For those who read the book or watched the movie The Big Short, Michael Lewis’s telling of how a handful of people foresaw the 2008 crisis in the US housing market, Michael Burry was one of the most notable characters.
Burry, a physician by training, had stumbled into finance while studying and eventually ended up founding and running his own hedge fund, Scion Capital, in 2001.
Back then, he had quickly made a name for himself ‘shorting’ technology stocks. He thought they were overvalued and in effect made money from the ‘dotcom crash’ by betting their share prices would drop.
Though he made a lot of money from this, what he is best known for was betting against the US housing market. Scion Capital made about $800 million in the process, of which Burry got $100 million.
The film compressed how long Burry had foreseen the coming crash. He had been studying the property market since 2005, not just a few months, so by the time the crash eventually happened he had known for years that the market was built on a shaky foundation.
What the movie got right was the displease of Scion Capital’s investors in Burry when it came to his insistence that the market was about to crash and him pushing through with a strategy of buying credit default swaps – a form of insurance on mortgage debt.
Credit default swaps see the seller (in Scion Capital’s case Goldman Sachs) paying out the buyer for the face value of the loan if there is a default. As part of the deal, Scion Capital would also pay Goldman Sachs a series of fees.
For Goldman Sachs, it was a good deal as it was not only selling insures on products that were literally ‘as safe as houses’, it was also getting some fees.
What Goldman Sachs did not grasp was that housing was not safe. A lot of mortgages were given to people who could not afford them. These mortgages were then bundled into financial products, which were then given investment-grade ratings and later sold off.
Despite all of this, some of Scion Capital’s investors were in open revolt against Burry’s investment strategy, as they did not see any signs of a coming crash. Burry, in an interview with 60 Minutes, said the animus was so great they were still angry with him, even after he made them tens of millions of dollars.
A new game
After the 2008 financial crisis, Scion Capital was closed and Burry disappeared from the limelight somewhat. Then in 2013 he reopened his hedge fund, this time naming it Scion Asset Management.
For the last few years, Scion Asset Management has gone relatively unnoticed. But in August 2019, it announced that it had bought three million shares worth $16.56 million in gaming and electronics retailer GameStop.
It later emerged that Scion Asset Management had sent a letter to GameStop’s board, asking it to buy back $300 million of its own shares, to boost the value of its shares.
GameStop seemingly took this advice as it bought back $198.7 million in shares between July 31, 2019 and January 31, 2020.
Small-time investors on the internet forum Reddit took note. They knew of Burry’s reputation and stated watching the stock.
They were not the only ones taking note of GameStop. Some hedge funds saw an opportunity to make money by shorting it.
But the hedge funds got their sums wrong. In order to short a stock, there must be enough shares in the open market for them to ‘borrow’. With only 27.29 million of GameStop’s total 69.75 million shares outstanding freely traded, this meant only 39.12% of its shares were available to be traded.
By the time Ryan Cohen, founder of online retailer Chewy, had taken a 13% holding in GameStop on January 11, it was clear that the funds would have to scramble to buy enough stock to return to whoever they ‘borrowed’ it from, as Cohen’s involvement now signalled a positive change in the group.
This saw the small-time investors spring their trap. They bought up GameStop shares and waited till the hedge funds started pushing up the price by panic buying.
This spike in the price saw Scion Asset Management’s holdings rise from $17.37 million at the end of September to about $271 million at its peak.
Trade with caution
Although his holding in GameStop worked out well, Burry urged the small-time investors to trade with caution.
In a since-deleted tweet, he said: “If I put $GME [GameStop] on your radar, and you did well, I’m genuinely happy for you. However, what is going on now – there should be legal and regulatory repercussions.
“This is unnatural, insane, and dangerous.”
Burry has a point. He knows what he’s doing and made a lot of money making calls against the prevailing market views.
Investors who just invested in a company because he took a holding in it are not really investing, they are gambling. And any gambler who’s made their money should know to leave the table with their winnings, rather than further chance their luck.