Lessons from The Big Short for Individual Investors

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Lawrence: Your big mortgage bet concerns us. We have no confidence in your ability to identify macroeconomic trends.
Michael: You flew here to tell me that? Why? Anyone can see that there is a real estate bubble.
Actually, no one can see a bubble. That’s what makes it a bubble.

That’s dumb, Lawrence. There’s always markers. Mortgage fraud it’s quadrupled since 2000 and the average take home pay is flat yet home prices are soaring. That means the homes are debts, not assets.

Martin Blaine: So Mike Burry of San Jose, a guy who gets his hair cut at Supercuts and doesn’t wear shoes, knows more than Alan Greenspan and Hank Paulson.
Well, Dr. Mike Burry. And yes, he does.

Yep, it turns out Burry was right.

Burry was the founder of hedge fund Scion Capital. He was one of the few to realise the dangers of the subprime mortgages in the US that led to the 2008 crisis….and to figure out a way to profit from it.

He is talking to Lawrence Fields and Martin Blaine, Scion’s bankers.

The above is a snippet from the movie The Big Short.

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The movie follows a group of people like Burry, who profited from investing against the real estate market before it collapsed in 2008.

After looking through the top selling mortgage bonds, Burry realises that the booming house market is propped up by bad loans. He then comes to believe that many Americans were going to default on their loans, so he is looking to short them.

The property market was strong. In fact, there were no instruments to short them. So Burry goes to the banks and asks them to create a way for him to do so.

Of course, the banks laughed at him.

The idea that millions of people would default in their mortgages was ludicrous then. They saw it as a ‘foolish’ investment. But Burry was adamant that everyone else was wrong.

And, they laughed even harder when he raised the concern that banks were really exposed, and he was concerned about not getting payment.

I re-watched the movie over Easter weekend. The movie does a great job at explaining what happened, and in using celebrities to explain complicated concepts like subprime or collateralised debt obligations.

Investment advice from The Big Short

But the movie also offers some jewels on investment advice throughout. Here are some that I picked up as I watched.

It ain’t what you don’t know that gets you in trouble. It’s what you know for sure that just ain’t so.

This quote by Mark Twain appears quite early on the screen. As Burry talks to banks and investors, we also hear throughout that the housing market is rock solid.

Not many expected that millions of people would be defaulting on their mortgages in a few years. But they did. The point is, believing in something that is false can hurt you more than not knowing something.

Another of my favourite quotes from Deutsche bank’s Jared Vennett:

Mortgage backed securities, subprime loans, tranches…it’s pretty confusing right? Does it make you feel bored, or stupid? Well, it’s supposed to. Wall Street loves to use confusing terms to make you think only they can do what they do. Or even better, for you to just leave them the f*** alone.

Finance is full of complicated terms and jargon. If you are confused or not clear about an investment, it pays to do your own research. And if you are still not clear about it, don’t invest in it.

Stripper: James says I can always refinance.
Mark Baum: Well, he is a liar. Actually in this particular case James probably is wrong.

Looking to see if the property market is in a bubble, investor Mark Baum and his team travel to Miami to find out. They meet with a real estate agent, who puts them in touch with James, a mortgage broker.

As James tells Baum, he can make US$2,000 by selling a fixed rate prime loan. But he can make five times more when selling a subprime adjustable loan. ‘Adjustable is our bread and honey,’ we hear. Adjustable rates have lower rates early in the mortgage.

That’s why James concentrates on cash rich credit poor candidates, like strippers.

Baum goes on to meet one of James’ clients, who tells him she always gets option pay adjustable because she likes the flexibility. But as Baum tells her, the problem is that if home prices don’t keep increasing, she won’t be able to refinance. Her jaw drops as he tells her she could see her monthlies go up by 200–300%.

Point is, be wary of investment advice from those who work on commission. They may not be giving you the best product for your situation.

I’m on a winning streak. Everybody in this place wants to get in on the action. How could I lose right?

That’s actress Selena Gomez, in a scene where together with economist Dr Richard Thaler they explain synthetic CDOs as they play blackjack. They mention something that in basketball is called ‘hot hand fallacy’.

This, as Richard Thaler explains, is when a basketball player makes a set of shots in a row. The player and people are sure that he will make the next shot. In other words, they think that what has happened in the past will continue to happen in the future.

The fact is, things change. So, be prepared for things to change.

And lastly one of my favourites.

All is done. The market has crashed, and Burry has made lots of money. Burry is sitting alone in his office when he listens to the following message on his answering machine:

It’s Jack. You are buying stocks? The market’s at an all-time low. This is crazy.

Those are other words for Warren Buffett’s famous ‘buy low and sell high’.


Selva Freigedo,
Editor, Global Investor

Editor’s note: The above article was previously published in Markets & Money.

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About Selva Freigedo

Selva Freigedo is an analyst at Money Morning. She has a background in financial economics, but what makes Selva´s experiences different to many are the places she has lived and worked. Born in Argentina, she has also lived in Brazil, the US, Spain, and now Australia. She has seen up…

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