Who watched the Big Short?

[Liberty]

Edit: Also reading the Canadian RE thread, I wonder how much of Burry's & co success was luck. The US housing market looking back was not horribly overvalued - or at least no more so than a bunch of other markets that have not crashed for longer. The music could have played couple years more - and most of the shorts would have gone bust, especially the ones who had to pay fees and/or put collateral.

 

The problem wasn't just the overvaluation, it was the whole structure of the market; classifying crap as triple A, creating derivatives on these to compound the risk, nobody holding on to what they underwrote, so standards went down a lot because everybody just dumped the risk on someone else, high leverage everywhere making everything more brittle, implicit government support, socially acepted liar's loans, etc

[randomep]

Edit: Also reading the Canadian RE thread, I wonder how much of Burry's & co success was luck. The US housing market looking back was not horribly overvalued - or at least no more so than a bunch of other markets that have not crashed for longer. The music could have played couple years more - and most of the shorts would have gone bust, especially the ones who had to pay fees and/or put collateral.

 

The problem wasn't just the overvaluation, it was the whole structure of the market; classifying crap as triple A, creating derivatives on these to compound the risk, nobody holding on to what they underwrote, so standards went down a lot because everybody just dumped the risk on someone else, high leverage everywhere making everything more brittle, implicit government support, socially acepted liar's loans, etc

 

Ya to reiterate what Liberty wrote. Burry didn't directly look at housing prices. He looked at the quality of the mortgages. They were defaulting at 4% and if it went to 8% the CDS would payout. And it was expected in mid 2007.  The only way for his trade to fail is if housing prices went to the moon by then.

 

 

[TwoCitiesCapital]

Edit: Also reading the Canadian RE thread, I wonder how much of Burry's & co success was luck. The US housing market looking back was not horribly overvalued - or at least no more so than a bunch of other markets that have not crashed for longer. The music could have played couple years more - and most of the shorts would have gone bust, especially the ones who had to pay fees and/or put collateral.

 

The problem wasn't just the overvaluation, it was the whole structure of the market; classifying crap as triple A, creating derivatives on these to compound the risk, nobody holding on to what they underwrote, so standards went down a lot because everybody just dumped the risk on someone else, high leverage everywhere making everything more brittle, implicit government support, socially acepted liar's loans, etc

 

This! Also, I question the notion that it could've continued for a few more years. Burry did the research to know when the rates reset on the loans - he knew when the pressure would be applied and knew to wait for it to be applied instead of giving up even as valuations moved against him.

[JBTC]

 

Edit: Also reading the Canadian RE thread, I wonder how much of Burry's & co success was luck. The US housing market looking back was not horribly overvalued - or at least no more so than a bunch of other markets that have not crashed for longer. The music could have played couple years more - and most of the shorts would have gone bust, especially the ones who had to pay fees and/or put collateral.

 

Surely there's a lot of luck.

 

But your comment that the US housing market looking back was not too overvalued is probably not valid. Compared to its own history, the US housing market at the time was conspicuously overvalued by almost all measures.

 

Your sentiment comes from the fact that other markets have appeared way more overvalued (relative to income, rents, etc) but are still holding up - Canada, Australia, not to mention China, Hong Kong, Singapore.

 

My personal view is you have got to be very careful when comparing property prices across countries. I almost want to say you just can't do it.

 

For all sorts of reasons, Germans don't like to own homes, and they have low home prices. For many reasons, Chinese are crazy about homes, and the prices in key Chinese cities are high on an absolute and relative basis. (I'll be the first to question the long-term sustainability of Chinese home prices, but that's besides the point of this post.)

 

If you really examine global property prices, the US is at the very low end of the spectrum. But because the US is such a major country and its data most readily available, many people have the tendency to declare any market that is more expensive than the US as overvalued.

 

Plenty of posts on the Canadian RE thread make those claims. I am not here saying Canadian prices are not overvalued, but pointing out the basis for some of the claims is flawed.

 

There is no short cut in analyzing property prices. You have to study all the supply and demand factors which are numerous, such as demography, income, rates, tax laws, zoning regulations, rents, new construction, different attitudes to treat homes as investment vs. consumption, and others.

 

[Jurgis]

LOL, as expected everyone is 20/20 Monday morning quarterback in explaining how Burry & co. could have never been wrong. Carry on, guys, keep your cognitive biases as much as you want.

[Liberty]

Burry could have been wrong in that the "music could have played for a few more years" and his investors could've yanked their money before the bets paid.

 

But he couldn't have been wrong in that the situation wasn't something that was sustainable, so it had to stop at some point, from one shock to the system or another, or just crumbling under its own weight.

[LC]

Burry could have been wrong in that the "music could have played for a few more years" and his investors could've yanked their money before the bets paid.

 

But he couldn't have been wrong in that the situation wasn't something that was sustainable, so it had to stop at some point, from one shock to the system or another, or just crumbling under its own weight.

I agree: he was correct on the fundamentals and probably lucky on the timing. Im sure others were correct on the fundamentals but unlucky on the timing.

[Liberty]

Burry could have been wrong in that the "music could have played for a few more years" and his investors could've yanked their money before the bets paid.

 

But he couldn't have been wrong in that the situation wasn't something that was sustainable, so it had to stop at some point, from one shock to the system or another, or just crumbling under its own weight.

I agree: he was correct on the fundamentals and probably lucky on the timing. Im sure others were correct on the fundamentals but unlucky on the timing.

 

To be clear, I don't think he was just lucky on the timing. He studied when mortgage rates would reset for teaser mortgages and such, so he bet on the highest probability that he could see, but I'm sure some exogenous event could have taken place and stretched things out a bit and made him unlucky in that regard. In other words, even if something has an 80% chance of happening, sometimes you fall in that remaining 20%..

 

But it gets hard to imagine the situation in the US in 2007 going on for 5 more years, for example.

[randomep]

LOL, as expected everyone is 20/20 Monday morning quarterback in explaining how Burry & co. could have never been wrong. Carry on, guys, keep your cognitive biases as much as you want.

 

 

 

Well, LOL if I have cognitive bias I want to know and to correct it.

 

If you are saying that the bet M Burry made is a bad bet and he just got lucky, then you are that all those people that made that bed got lucky. We are talking about Kyle Bass, Seth Klarman, Paulson, Jamie Mai, etc etc that are mentioned in the Big Short and the Greatest Trade ever.  M Burry was paying tens of millions in premiums per year so you can say the made a huge bet.  His investors freaked out because he was better the fund on this trade.  Paulson had a dedicated fund for it so he too bet big. I am sure the others made significant bets also.  If that is the case then these guys all got lucky on huge bets. And if that is the case I would deem them not great investors. All of them!

 

If they are not great investors we will quietly see them disappear into the sunset because they will either blow up or at least not do well in the future.  Time will tell but nothing indicates that these guys are doing badly.

 

In summary, the bet wasn't just M Burry, there were many on this trade.  And I cannot imagine all these guys did something dumb.

 

Another key point is that Burry said his bet was a certainty.  And people critique it as if he is betting on something that has never happened: millions defaulting.  But I think that is the wrong way to look at it.  Median house prices were 6x median income, that is unprecedented. And the more it rises the more unprecedented it is.  He is betting against something that is unprecedented.  If only that ratio stayed flat, he would win his bet.

 

I think the subprime bond trade is something very different from investing in say Valeant or Horsehead (sorry to kick the horse when it is down). But Horsehead must do something something unprecedented (for them): build a cheap Zinc plant. They may lack experience and all engineering has inherent risks that you just can't get away from.

 

And a little tangent. I remember that Ackman's Pershing sq returns are something like 600% (after fees) 3 yrs ago over the last 10yrs. But he was down 20% in 2015 and another 20% in 2016. So that means he is up about 400% or 12%/yr. That is phenomenal but it shows he is a human who makes monster bets.  Time will tell if guys are Burry are really like investing gods or if they are human too.

 

 

 

[Jurgis]

randomep: I think you switched the discussion topic. I was not discussing whether Burry (and anyone else who shorted housing market) was/is a great investor. You build up argument about that, which I may disagree with, but that's not what I was talking about at all.

 

Just to clarify, what I am saying is that IMO Burry's position was quite risky because he was paying the premiums and therefore it was very timing dependent. I acknowledge the difference from Canada/Australia/China in terms of mortgage/CDO setups. But even with that the situation could have gone longer for 1-3 years (perhaps) and the result for Burry could have been disastrous. This does not mean that he's bad investor or that his investment was just luck. It was close to a binary trade (because of premiums, investor revolt, etc.) and IMHO a risky binary trade. That's all I am saying. :)

 

Regarding the topic that you are writing about, that's a toughie in abstract (or even within the context of housing trade). I might argue that people who pile into binary idea are not great investors, but I could also argue that they are. In the end, if they are right, they can retire and ride into sunset and who cares if the result was luck or whatever. And if they continue, they may or may not blow up later. Some people change with experience, some don't. Some of them allocated a lot of capital (and risked a lot) some of them didn't. Some people ride from one success to another quite different success, some don't.

 

But based on VRX, the fact that a lot of famous names pile into idea (while other famous names oppose it), does not make it a great/bad idea, does not make people who succeed/fail automatically great/bad or lucky/unlucky. It all depends. :)

[Liberty]

Burry could always have scaled down his bet if things went on longer. He could have sold part of his CDS and still have had a very large payout if things took longer. His biggest risk was his investors bailing, and that's always a risk if you temporarily underperform with other people's money, that's not specific to Burry.

 

There's probably also another alternate universe where his investors supported him more and put even more money in his fund and his winning bet was even bigger. We'll never know.

[Jurgis]

Burry could always have scaled down his bet if things went on longer. He could have sold part of his CDS and still have had a very large payout if things took longer.

 

It's not clear that's true. Would have depended on CDS pricing and he might have made losses permanent. But I see that potentially by selling let's say 1/3 at a loss, he still might have survived 1-3 years and still made something like 2/3 of the gain. I'll go with that since I don't think I want to spend time evaluating possible CDS pricing and various outcomes. :)

[jay21]

Burry could always have scaled down his bet if things went on longer. He could have sold part of his CDS and still have had a very large payout if things took longer. His biggest risk was his investors bailing, and that's always a risk if you temporarily underperform with other people's money, that's not specific to Burry.

 

There's probably also another alternate universe where his investors supported him more and put even more money in his fund and his winning bet was even bigger. We'll never know.

 

Its cost of carry. Every year that he has the position on costs him 2-5% of notional. Hes return is capped at 100% of notional. He put on 3 times his AUM in notional. So 6 to 15% a year in cost of carry over 2 years is 12% to 30% of AUM. At 4 years its 24% to 60%. Its astronomical.

 

I think he did good work but the position sizing is kinda head scratching.

[merkhet]

Indeed. They cost of carry is what made that risky. Agree that prices weren't sustainable, but it's not altogether clear to me that the market couldn't have continued staying irrational long enough for Burry to have paid out all his AUM as carry. Remember too that his CDS bets stayed largely worthless until things got very, very bad. Prior to that, scaling down wouldn't have netted him much money. It would only serve to reduce the cost of carry and reduce the notional payout.

 

But hey, maybe Burry had done enough research to know that the particular loans he bet against would sour at a particular time irrespective of how the broader market held up. ¯\_(ツ)_/¯

[randomep]

Burry could always have scaled down his bet if things went on longer. He could have sold part of his CDS and still have had a very large payout if things took longer.

 

It's not clear that's true. Would have depended on CDS pricing and he might have made losses permanent. But I see that potentially by selling let's say 1/3 at a loss, he still might have survived 1-3 years and still made something like 2/3 of the gain. I'll go with that since I don't think I want to spend time evaluating possible CDS pricing and various outcomes. :)

 

Ok Jurgus, I see your line of thinking more now.  We really don't know the data except from a chapter in a book.

 

However I did just reread the book and he just bought $1B in mortgage protection in mid 2015, by Nov Lipperman (Ryan Gossling in the movie) managed to buy back $50M from him and he (Burry) made a small profit.  So the CDS market was more liquid than the movie would lead us to think.

 

 

[dorsiacapital]

Burry could always have scaled down his bet if things went on longer. He could have sold part of his CDS and still have had a very large payout if things took longer. His biggest risk was his investors bailing, and that's always a risk if you temporarily underperform with other people's money, that's not specific to Burry.

 

There's probably also another alternate universe where his investors supported him more and put even more money in his fund and his winning bet was even bigger. We'll never know.

 

The alternative universe was Paulson who was late to the trade but much, much, much better at managing investors and made the biggest profit ever in the history of hedge funding.

[Liberty]

Burry could always have scaled down his bet if things went on longer. He could have sold part of his CDS and still have had a very large payout if things took longer. His biggest risk was his investors bailing, and that's always a risk if you temporarily underperform with other people's money, that's not specific to Burry.

 

There's probably also another alternate universe where his investors supported him more and put even more money in his fund and his winning bet was even bigger. We'll never know.

 

The alternative universe was Paulson who was late to the trade but much, much, much better at managing investors and made the biggest profit ever in the history of hedge funding.

 

Touché.

 

Paulson deserves a lot of credit for managing the trade. Pellegrino (his analyst) probably doesn't get enough credit for coming up with it and convincing him, though.

[Graham Osborn]

You are overascribing godlike qualities to Mike while doing selective reading and interpretation of his writings.

 

He wasn't God and he isn't.

 

Jurgis,

 

I'd be grateful and interested to hear more of your thoughts on MCB and specifically, your main criticisms of him.

 

Thanks in advance.

G.

 

I don't have any direct criticisms about Mike's investments offhand. He did great in the past and I wish him well in the future (though obviously he could just sit happily on the pile of money he made and do nothing). I just object his deification.

 

In particular, commodity pricing could be explained by cyclical (or supercyclical for hyperbole inclined) nature: China growth drove up demand, demand drove up pricing, a lot of projects to increase production are/were multiyear, then they come online when China is slowing, etc. Sure, there is also some fiscal, monetary, currency effects too, but that doesn't mean that a paragraph from Burry predicted yet another 100 year flood or something.

 

I have some objections towards some thoughts and sentiments he expressed post crash. But he is entitled to his opinions - and he paid dearly for them - so I don't see a point to return to them.  :)

 

Finally, my direct interactions with Mike are now more than 10 years ago. He was nice and smart guy, though I'd say CoBF has people who seem as smart as him or smarter. And if he'd be on CoBF, he'd probably wouldn't be treated as a prophet (if we exclude hindsight bias). ;) In the end though it's the investment results that matter and not our posts on SI or CoBF.  8)

 

Take care.

 

I agree that a lot of Mike's ideas probably were borrowed.  I have no problem with that since most people lose money borrowing ideas.  Good examples - commodities.  If you read Hot Commodities in 2004 or did the same basic supply/ demand analysis Jim Rogers did that was a no-brained as far back as 1999.  Rogers, Ackman, Einhorn, and many others were all aware of the declining subprime standards and proliferation of derivatives around the same time period, so calling any of them the father of the idea is silly.

 

I still think Mike is one of the top 5 or so investment-philosophical minds of the 21st century along with Buffett, Soros, Rogers, Dalio.  There are a lot of small investors out there achieving great returns, but that's a different ball game from managing someone else's money in terms of strategy.  Frankly, there's a reason these guys are centimillionnaires/ billionaires and the others are not - they had the guts/ ingenuity to not only achieve great returns bit turn it into a business.

[jay21]

 

 

I still think Mike is one of the top 5 or so investment-philosophical minds of the 21st century along with Buffett, Soros, Rogers, Dalio.

 

Why do you think this?

[namo]

I thought we were supposed to evaluate Process (which is controlled by the investor) and not Result (which is is inextricably tied to luck).

Given what (little) we're told, Burry's process seems really sound to me: he did a lot of reading, identified some fundamental issues + a catalyst to speed up the crash (rate resets), then selected the worst of the crop and bet against it.

 

It could have gone wrong, and it may be legitimate to criticize his sizing, but I'd rather hear criticism of his process.

[doughishere]

I thought we were supposed to evaluate Process (which is controlled by the investor) and not Result (which is is inextricably tied to luck).

Given what (little) we're told, Burry's process seems really sound to me: he did a lot of reading, identified some fundamental issues + a catalyst to speed up the crash (rate resets), then selected the worst of the crop and bet against it.

 

It could have gone wrong, and it may be legitimate to criticize his sizing, but I'd rather hear criticism of his process.

 

Even Munger has commented that he wouldn't feel bad going in 100% in some situations.

[jay21]

I thought we were supposed to evaluate Process (which is controlled by the investor) and not Result (which is is inextricably tied to luck).

Given what (little) we're told, Burry's process seems really sound to me: he did a lot of reading, identified some fundamental issues + a catalyst to speed up the crash (rate resets), then selected the worst of the crop and bet against it.

 

It could have gone wrong, and it may be legitimate to criticize his sizing, but I'd rather hear criticism of his process.

 

Sizing is one of the most important aspects of process.

 

And what famous investor doesnt try to do what you just said? He took a very idiosyncratic risk, exposed himself heavily to it, and it paid off. You can make up your own mind on the luck vs skill tradeoff.

[Graham Osborn]

 

 

I still think Mike is one of the top 5 or so investment-philosophical minds of the 21st century along with Buffett, Soros, Rogers, Dalio.

 

Why do you think this?

 

It's personal bias of course.  They are all folks with phenomenal returns that also invested considerable time and energy on sharing their knowledge/ experience with the populace.  There are many others that deserve inclusion on such a list I am sure.

[Graham Osborn]

Burry could always have scaled down his bet if things went on longer. He could have sold part of his CDS and still have had a very large payout if things took longer. His biggest risk was his investors bailing, and that's always a risk if you temporarily underperform with other people's money, that's not specific to Burry.

 

There's probably also another alternate universe where his investors supported him more and put even more money in his fund and his winning bet was even bigger. We'll never know.

 

Its cost of carry. Every year that he has the position on costs him 2-5% of notional. Hes return is capped at 100% of notional. He put on 3 times his AUM in notional. So 6 to 15% a year in cost of carry over 2 years is 12% to 30% of AUM. At 4 years its 24% to 60%. Its astronomical.

 

I think he did good work but the position sizing is kinda head scratching.

 

It's a huge problem.  His argument on timing the first wave of defaults was compelling, but you really never can be 100% sure until actual capitulation.  That's what makes this strategy an apparent nail-biter.  If you get over-confident on the timing you'll be tempted to hold policies until near-expiry rather than selling them off at the first big round of volatility and exchanging for a longer-term policy ideally closer to the money (so you don't overpay for volatility).  Of course the CDS contracts work a bit differently from regular put options but the general concept is the same.

 

If you buy DITM, you are taking essentially a levered position in the underlying.  If you buy way OTM, you are making a time-vs-volatility play.  The latter type of position is very hard to manage due to the spreads.  I've learned this the hard way.  OTOH, if you buy as close to the money as possible with ample time to reach the strike, the position stability/ liquidity is much better and you can rotate to give yourself more time.  Of course, if the market fundamentals are against you you'll lose money either way.

 

My point is you can't just look at the percent of the portfolio he had in CDS and say what the risk was.  You need to look at the individual contracts and determine how conservatively/ speculatively they were structured.  More conservative contracts tend to have a higher cost of carry.

 

From what I understand, Burry was buying the most conservative contracts he could (probably not DITM but either ATM or marginally OTM).  OTOH, the crazy Cornwall guys were buying AAA CDS (equivalent of WOTM).  As they were entitled to do given it was their own capital ;) The movie has the unfortunate effect of portraying Burry as a lottery-ticket investor like Paulson (who has gotten blown up repeatedly since then) whereas Burry has always been one to manage the downside and let the upside take care of itself.

 

Good luck,

Graham

[tede02]

I'm pretty late to this thread, but I saw the movie over the weekend and really enjoyed it.  I have not read the book, only the Vanity Fair piece which mainly profiled Burry.  The movie makes me want to read the book now more than ever to get the more detailed story.  Movie get's a thumbs up for me.