The 4-Hour Workweek: Chapter Summary (Preface)
Burry’s foresight--There was one other investor with the same level of insight and detailed observation as Grant and Eisman, and that was, of course, Michael Burry. Grant had been warning investors of potential disaster for several decades, and according to Lewis, Burry was the first investor to spot the specific issue in the impending crisis, namely, the unwise creation of financial instruments for the purpose of extending credit to subprime candidates. That was in 2003. Although Burry had foreseen the ultimate outcome that began to manifest in 2007, he had not anticipated the interim difficulties that would precede it: the impatience and lack of trust on the part of his investors and the need to downsize his staff and streamline his investments in order to maintain his major bets.
Diagnosis of Asperger’s syndrome--The other more personal surprise was the diagnosis of his four-year-old son with Asperger’s syndrome, which brought with it the recognition of the same patterns in himself. To have what he had always considered special personal qualities diagnosed as a disturbance did not sit will with Burry. Although it did not particularly change his behavior, it did to some extent change the way he looked at himself and his son. At least, he had to dispense with the glass eye theory that for so long had provided an explanation for his personality.
Asperger’s gifts--Still, having Asperger’s was helpful in many ways, especially considering Burry’s career. Asperger’s may have been viewed as an abnormality by medical clinicians, but under the right circumstances, it brought with it many useful gifts, such as the ability to focus intensely and learn quickly; the level of obsessiveness needed for studying reams of material most would consider too boring to deal with; and the decided preference for logical thought and hard data.
Relationship to money management--Those abilities had stood Burry in good stead. For one thing, he had been able to choose exactly the right loans in 2005. Their quality may not have been as low as those that followed in 2006, but they were still the worst of 2005. Now, in early 2007, their teaser-rate period was about to expire, which meant that they should be defaulting soon.
Hints of fraud on Wall Street--Something had not been right with the way the market had been operating, though. Throughout 2006, the subprime market had been worsening, which implied that Burry should have been making money. Defaulting loans meant that the premiums for insuring them should have increased, but they weren’t. The large investment banks, who were supposed to be functioning as middlemen, seemed to be acting more like market manipulators for the benefit of their own investments.
The fact that he was operating in isolation from the rest of the market made it easy for them to do so. Had the market been acting normally, Wall Street should have been paying Burry on days when the market worsened, just as he was supposed to pay them when it improved. Somehow, though, they were quick to collect when it served their interests and equally quick to deny any relevancy to Burry’s particular investments when the market declined.
That convenient pattern did not escape Burry’s notice, so he did a little test. He decided to ask the Wall Street firms whether they would sell him the credit default swaps on the lists he sent them at the prices they were claiming. Not only were they not willing to do so, most of the credit default swaps he asked about were not even available on the general market. That and other facts, such as Goldman Sachs’s hefty employee bonus pool for 2006, convinced Burry that he was looking at fraud.
Scion Investor Shortsightedness
Despite the fraudulent, overly controlled market, Burry still had other hedge fund managers calling him for advice on doing a similar trade. It was obvious in spite of everything that he knew what he was doing—at least, to everyone but his investors. His innate discomfort around people would only intensify as their shortsighted, emotional approach to investing increasingly led them to question Burry’s longer-term vision. They might have admired his abilities, but when their short-term gains appeared threatened, admiration quickly turned to unwarranted anger and distrust, all because of minor losses that not only paled in comparison to Scion’s previous spectacular gains but also promised to ultimately rectify themselves when the market inevitably reverted to rationality.
Threats to remove investment capital--At the moment, though, rationality was not a keyword for Scion’s investors, who demanded to know why the fund was losing money. Even worse, they were threatening to remove their money, which could potentially destroy Scion’s position. According to the credit default swap contracts with Wall Street, Scion’s total assets had to remain above a certain point; otherwise, Wall Street would have the option to cancel.
Scion’s moratorium--With the possibility of losing more than half his fund by mid-2007 due to looming investor withdrawals, Burry decided to take advantage of a clause that allowed him to hold their money in cases where the investments were not being traded on the public market. His investors would not be able to withdraw slightly more than half their money until the pertinent bets had completed their cycles.
The growing rift with investors--Although Burry was thoroughly convinced of his move, predictably, it did not sit well with his investors, who were now threatening to sue. Joel Greenblatt and John Petry of Gotham Capital even flew to California to visit Burry in his San Jose office. This was initially hard for Burry because Greenblatt had been his first investor and supporter and consequently was like a mentor to him. Now Gotham wanted to withdraw its investment, and Burry refused to even comply with Greenblatt’s demands for information.
To Gotham Capital and Burry’s other investors, it simply looked like Burry was refusing to admit his mistakes. The idea that the market might be fraudulent didn’t make sense to them. In short, Burry’s insights separated him from his investors, and he hadn’t been successful in his efforts to explain his position. In fact, in spite of all his efforts and his prior extraordinary success, most had grown to hate him, which inspired more of the same on Burry’s part, although he could not understand why his investors couldn’t give him the benefit of the doubt.
The reason was simple: they were losing money—at least for now. The same person who had so spectacularly outperformed everyone else was now underperforming, and they were blaming him entirely instead thinking objectively about the situation. As hard and as isolated as his position was, though, Burry believed in the process and in the ultimate rationality of the market. With the failure of three major home loan originators within in two months and with official predictions by the Center for Responsible Lending of more than 2 million mortgage defaults, things were occurring as Burry had foretold.
His investors, however, were blinded by their temporary losses and were determined to take their anger out on him. Burry’s private investor newsletters were being leaked to the press, wild and untrue rumors were being spread, unfair accusations were being concocted against him, and whatever personal idiosyncrasies he had were being tolerated less and less. His investors were not the only ones who were having issues: colleagues and employees, too, were having a hard time with the situation.
Cornwall, FrontPoint, and Scion all had similar, though not identical, views on the market. All of them knew that something was strange—that the market was not operating as it normally should. Eisman was convinced that the market was governed by delusional opportunism. Ledley had a broadly cynical view that suspected a fraudulent conspiracy, which included everyone from the banks to the rating agencies and even the government. Burry’s view was more specialized: his observations of the so-called middlemen at the large Wall Street investment firms gave him the distinct impression that they were manipulating the market. And that was what he wrote to his investors in early 2007 in explanation of why he chose to side-pocket the money they were clamoring to withdraw.
The Market Begins to Turn
The strange discrepancy between housing market realities and bond prices and premiums continued to increase. But in 2005, at a time when serious credit analysis had apparently become unfashionable, Burry had done his homework. As part of his investment scheme, he had honed in on silent second mortgages as a sign that the homebuyers in question were having trouble paying their bills. His homework was now beginning to pay off as Scion was showing gains of 18 percent.
Rapid, dramatic decline in the market--That wasn’t all. The large Wall Street firms were showing signs of serious trouble. In mid-June, two Bear Stearns subprime mortgage bond hedge funds went bankrupt. That was followed two weeks later by a 20 percent decline in the publicly traded triple-B-rated subprime mortgage bond index, after which Goldman Sachs, Burry’s largest “middleman”/counterparty, became first incapable of evaluating Burry’s positions and then mysteriously unavailable. Burry was not surprised. Sudden disappearances for one reason or another had become a standard routine with the large investment banks, who always had an ostensible reason for being unavailable when things weren’t going their way.
The change that Burry had been waiting for was now beginning to happen. Morgan Stanley’s and Goldman’s long positions had started to work against them. Suddenly it was in their own interest to switch their fraudulent marking methods to fair and accurate ones, and Morgan Stanley was even looking to buy from Burry, while everyone else sought his advice.
No acknowledgement--In line with all the other developments leading up to the final crisis, it seems somehow appropriate that neither Scion, FrontPoint, nor Cornwall should have received any credit for their ability to accurately foresee the disastrous outcome of the subprime mortgage bond situation. Of all Lewis’s main characters, Greg Lippmann was the only one mentioned in a Bloomberg News service article. Instead, the article gave the visionary credit to a few—John Paulson, for example—who followed in the footsteps of the real original seers. And although Burry was gracious enough to acknowledge Lippmann’s perspicacity, his own investors lacked the equivalent grace toward Burry: they never apologized, never gave him credit, and never thanked him.