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In 2005, a doctor who had left neurology to invest, bet that many people would stop paying their mortgages in the United States. He bought insurance on at least $1 billion of that debt, and his own customers wanted to withdraw their money. His name was Michael Burry and he was right, but waiting cost him money and confidence.
Let's go through their accounts and then yours. What happened to a €200,000 apartment during the Spanish housing bubble? It is educational content, not financial advice. Michael Burry studied medicine. According to journalist Michael Lewis in his 2010 book The Big Short, he had never attended a finance class.
He learned to invest on his own, by reading. In November 1996, he started a thread on value investing in an internet forum. It consists of looking for shares that are small pieces of a company that are sold for less than what the investor estimates they are worth. Then he created his own website, which would later be called a blog, where he published his purchases and his reasons for them.
She wrote it between midnight and 3 a.m., after 16- hour shifts at the hospital. In 1998, he was a neurology resident at Stanford and was already being read by investment professionals. In the end, he left medicine to manage money. According to Lewis, while he was looking for an office, he received a call from Joel Greenblatt, who ran a fund in New York, offering to invest with him.
A fund pools money from many investors to invest it together. Burry's, Scion Capital, started on November 1, 2000. As he wrote himself in 2010, in 2003, he began to worry about what he saw. Banks were giving mortgages with increasingly fewer requirements. Many were subprime mortgages, loans to buy homes for people at higher risk of defaulting.
Often, they would start with a low fee for 2 years and then the fee would increase. Luis gives an example. An interest rate, what the bank charges for lending, of 6% which in 2007 would jump to 11%. Generally, banks did not keep those mortgages. They bundled them into large packages and sold them as bonds, which are pieces of debt.
Burry spent late 2004 and early 2005 reading the brochures for those bonds, which were about 130 pages each. And he found his tool, the credit default swap. It works like car insurance, with one important difference. You can insure a car that isn't yours. You pay a fee every year and if the car crashes, you get paid.
In his case, the car was mortgage bonds and crashing meant people would stop paying. On May 19, 2005, he bought insurance from the German bank Deutsche Bank on $60 million worth of mortgage bonds. These bonds were divided into sections, like the floors of a building. When mortgages failed, the losses first hit the lower floors.
Barry chose low-end positions, those with a triple B rating, offering little protection against losses. Insuring them cost him about 2% a year. For every 10 million insured, he paid about $200,000 a year. If the mortgages were paid off, that money was lost. If the losses reached their section, the insurance paid, up to 10 million if the section lost everything.
By the end of July, it already had insurance coverage of over 750 million. According to Luis, in his October 2005 letter, he told his investors that the fund had insurance on at least $1 billion in subprime mortgage bonds. He had been chosen to pick stocks, not to bet against the United States' housing stock.
Barry was looking for an asymmetrical bet. He paid a fee each year and could earn much more if he was right. According to Lewis, it was enough for him if only a small part of those mortgages failed. Now, the calculation that nobody does. Up until then, Barry had been doing very well. According to Lewis, in 2001, the S&P 500, the index that tracks the 500 largest U.S.
companies, fell 12% and Scion gained 55%. It also beat the index in 2002 and 2003. But insurance cost money and at the moment it wasn't paying anything out. Furthermore, as he himself recounted in 2011, the banks valued his insurance policies below what he believed was fair. Anyone who joined Scion committed to staying for at least a year.
And in 2006, according to Barry, the fund had to put mortgage insurance into a separate account, which customers could not withdraw while it was still there. He faced many very angry investors demanding their money back. He was threatened with lawsuits and had to cut salaries and lay off part of the team.
In 2007, mortgages began to default in record numbers and their insurance policies became much more valuable, because they covered precisely those defaults. According to Lewis, the bet netted Barry about $100 million and his investors about $725 million. And for those who were with Scion from its inception on November 1, 2000, until June 30, 2008, the profit was 489% after commissions and expenses.
With $10,000 to start, you would have ended up with about $58,900. In the S&P 500, with about 10,200. Three principles emerge from its history. The first one. The information is usually in plain sight, but hardly anyone reads it. The bond brochures were public. The same applies to the fine print in your mobile phone contract.
Permanence was written, it's just that nobody got to that page. Secondly, being right ahead of time is very similar to being wrong. Since May 2005, Burry paid fees and endured negative valuations while waiting and his customers only saw the expense. It's like warning that the ice on the lake is thin while everyone is skating without a problem, until it breaks.
You're the weird one. Third, distinguish what each year costs from what waiting costs. Burry knew how much he paid per year for each insurance policy, but not how many years he would have to pay it. Like home insurance, you know the premium, but if 10 years go by without needing it, you've paid 10 premiums.
We'll take your euros and the cost of waiting. Spain had its own housing bubble. To measure it, we use the average appraised value of free housing, that is, housing that is not protected. This is the Ministry of Housing's statistic, what appraisers say the square meter is worth, on average throughout Spain.
In the first quarter of 2008 it reached its peak, 2101 euros per square meter. Then it fell for 6 and a half years to 1456 euros in the third quarter of 2014. It was a drop of 31%. Suppose you bought a flat for 200,000 euros right at the peak and that its price moved in line with the average. In 2014 it would have been worth about 138,600 euros, about 61,400 less.
How long did it take to get back to 200,000 euros? Until the third quarter of 2025, 17 and a half years. But recovering the amount is not recovering what you can buy with it. According to the CPI, the INE's consumer price index, prices rose by around 44% between the first quarter of 2008 and the second quarter of 2016.
To buy the same things as with those 200,000 euros, you would need about 287,600. And the apartment, following the average, would be worth about 224,100. Still 22% below in purchasing power. Watch out for the limits. This account only tracks the appraised value. It does not include purchase costs, taxes, the mortgage, or the cost of living in or renting the apartment.
It's the national average, not your apartment or your neighborhood. And with purchase and sale prices, instead of appraisals, the INE index shows an even greater drop, of 37%. According to what he told Lewis, when the bet paid off, none of his clients came back to prove him right. And as he himself wrote, discouraged for many reasons, he closed Zion in 2008.
His story leaves an idea that is worthwhile for a fund and for an apartment. Being right doesn't erase the cost of waiting. If you liked it, give it a like and subscribe. Here are the videos that might interest you most. See you at the next Titan.
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