Lessons from the big short...

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Summary: In 2007, the market crashed due to the worst financial crisis since the great depression of the 1930's ! For private investors that crisis was totally unexpected, for most of the financial experts too but ... for some asset managers that crash met "positively" their expectations. Those people shorted the market (betting downwards) and recorded huge profits. Unbelievable isn't it? Not totally when we look closely to their methodology :

1. The market environnent - Signs:

  • We were in a situation of constant housing price increase. The famous :" It has always been like this !". Yes, a good condition for a housing bubble.

  • Credit loans for lending borrowers: People, particularly in the US, had the possibility to borrow money from banks in a period of easy credit conditions. Which means subsequently a "high probability of default payments". Unfortunattely this indicator of risk was not the only one. We can compare it to a situation of a plane crash. Shit happens not only due to one consequence. Remember that period, people chose massively for variable rates pushed by the economy in order to increase the consumption. Once the variable rates increased at sometimes 13 % what happened? People were unable to reimburse their mortgages. You link that to a recession, people lost in the same time their job and.....the story began !

  • Mortgage back securities (MBS) derivatives of Collateralized Debt Obligations (CDO's): some financial institutions put different mortgages with different level of risk in a basket of those products ....and then they sold those products to investors & other banks. What happened when those MBS composed by more than 20 % of unsecured mortgages failed ? as simple as it is a worldwide financial crisis !

  • On the other hand, banks were used to leverage their balance through subprimes, which means in the end a lack of solvency ...and when subprime clients weren't able to pay their monthly installments, banks faced the pitiless consequence...bankruptcy ! bye bye Lehman Brothers, Fortis in the hands of BNP Paribas others were saved at the very last moment by governments like ING, KBC, Dexia in Belgium, or Fannie Mae and Freddy Mac in the US etc etc...

But some smart people knew that something was going wrong ...

How did they identify the financial crisis of 2007, through which methodology did they discover the housing problem when other investment specialists were completely blind ?

2. The method analysed through the MBTI*'s perception:

Intuition: something is going bad here!

Adam Mc Kay, "The Big short"'s Director shows us through 4 teams of asset managers how they discovered the future collapse of the housing bubble. For most of them, that "investment opportunity" started from an intuition that pushed them to go further and analyse the situation.

Sensing through analysis: figures - figures - figures and questioning people.

Michael Burry, founder of Scion Capital, doctor in...neurology and economist played by Christian Bale is committed to the Contrarian strategy which is based on Warren Buffet's method to invest in value assets. But more than that Burry is focused on bargain-price stocks. Those people never invest because assets are trendy. Through his deep analysis (Judging) Michael discovered 2 years before the subprime risk and identified the opportunity to short the CDO's. In 2007, his fund grew up by.. 166,91%

Another team went down the streets to meet people. Like a police investigation, they interviewed real estate agents, landlords, tenants and analyzed the financial situation of people affected by a mortgage (Perception). No doubts, the "temporary" downturn of the real estate market, wasn't just an epiphenomenon. And the reason is that those analysts discovered also that landlords won't be able to reimburse their mortgages when in 2007 the variable rates were going to increase dramatically.

Thinking: "What could be the worst case scenario?" "How can I think differently?"

If you think contrarian, you have to forget the sentence "it has always been like this"! A professional investor has to analyse the market, make some scenarios and projections. Supported by his intuition and after having analyzed the figures, the investor meets the reality.

This quote of Dr Bury summarize this attitude :

"It is ludicrous to believe that asset bubbles can only be recognized in hindsight."

Feelings: "Do I like it or not?"

Concretely, the attitude of a Feeling mindset is to anwer yes or no to a proposition. Which means that it's not everything to have a good intuition or having analyzed figures. In the end you have to have confidence in your conviction(s). Doctor Burry was right but too early. which is not so confortable when you have investors looking for annual results. He had to stay strongly confident because he had the feeling, the mathematical feeling that he was right. Even if some clients wanted to sell their participations. Not a very confortable situation when you manage 600 MM USD for your customers, isn't it?

3. Conclusions : What are the lessons to learn from "The Big short"?:

  1. Only one point of perception is not enough to discover investment opportunities or risks;

  2. If you identify a risk, its important to analyse your figures;

  3. What are the consequences if your scenario is going to succeed?;

  4. Think differently, forget the sentence : "It as always been like this";

  5. Look at the real value of your investments;

  6. There are always opportunities. It means don't be afraid about bad news, enjoy the opportunities. And in this case the opportunity was to short the CDO's (to bet on the downwards );

In the next investment tips, we will see how to take some investment decisions linked to your convictions in a diversified portfolio.

Sébastien Van Passel


Glossary (from www.investopedia.com):

Mortgage back securities : A type of asset-backed security that is secured by a mortgage or collection of mortgages. These securities must also be grouped in one of the top two ratings as determined by a accredited credit rating agency, and usually pay periodic payments that are similar to coupon payments. Furthermore, the mortgage must have originated from a regulated and authorized financial institution.

Collateralized debt Obligation or CDO: A structured financial product that pools together cash flow-generating assets and repackages this asset pool into discrete tranches that can be sold to investors. A collateralized debt obligation (CDO) is so-called because the pooled assets – such as mortgages, bonds and loans – are essentially debt obligations that serve as collateral for the CDO. The tranches in a CDO vary substantially in their risk profile. The senior tranches are relatively safer because they have first priority on the collateral in the event of default. As a result, the senior tranches of a CDO generally have a higher credit rating and offer lower coupon rates than the junior tranches, which offer higher coupon rates to compensate for their higher default risk.

Sources :

S1: https://en.wikipedia.org/wiki/Financial_crisis_of_2007%E2%80%9308

S2: Financial crisis /WSO



S5: Michael Burry :http://www.valuewalk.com/2015/02/dr-michael-burry-scion-capital/

S6 http://www.myersbriggs.org/my-mbti-personality-type/mbti-basics/

S7: Michael Burry :http://basehitinvesting.com/michael-burry-focus-on-bargains-and-not-stock-market-valuations/

#bighshort #subprime #MBTI #investissements #AdamMcKay #Thebigshort #Michaelburry #scioncapital #cdo #MBS #Mortgagebacksecurities

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