wash them, dry them off with a towel, press them between the pages of books, and then stack books on top of those books--all so he might have money that looked "new." "All of a sudden I've become this caricature," said Burry. "I've always been able to study up on something and ace something really fast. I thought it was all something special about me. Now it's like, 'Oh, a lot of Asperger's people can do that.' Now I was explained by a disorder."
He resisted the news. He had a gift for finding and analyzing information on the subjects that interested him intensely. He always had been intensely interested in himself. Now, at the age of thirty-five, he'd been handed this new piece of information about himself--and his first reaction to it was to wish he hadn't been given it. "My first thought was that a lot of people must have this and don't know it," he said. "And I wondered, Is this really a good thing for me to know at this point? Why is it good for me to know this about myself?"
He went and found his own psychologist to help him sort out the effect of his syndrome on his wife and children. His work life, however, remained uninformed by the new information. He didn't alter the way he made investment decisions, for instance, or the way he communicated with his investors. He didn't let his investors know of his disorder. "I didn't feel it was a material fact that had to be disclosed," he said. "It wasn't a change. I wasn't diagnosed with something new. It's something I'd always had." On the other hand, it explained an awful lot about what he did for a living, and how he did it: his obsessive acquisition of hard facts, his insistence on logic, his ability to plow quickly through reams of tedious financial statements. People with Asperger's couldn't control what they were interested in. It was a stroke of luck that his special interest was financial markets and not, say, collecting lawn mower catalogues. When he thought of it that way, he realized that complex modern financial markets were as good as designed to reward a person with Asperger's who took an interest in them. "Only someone who has Asperger's would read a subprime mortgage bond prospectus," he said.
By early 2007 Michael Burry found himself in a characteristically bizarre situation. He'd bought insurance on a lot of truly crappy subprime mortgage bonds, created from loans made in 2005, but they were his credit default swaps. They weren't traded often by others; a lot of people took the view that the loans made in 2005 were somehow sounder than the loans made in 2006; in bond market parlance, they were "off the run." That was their biggest claim: The pools of loans he had bet against were "relatively clean." To counter the assertion, he commissioned a private study, and found that the pools of loans he had shorted were nearly twice as likely to be in bankruptcy and a third more likely to have been foreclosed upon than the general run of 2005 subprime deals. The loans made in 2006 were indeed worse than those made in 2005, but the loans made in 2005 remained atrocious, and closer to the dates when their interest rates would reset. He had picked exactly the right homeowners to bet against.
All through 2006, and the first few months of 2007, Burry sent his list of credit default swaps to Goldman and Bank of America and Morgan Stanley with the idea they would show it to possible buyers, so he might get some idea of the market price. That, after all, was the dealers' stated function: middlemen. Market-makers. That is not the function they served, however. "It seemed the dealers were just sitting on my lists and bidding extremely opportunistically themselves," said Burry. The data from the mortgage servicers was worse every month--the loans underlying the bonds were going bad at faster rates--and yet the price of insuring those loans, they said, was falling. "Logic had failed me," he said. "I couldn't explain the outcomes I was seeing." At the end of each day there was meant to be a tiny reckoning: If the subprime market had fallen, they would wire money to him; if it had strengthened, he would wire money to them. The fate of Scion Capital turned on these bets, but that fate was not, in the short run, determined by an open and free market. It was determined by Goldman Sachs and Bank of America and Morgan Stanley, who decided each day whether Mike Burry's credit default swaps had made or lost money.
It was true, however, that his portfolio of credit default swaps was uncommon. They were selected by an uncommon character, with an uncommon view of the financial markets, operating alone and apart. This fact alone enabled Wall Street firms to dictate to him the market price. With no one else buying and selling exactly what Michael Burry was buying and selling, there was no hard evidence what these things were worth--so they were worth whatever Goldman Sachs and Morgan Stanley said they were worth. Burry detected a pattern in how they managed their market: All good news about the housing market, or the economy, was treated as an excuse to demand collateral from Scion Capital; all bad news was pooh-poohed as in some way irrelevant to the specific bets he had made. The firms always claimed that they had no position themselves--that they were running matched books--but their behavior told him otherwise. "Whatever the banks' net position was would determine the mark," he said. "I don't think they were looking to the market for their marks. I think they were looking to their needs." That is, the reason they refused to acknowledge that his bet was paying off was that they were on the other side of it. "When you talk to dealers," he wrote in March 2006 to his in-house lawyer, Steve Druskin, "you are getting the view from their book. Whatever they've got on their book will be their view. Goldman happens to be warehousing a lot of this risk. They'll talk as if nothing has been seen in the mortgage pools. No need to incite panic...and this has worked. As long as they can entice more [money] into the market, the problem is resolved. That's been the history of the last 3-4 years."
By April 2006 he'd finished buying insurance on subprime mortgage bonds. In a portfolio of $555 million, he had laid $1.9 billion of these peculiar bets--bets that should be paying off but were not. In May he adopted a new tactic: asking Wall Street traders if they would be willing to sell him even more credit default swaps at the price they claimed they were worth, knowing that they were not. "Never once has any counterparty been willing to sell me my list at my marks," he wrote in an e-mail. "Eighty to ninety per cent of the names on my list are not even available at any price." A properly functioning market would assimilate new information into the prices of securities; this multi-trillion-dollar market in subprime mortgage risk never budged. "One of the oldest adages in investing is that if you're reading about it in the paper, it's too late," he said. "Not this time." Steve Druskin was becoming more involved in the market--and couldn't believe how controlled it was. "What's amazing is that they make a market in this fantasy stuff," said Druskin. "It's not a real asset." It was as if Wall Street had decided to allow everyone to gamble on the punctuality of commercial airlines. The likelihood of United Flight 001 arriving on time obviously shifted--with the weather, mechanical issues, pilot quality, and so on. But shifting probabilities could be ignored, until the plane did or did not arrive. It didn't matter when big mortgage lenders like Ownit and ResCap failed, or some pool of subprime loans experienced higher than expected losses. All that mattered was what Goldman Sachs and Morgan Stanley decided should matter.
The world's single biggest capital market wasn't a market; it was something else--but what? "I am actually protesting to my counterparties that there must be fraud in the marketplace for credit default swaps to be at all-time lows," Burry wrote in an e-mail to an investor he trusted. "What if CDSs are a fraud? I am asking myself that question all the time, and never have I felt like I should be thinking that way more than now. No way we should be down 5% this year just in mortgage CDSs." To his Goldman Sachs saleswoman, he wrote, "I think I am short housing but am I not, because CDSs are criminal?" When, a few months later, Goldman Sachs announced it was setting aside $542,000 per employee for the 2006 bonus pool, he wrote again: "As a former gas station attendant, parking lot attendant, medical resident and current Goldman Sachs screwee, I am offended."
In the middle of 2006, he began to hear of other money managers who wanted to make the same bet he did. A few actually called and asked for his help. "I had all these people telling me I needed to get out of this trade," he said. "And I was looking at these other people and thinking how lucky they were to be able to get into this trade." If the market had been at all rational it would have blown up long before. "Some of the biggest funds on the planet have picked my brain and copied my strategy," he wrote in an e-mail. "So it won't just be Scion that makes money if this happens. Still, it won't be everyone."
He was now undeniably miserable. "It feels like my insides are digesting themselves," he wrote to his wife in mid-September. The source of his unhappiness was, as usual, other people. The other people who bothered him the most were his own investors. When he opened his fund, in 2000, he released only his quarterly returns, and told his investors that he planned to tell them next to nothing about what he was up to. Now they were demanding monthly and even fortnightly reports, and pestered him constantly about the wisdom of his pessimism. "I almost think the better the idea, and the more iconoclastic the investor, the more likely you will get screamed at by investors," he said. He didn't worry about how screwed-up the market for some security became because he knew that eventually it would be disciplined by logic: Businesses either thrived or failed. Loans either were paid off or were defaulted upon. But these people whose money he ran were incapable of keeping their emotional distance from the market. They were now responding to the same surface stimuli as the entire screwed-up subprime mortgage market, and trying to force him to conform to its madness. "I do my best to have patience," he wrote to one investor. "But I can only be as patient as my investors." To another griping investor he wrote, "The definition of an intelligent manager in the hedge fund world is someone who has the right idea, and sees his investors abandon him just before the idea pays off." When he was making them huge sums of money, he had barely heard from them; the moment he started actually to lose a little, they peppered him with their doubts and suspicions:
So I take it the monster dragging us out to sea is the CDS. You have created the plight of the old man and the sea.
When do you see the end of the bleeding? (August down again 5%.) Are you running a riskier strategy now?
You make me physically ill.... How dare you?
Can you explain to me how we keep losing money on this position? If our potential losses are fixed it would seem to me based on how much we have lost that they should be a tiny part of the portfolio now.
This last question kept popping up: How could a stock picker be losing so much on this one quixotic bond market bet? And he kept trying to answer it: He was committed to paying annual premiums amounting to about 8 percent of the portfolio, every year, for as long as the underlying loans existed--likely around five years but possibly as long as thirty. Eight percent times five years came to 40 percent. If the value of the credit default swaps fell by half, Scion registered a mark-to-market loss of 20 percent.
More alarmingly, his credit default swap contracts contained a provision that allowed the big Wall Street firms to cancel their bets with Scion if Scion's assets fell below a certain level. There was suddenly a real risk that that might happen. Most of his investors had agreed to a two-year "lockup" and could not pull their money out at will. But of the $555 million he had under management, $302 million was eligible to be withdrawn either at the end of 2006 or in the middle of 2007, and investors were lining up to ask for their money back. In October 2006, with U.S. house prices experiencing their greatest decline in thirty-five years, and just weeks before the ABX index of triple-B mortgage bonds experienced its first "credit event" (that is, loss), Michael Burry faced the likelihood of a run on his fund--a fund that was now devoted to betting against the subprime mortgage market. "We were clinically depressed," said one of the several analysts Burry employed but never figured out what to do with, as he insisted on doing all the analysis himself. "You'd go to work and you'd say, 'I don't want to be here.' The trade was moving against you and investors wanted out."
One night, as Burry was complaining to his wife about the complete absence of long-term perspective in the financial markets, a thought struck him: His agreement with his investors gave him the right to keep their money if he had invested it "in securities for which there is no public market or that are not freely tradable." It was left to the manager to decide if there was a public market for a security. If Michael Burry thought there wasn't--for instance, if he thought a market was temporarily not functioning or somehow fraudulent--he was permitted to "side-pocket" an investment. That is, he could tell his investors that they couldn't have their money back until the bet he'd made with it had run its natural course.
And so he did what seemed to him the only proper and logical thing to do: He side-pocketed his credit default swaps. The long list of investors eager to get their money back from him--a list that included his founding backer, Gotham Capital--received the news from him in a terse letter: He was locking up between 50 and 55 percent of their money. Burry followed this letter with his quarterly report, which he hoped might make everyone feel a bit better. But he had no talent for caring what others thought of him: It was almost as if he didn't know how to do it. What he wrote sounded less like an apology than an assault. "Never before have I been so optimistic about the portfolio for a reason that has nothing to do with stocks," it began, and then it went on to explain how he had established a position in the markets that should be the envy of any money manager. How he had placed a bet not on "housing Armageddon" (even though he suspected that was coming) but on "the worst 5% or so of loans made in 2005." How his investors should feel lucky. He wrote as if he was sitting on top of the world, when he was expected to feel as if the world was sitting on top of him. One of his biggest New York investors shot him an e-mail: "I'd be careful in the future using derogatory phrases such as 'we're short the mortgage portfolio everyone would want if they knew what they were doing' and 'sooner or later one of the big boys should really read a prospectus.'" One of his original two e-mail friends--both had stuck by him--wrote, "Nobody else except the North Korean dictator Kim Jong-Il would write a letter like that when they are down 17%."
Immediately, his partners at Gotham Capital threatened to sue him. They soon were joined by others, who began to organize themselves into a legal fighting force. What distinguished Gotham was that their leaders flew out from New York to San Jose and tried to bully Burry into giving them back the $100 million they had invested with him. In January 2006 Gotham's creator, Joel Greenblatt, had gone on television to promote a book and, when asked to name his favorite "value investors," had extolled the virtues of a rare talent named Mike Burry. Ten months later he traveled three thousand miles with his partner, John Petry, to tell Mike Burry he was a liar and to pressure him into abandoning the bet Burry viewed as the single shrewdest of his career. "If there was one moment I might have caved, that was it," said Burry. "Joel was like a godfather to me--a partner in my firm, the guy that 'discovered' me and backed me before anyone outside my family did. I respected him and looked up to him." Now, as Greenblatt told him no judge in any court of law would side with his decision to side-pocket what was clearly a tradable security, whatever feelings Mike Burry had for him vanished. When Greenblatt asked to see a list of the subprime mortgage bonds Burry had bet against, Burry refused. From Greenblatt's point of view, he had given this guy $100 million and the guy was not only refusing to give it back but to even talk to him.
And Greenblatt had a point. It was wildly unconventional to side-pocket an investment for which there was obviously a market. There was clearly some low price at which Michael Burry might bail out of his bet against the subprime mortgage bond market. To some meaningful number of his investors, it looked as if Burry simply did not want to accept the judgment of the marketplace: He'd made a bad bet and was failing to accept his loss. But to Burry, the judgment of the marketplace was fraudulent, and Joel Greenblatt didn't know what he was talking about. "It became clear to me that they still didn't understand the [credit default swap] positions," he said.
He was acutely aware that a great many of the people who had given him their money now despised him. The awareness caused him to (a) withdraw into his office and shout "Fuck" at the top of his lungs even more than usual; (b) develop a new contempt for his own investors; and (c) keep trying to explain his actions to them, even though they quite clearly were no longer listening. "I would prefer that you talk less and listen more," his lawyer, Steve Druskin, wrote to him, in late October 2006. "They are strategizing litigation."
"It was kind of interesting," said Kip Oberting, who had arranged for White Mountains to become Burry's other original investor, before leaving for other ventures. "Because he had explained exactly what he was doing. And he had made people a bunch of money. You would have thought people would stick with him." They weren't merely not sticking with him but fleeing as fast as he would allow them. They hated him. "I just don't understand why people just don't see that I don't mean any harm," he said. Late on the night of December 29, Michael Burry sat alone in his office and typed a quick e-mail to his wife: "So incredibly depressing; I'm trying to come home, but I'm just so mad and depressed right now."
And so in January 2007, just before Steve Eisman and Charlie Ledley headed gleefully to Las Vegas, Michael Burry sat down to explain to his investors how, in a year when the S&P had risen by more than 10 percent, he had lost 18.4 percent. A person who had had money with him from the beginning would have enjoyed gains of 186 percent over those six years, compared to 10.13 percent for the S&P 500 Index, but Burry's long-term success was no longer relevant. He was now being judged monthly. "The year just completed was one in which I underperformed nearly all my peers and friends by, variably, thirty or forty percentage points," he 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." The effect, he went on to demonstrate, was to make him ever more certain that the entire financial world was wrong and he was right. "I have always believed that a single talented analyst, working very hard, can cover an amazing amount of investment landscape, and this belief remains unchallenged in my mind."
Then he returned, as he always did, to the not so small matter of his credit default swaps: All the important facts pointed to their eventual success. In just the last two months, three big mortgage originators had failed...The Center for Responsible Lending was now predicting that, in 2007, 2.2 million borrowers would lose their homes, and one in five subprime mortgages issued in 2005 and 2006 would fail...
Michael Burry was as good as teed up to become a Wall Street villain. His quarterly letters to his investors, which Burry considered private, were now routinely leaked to the press. A nasty piece appeared in a trade journal, suggesting that he had behaved unethically in side-pocketing his bet, and Burry felt certain it had been planted by one of his own investors. "Mike wasn't paranoid," said a New York investor who observed the behavior of other New York investors in Scion Capital. "People really were out to get him. When he becomes a bad guy he becomes this greedy sociopath who is going to steal all the money. And he can always go back to being a neurologist. It was the first thing everyone jumped to with Mike: He was a doctor." Burry began to hear strange rumors about himself. He'd left his wife and gone into hiding. He had fled to South America. "It's an interesting life I'm leading lately," Burry wrote to one of the e-mail friends.
With all that has gone on recently, I've had the opportunity to talk with many of our investors, which is the first time I've done so in the history of the funds. I've been shocked by what I've heard. It appears that investors only have passingly paid attention to my letters, and many have been clinging to various rumors and hearsay in place of analysis or original thought. I've variably launched a private equity fund, tried to buy a Venezuelan gold company, launched a separate hedge fund called Milton's Opus, got divorced, got blown up, never disclosed the derivatives trade, borrowed $8 billion, spent much of the last two years in Asia, accused everyone but me on Wall Street of being idiots, siphoned off the capital of the funds into my personal account, and more or less turned Scion into the next Amaranth.* None of this is made up.
He'd always been different from what one might expect a hedge fund manager to be. He wore the same shorts and t-shirts to work for days on end. He refused to wear shoes with laces. He refused to wear watches or even his wedding ring. To calm himself at work he often blared heavy metal music. "I think these personal foibles of mine were tolerated among many as long as things were going well," he said. "But when things weren't going well, they became signs of incompetence or instability on my part--even among employees and business partners."
After the conference in Las Vegas the market had dropped, then recovered right through until the end of May. To Charlie Ledley at Cornwall Capital, the U.S. financial system appeared systematically corrupted by a cabal of Wall Street banks, rating agencies, and government regulators. To Steve Eisman at FrontPoint Partners, the market seemed mainly stupid or delusional: A financial culture that had experienced so many tiny panics followed by robust booms saw any sell-off as merely another buying opportunity. To Michael Burry, the subprime mortgage market looked increasingly like a fraud perpetrated by a handful of subprime bond trading desks. "Given the massive cheating on the part of our counterparties, the idea of taking the CDS[s] out of the side pocket is no longer worth considering," he wrote at the end of March 2007.
The first half of 2007 was a very strange period in financial history. The facts on the ground in the housing market diverged further and further from the prices on the bonds and the insurance on the bonds. Faced with unpleasant facts, the big Wall Street firms appeared to be choosing simply to ignore them. There were subtle changes in the market, however, and they turned up in Burry's e-mail in-box. On March 19 his salesman at Citigroup sent him, for the first time, serious analysis on a pool of mortgages. The mortgages were not subprime but Alt-A.* Still, the guy was trying to explain how much of the pool consisted of interest-only loans, what percentage was owner-occupied, and so on--the way a person might do who actually was thinking about the creditworthiness of the borrowers. "When I was analyzing these back in 2005," Burry wrote in an e-mail, sounding like Stanley watching tourists march through the jungle on a path he had himself hacked, "there was nothing even remotely close to this sort of analysis coming out of brokerage houses. I glommed onto 'silent seconds'* as an indicator of a stretched buyer and made it a high-value criterion in my selection process, but at the time no one trading derivatives had any idea what I was talking about and no one thought they mattered." In the long quiet between February and June 2007, they had begun to matter. The market was on edge. In the first quarter of 2007 Scion Capital was up nearly 18 percent.
Then something changed--though at first it was hard to see what it was. On June 14, the pair of subprime mortgage bond hedge funds effectively owned by Bear Stearns went belly-up. In the ensuing two weeks, the publicly traded index of triple-B-rated subprime mortgage bonds fell by nearly 20 percent. Just then Goldman Sachs appeared to Burry to be experiencing a nervous breakdown. His biggest positions were with Goldman, and Goldman was newly unable, or unwilling, to determine the value of those positions, and so could not say how much collateral should be shifted back and forth. On Friday, June 15, Burry's Goldman Sachs saleswoman, Veronica Grinstein, vanished. He called and e-mailed her, but she didn't respond until late the following Monday--to tell him that she was "out for the day."
"This is a recurrent theme whenever the market moves our way," wrote Burry. "People get sick, people are off for unspecified reasons."
On June 20, Grinstein finally returned to tell him that Goldman Sachs had experienced "systems failure."
That was funny, Burry replied, because Morgan Stanley had said more or less the same thing. And his salesman at Bank of America claimed they'd had a "power outage."
"I viewed these 'systems problems' as excuses for buying time to sort out a mess behind the scenes," he said. The Goldman saleswoman made a weak effort to claim that, even as the index of subprime mortgage bonds collapsed, the market for insuring them hadn't budged. But she did it from her cell phone, rather than the office line, on which the conversations would have been recorded.
They were caving. All of them. At the end of every month, for nearly two years, Burry had watched Wall Street traders mark his positions against him. That is, at the end of every month his bets against subprime bonds were mysteriously less valuable. The end of every month also happened to be when Wall Street traders sent their profit and loss statements to their managers and risk managers. On June 29, Burry received a note from his Morgan Stanley salesman, Art Ringness, saying that Morgan Stanley now wanted to make sure that "the marks are fair." The next day, Goldman followed suit. It was the first time in two years that Goldman Sachs had not moved the trade against him at the end of the month. "That was the first time they moved our marks accurately," he notes, "because they were getting in on the trade themselves." The market was finally accepting the diagnosis of its own disorder.
The moment Goldman was getting in on his trade was also the moment the market flipped. Some kind of rout was now on: Everyone at once seemed eager to talk to him. Morgan Stanley, which had been, by far, the most reluctant to acknowledge negative news in subprime, now called to say it would like to buy whatever he had "in any size." Burry heard a rumor--soon confirmed--that a fund run by Goldman, called Global Alpha, had taken huge losses in subprime and that Goldman itself had rapidly turned from betting on the subprime mortgage market to betting against it.
It was precisely the moment he had told his investors, back in the summer of 2005, that they only needed to wait for. Crappy mortgages worth three-quarters of a trillion dollars were resetting from their teaser rates to new, higher rates. A single pool of mortgages, against which Burry had laid a bet, illustrated the general point: OOMLT 2005-3. OOMLT 2005-3 was shorthand for a pool of subprime mortgage loans made by Option One--the company whose CEO had given the speech in Las Vegas that Steve Eisman had walked out of, after raising his zero in the air. Most of the loans had been made between April and July of 2005. From January to June 2007, the news from the pool--its delinquencies, its bankruptcies, its house foreclosures--had remained fairly consistent. The losses were much greater than they should have been, given the ratings of the bonds they underpinned, but the losses did not change a great deal from one month to the next. From February 25 to May 25 (the remittance data always came on the twenty-fifth of the month), the combined delinquencies, foreclosures, and bankruptcies inside OOMLT 2005-3 rose from 15.6 percent to 16.9 percent. On June 25 the total number of loans in default spiked to 18.68 percent. In July it spiked again, to 21.4 percent. In August it leapt to 25.44 percent, and by the end of the year it stood at 37.7 percent--more than a third of the pool of borrowers had defaulted on their loans. The losses were sufficient to wipe out not only the bonds Michael Burry had bet against but also a lot of the more highly rated ones in the same tower. That the panic inside Wall Street firms had begun before June 25 suggested to Michael Burry mainly that the Wall Street firms might be working with inside information about the remittance data. "The dealers often owned [mortgage] servicers," he wrote, "and might have been able to get an inside track on the deterioration in the numbers."
In the months leading up to the collapse of OOMLT 2005-3--and all of the other pools of home loans he had bought credit default swaps on--Michael Burry noted several remarks from both Ben Bernanke and the Secretary of the U.S. Treasury, Henry Paulson. Each said, repeatedly, that he saw no possibility of "contagion" in the financial markets from the losses in subprime mortgages. "When I first started shorting these mortgages in 2005," Burry wrote in an e-mail, "I knew full well that it was not likely to pay out within two years--and for a very simple reason. The vast majority of mortgages originated the last few years had a rather ominously attractive feature called the 'teaser rate period.' Those 2005 mortgages are only now reaching the end of their teaser rate periods, and it will be 2008 before the 2006 mortgages get there. What sane person on Earth would confidently conclude in early 2007, smack dab in the midst of the mother of all teaser rate scams, that the subprime fallout will not result in contagion? The bill literally has not even come due."
Across Wall Street, subprime mortgage bond traders were long and wrong, and scrambling to sell their positions--or to buy insurance on them. Michael Burry's credit default swaps were suddenly fashionable. What still shocked him, however, was that the market had been so slow to assimilate material information. "You could see that all these deals were sucking wind leading up to the reset date," he said, "and the reset just goosed them into another dimension of fail. I was in a state of perpetual disbelief. I would have thought that someone would have recognized what was coming before June 2007. If it really took that June remit data to cause a sudden realization, well, it makes me wonder what a 'Wall Street analyst' really does all day."
By the end of July his marks were moving rapidly in his favor--and he was reading about the genius of people like John Paulson, who had come to the trade a year after he had. The Bloomberg News service ran an article about the few people who appeared to have seen the catastrophe coming. Only one worked as a bond trader inside a big Wall Street firm: a formerly obscure asset-backed bond trader at Deutsche Bank named Greg Lippmann. FrontPoint and Cornwall were both missing from the piece, but the investor most conspicuously absent from the Bloomberg News article sat alone in his office, in Cupertino, California. Michael Burry clipped the article and e-mailed it around the office with a note: "Lippmann is the guy that essentially took my idea and ran with it. To his credit." His own investors, whose money he was doubling and more, said little. There came no apologies, and no gratitude. "Nobody came back and said, 'Yeah, you were right,'" he said. "It was very quiet. It was extremely quiet. The silence infuriated me." He was left with his favored mode of communication, his letter to investors. In early July 2007, as the markets crashed, he posed an excellent question. "One rather surprising aspect of all this," he wrote, "is that there have been relatively few reports of investors actually being hurt by the subprime mortgage market troubles....Why have we not yet heard of this era's Long-Term Capital?"