Michael (CDS) Burry

Michael Burry is one of the most influential figures in recent investment history, known for anticipating and betting against the 2008 financial crisis through the use of Credit Default Swaps (CDS). His approach, based on in-depth market analysis and his ability to detect financial bubbles, has made him a reference for investors worldwide.

Burry observed that:

Many adjustable-rate mortgages (ARM loans) would see significant payment increases in 2007 and 2008.
The delinquency rate was rising, meaning many people would be unable to pay their mortgages.
Banks were not properly assessing risk, and AAA-rated mortgage bonds were artificially inflated.

Burry concluded that the bubble would burst and found a way to bet against the mortgage market using Credit Default Swaps (CDS)—a type of financial derivative that allowed him to profit if mortgage-backed securities collapsed.

1. Biography and Career of Michael Burry

Michael Burry was born in 1971 and studied medicine at Vanderbilt University. Although he trained as a doctor, his true passion was always investing, leading him to found his hedge fund, Scion Capital, in the year 2000.

By the mid-2000s (around 2005), Burry identified that the U.S. mortgage market was in a bubble. Analyzing data on subprime mortgages, he concluded that a significant portion of these loans would collapse en masse.

To capitalize on this imminent crisis, he used an innovative financial instrument: Credit Default Swaps (CDS), which allowed him to bet against the subprime mortgage market. His strategy generated enormous profits for his fund when the crisis finally erupted in 2008.

2. Credit Default Swaps (CDS)

2.1 What is a Credit Default Swap?

A Credit Default Swap (CDS) is a financial derivative used as insurance against debt default. It is a contract between two parties:

CDS Buyer: Pays a periodic premium and receives compensation if the debt issuer defaults.
CDS Seller: Collects the premiums but must pay the buyer if a default event occurs.

2.2 How a CDS Works

Credit Default Swaps function similarly to car insurance:

Imagine you purchase insurance for your car. You pay a monthly premium to protect yourself in case of an accident.
If you have an accident and the car is damaged, the insurer covers the repair or replacement costs.
If you do not have an accident, the insurer simply keeps the premiums you have paid.

In the case of CDS, instead of insuring a car, a financial debt is insured. If the debt defaults, the CDS buyer receives compensation; if no default occurs, the CDS seller keeps the collected premiums, just as an insurer keeps the insurance fees from accident-free clients.

2.3 Use of CDS in the 2008 Crisis

CDS were widely used to speculate against mortgage-backed securities (MBS). When subprime mortgages began to fail, CDS skyrocketed in value, generating massive profits for investors like Michael Burry and catastrophic losses for financial institutions such as Lehman Brothers and AIG.

3. Mortgage REITs (mREITs)

3.1 What is a Mortgage REIT?

A Mortgage REIT (mREIT) is a type of real estate investment trust that invests in mortgages and mortgage-backed securities (MBS) instead of owning physical properties. Their business model is based on earning income from the difference between the interest rates at which they borrow money and the interest rates they generate from their mortgage investments.

3.2 How Do mREITs Work?

Mortgage REITs profit from the spread between:

The rate at which they borrow capital (typically short-term).
The rate they receive from their investments in mortgages and MBS (long-term).

3.3 Advantages and Risks of mREITs

Advantages:

High yields: Due to the leveraged nature of their investments.
Exposure to the mortgage market without purchasing properties.

Risks:

Sensitivity to interest rates: An increase in rates can reduce their profit margin.
Impact of financial crises: As seen in 2008, they can be highly vulnerable to liquidity shocks and mortgage market changes.

4. The Role of Credit Rating Agencies in the Financial Crisis

Major credit rating agencies, such as Moody’s, Standard & Poor’s, and Fitch Ratings, played a key role in the 2008 financial crisis. These agencies gave AAA ratings to mortgage-backed securities (MBS) composed largely of high-risk subprime mortgages.

How did they contribute to the crisis?

Lack of risk assessment rigor: The agencies overvalued the quality of MBS and CDOs, enabling their massive commercialization.
Conflict of interest: Since the issuers of the securities paid for the ratings, agencies had incentives to rate them favorably.
Domino effect: Institutional investors relied on these ratings for their investment decisions, leading to massive exposure to toxic assets.

When subprime mortgages began to fail, structured securities collapsed in value, causing massive losses and the bankruptcy of major financial institutions. This collapse amplified the crisis and exposed systemic failures in the credit rating model.

5. Why Was He Close to Losing Everything?

Although his analysis was correct, Burry faced three major challenges:

5.1 Betting Against the Market Too Early

Burry bought Credit Default Swaps (CDS) in 2005 and 2006 when there was no obvious problem in the market. Although he was right about the crisis, his timing was not perfect. For over a year, subprime mortgages continued to function smoothly, making his bet seem irrational.

As the housing market kept rising, the cost of maintaining his short position in CDS was very high. Investors in his fund, Scion Capital, began to grow impatient, seeing their money locked in an apparently losing bet.

5.2 Investor Pressure and Threats of Capital Withdrawal

Investors in Scion Capital, the hedge fund managed by Michael Burry, started doubting his strategy. Since his CDS position was generating short-term losses, investors wanted to withdraw their money. Burry faced:

Constant pressure from clients demanding he sell his positions and stop betting against the market.
Attempts at mass fund withdrawals, putting him in a liquidity crisis.
Doubts even from his own team, who began questioning his judgment.

5.3 Banks Tried to Manipulate the Market

One of the toughest moments for Burry was when banks and insurers failed to properly reflect the value of CDS on their balance sheets. Despite data indicating that subprime mortgages were failing, banks manipulated derivative prices, delaying the market collapse and making his investment seem even more misguided.

Burry suspected that financial institutions were hiding the magnitude of the problem, meaning his fund had to endure short-term losses before profiting.

6. Measures He Took to Survive

Faced with immense pressure and the risk of losing everything, Michael Burry made strategic decisions to hold on until the bubble burst.

6.1 Blocking Investor Withdrawals

To prevent his fund from collapsing before his bet paid off, Burry restricted investor capital withdrawals. This move was extremely unpopular, as many wanted to pull their money when they saw Burry holding onto his CDS positions despite temporary losses.

This decision allowed him to maintain his position until the markets reacted to the crisis.

6.2 Buying More CDS

Despite the pressure, he doubled down by purchasing more insurance contracts (CDS) against subprime mortgages, convinced that the bubble would collapse sooner or later.

6.3 Ignoring Media and Corporate Pressure

Burry avoided distractions from constant attacks by the media, investors, and banks that labeled him irrational. He stuck to the data and continued his strategy based on mathematical analysis.

7. How Much Money Did Burry Make?

When it was all over, Michael Burry turned his bet into one of the most successful investments in history:

His Scion Capital fund generated a return of over 489%.
Burry personally earned more than $100 million.
His investors, initially furious with him, made around $700 million.

After his success, Burry closed Scion Capital in 2008, returned the money to his investors, and temporarily retired from fund management.

8. What Can We Learn?

Timing is crucial in markets: Being right too early can be almost as bad as being wrong.
Investor pressure can collapse a fund if the manager lacks conviction and control.
Banks and markets do not always reflect reality immediately—they can manipulate prices to delay losses.
The greatest investment opportunities often seem crazy at first, but those with patience and solid analysis can achieve enormous profits.

Michael Burry endured months of extreme stress and pressure, but his conviction and discipline made him a Wall Street legend.

His story was documented in the book and film The Big Short, showcasing his battle against Wall Street’s conventional thinking.

The Big Short [USA] [DVD]