In early 2004, an investor named Michael Burry is investigating the same bond market that's got Eisman obsessed. He has similar concerns about the quality of the loans.
Burry has a plan—he wants to "short" subprime bonds (2.6). In the finance world, to "short" something is to make a bet with someone that a particular stock or industry will decline. If it declines, they pay you; if not, you pay them. Yeah—the stock market is strange.
Because no one has done this before, however, Burry must figure everything out from the ground up. To that end, he leverages something called a "credit default swap," which is an obscure financial method used to provide insurance on corporate bonds (2.6).
What's that? Basically, the person who buys the credit default swap pays the bond-owner a fixed rate over a period of time. If that bond loses value or defaults, the bond-owner is obligated to pay the other party back the full value of the bond.
Time for some Burry backstory, folks. When he was two, Burry got cancer and lost an eye. He blames his glass eye for his difficulty in social situations and utter lack of talent at sports.
Eventually, Burry's obsessive intellect leads him to medical school. That's when he starts researching and investing in the stock market, though it's just a hobby at first.
As his interest grows, Burry starts a blog to share his trades with the world—trades that happen to be massively successful. Similarly, Burry's blog quickly becomes pretty popular.
The stock market becomes such a big part of Burry's life that he quits his medical residency and decides to focus solely on the finance game. He starts an investment fund called Scion Capitol.
Shockingly, Burry attracts big-ticket investors without much effort, as he has earned quite the reputation by now through his blog.
Scion Capital is extremely successful: in 2001, when the S&P market was down 11.8 percent, Burry's fund recorded a 55 percent increase. By 2004, "Mike Burry was managing $600 million" (2.43).
Burry focuses on "'ick' investments," which are companies so shady-looking that they make you go "ick" (2.49). Dude makes a bunch of money this way.
Okay—backstory complete. We're back in 2005, with Burry attempting to use credit default swaps to bet against the subprime market (also known as "shorting").
After a bunch of legal wrangling, Burry makes his first deal, buying $60 million worth of credit default swaps from Deutsche Bank. He's surprised that they're so gung-ho about the deal, given that he handpicked the worst bonds he could possibly find.
Within a few weeks, Burry has purchased "several hundred million dollars in credit default swaps from half a dozen banks" (2.62). By July, he is worth about $750 million.
Burry's investors are none too happy about these bets, however, as they're losing a bunch of money in the short term. Many want to withdraw their funds entirely.
Meanwhile, it's becoming clear that other people are stealing Burry's idea. A bond trader from Deutsche Bank named Greg Lippmann even calls asking to buy back his credit default swaps.
Burry gets another call from Goldman Sachs a few days later, asking to buy as well. That only means one thing—these mortgages are going bad.
Later, a friend of Burry tells him how scary he found Lippmann's "exuberance" at the thought of making so much money off of other people's misfortunes (2.80).