Original posted on Bloomberg by James Pressley:
Michael Burry, the California hedge-fund manager who figured out how to bet against the subprime bubble, prodded seven Wall Street banks in early 2005 to create credit-default swaps for subprime-mortgage bonds, Michael Lewis writes in his book, “The Big Short.”
Five of them “had no idea what he was talking about,” Lewis says. Only Deutsche Bank AG and Goldman Sachs Group Inc. expressed any interest in the concept, he says.
“Inside of three years, credit-default swaps on subprime- mortgage bonds would become a trillion-dollar market and precipitate hundreds of billions of losses inside big Wall Street firms,” Lewis writes in an excerpt from the book on the Web site of Vanity Fair magazine.
“Yet, when Michael Burry pestered the firms in the beginning of 2005, only Deutsche Bank and Goldman Sachs had any real interest in continuing the conversation. No one on Wall Street, as far as he could tell, saw what he was seeing.”
The book is scheduled to be published later this month by W.W. Norton in the U.S. and by Allen Lane in the U.K.
Burry, the head of Cupertino, California-based Scion Capital Group LLC, had concluded that lending standards had hit bottom, Lewis writes. He had studied subprime mortgage bonds in detail, wading through hundreds of prospectuses, Lewis says, and had figured out that the way to bet against them would be with credit-default swaps, which allow investors to insure against -- or bet on -- the likelihood that the issuer will default.
At the time, there was no such thing for subprime mortgage bonds, writes Lewis, a Bloomberg News columnist. So Burry had to get Wall Street banks to create one.
He did his first subprime-mortgage deals on May 19, 2005, buying “$60 million of credit-default swaps from Deutsche Bank -- $10 million each on six different bonds,” Lewis writes.
As his bet against subprime mortgages grew, many of his investors began to mistrust Burry and feel betrayed, Lewis says. Those who kept their money with him were rewarded.
“By June 30, 2008, any investor who had stuck with Scion Capital from its beginning, on November 1, 2000, had a gain, after fees and expenses, of 489.34 percent,” Lewis writes. “Over the same period the S&P 500 returned just a bit more than 2 percent.”