Dr. Michael Burry - The Big Short’s Biggest Jerk

by Jacqueline Verrilli

Make no mistake, I have great respect for Dr. Michael Burry.  I think anyone with enough research prowess to find a huge investment opportunity, enough willingness to take a tremendous amount of criticism from investors, enough audacity to shut his investors out of taking their money back when they wanted it, and enough risk-tolerance and patience to pay huge sums out and wait years for a gigantic payoff deserves a lot of credit.  But it just so happens that his name is currently the one that is most associated with making a lot of money off the most recent financial meltdown, and hence he is going to be the whipping boy on this post.  We have had several financial crises of varying severity over the years including, but not limited to, the stock market crash of 1929, stag-flation of the 1970’s, the commercial real estate crisis of the 1990’s, the dot-bomb of the early 2000’s, and, of course, the Global Financial Market Meltdown of 2008-9.  And the fact of the matter is that the “Dr. Michael Burrys” of the world are part of the problem.  Scion Capital LLC (his old firm) and other hedge funds often promote and provide the liquidity necessary to increase the inefficiency in irrational markets and thereby exacerbate the value destruction in a financial crisis.  In an interview with “New York Magazine” Burry claims that he “knew what was happening, but there was nothing I, or anyone else, could do to stop it.”  That may have been true in 2007, but since the crash, instead of using his brains to help thwart another crisis, Scion Asset Management LLC (his new firm) is using his money and power to help create another one.

Who’s Responsible???!

In his rant to “New York Magazine”, Dr. Michael Burry, in the same breath, manages to disparage the defrauded ex-home owners, bash the Federal Reserve and big banks, and take pot shots at politicians - all after opening his rant by saying, “The biggest hope I had was that we would enter a new era of personal responsibility.  Instead, we doubled down on blaming others…”  I would love to think that he intended the irony as a hilarious joke, but I don’t think he did.  I would love to say that he, like so many others who get rich exploiting market inefficiencies, is in denial as to his role in the crash.  But Dr. Burry is not so lacking in self-awareness.  He knows that his short trades (buying credit default swaps against the incredibly poor quality bonds known as “CDOs”) contributed to the ultimate disaster, and he admits as much to Michael Lewis, the writer of The Big Short.  He knows better than anyone how it all went down and who paid the ultimate price.  He states, “The ones running the machine did not get punished after the dot-com bubble either — all those VCs and dot-com executives still live in their mansions lining the 280 corridor on the San Francisco peninsula. The little guy will pay for it — the small investor, the borrower. Which is why the little guy needs to be warned to be more diligent and to be more suspicious of society’s sanctioned suits offering free money. It will always be seductive, but that’s the devil that wants your soul.”  So rather than share the information about how to empower “the little guy”, or go on a mission to change what’s really broken, he spews vapid aphoristic statements that point the finger of blame away from himself and starts a new hedge fund.  Good show, I say, old boy.

Every party needs a pooper…

…and I guess that’s me.  I hate to say it in quite this way, but here’s the blunt truth.  Money makes people irrational and irrational people with money create irrational markets.  In the obfuscating language of economists and Federal Reserve Chair People, excessive liquidity can create a situation of decoupling asset pricing from the underlying fundamentals.  Allianz Chief Economist said yesterday (Jan 4^th, 2016) that the current level of the stock market indicates decoupling.  In common, everyday language “decoupling” means that stocks, bonds, and other assets (even homes), can become overpriced simply because investors continue to buy them.  Buyers often figure that the price they are given must be the right price, they assume that markets are rational.  We can’t all be experts, but clearly not enough people understand the factors that create an asset's underlying value.  If we stop to think about it for a moment, however, we can begin to get a clue.  The demand for the products a manufacturing company makes creates the underlying value of the company, and hence, of its stock.  For a bond, the credit and cash flow of the issuer creates the value.  But, for most of us, it’s just no fun to read prospectuses or industry market studies.  Watching a stock ticker, on the other hand… now that’s exciting!  From day to day, and even moment to moment, we can see how much other people think a company or a bond is worth, and, just like when the Earth was flat, what we see confirms our own ideas.  The stock is going up so other people must agree with our opinion that it will continue to do so, and all those people couldn’t possibly be wrong (least of all me), and so we buy.  But what may actually be happening is that the assets become priced based on the amount of money chasing them, and the availability of the assets, regardless of what actually creates their value. The asset pricing becomes tautology; they are going up because they are being bought at higher prices, not because the underlying company is becoming more efficient or because the market for its goods or services is growing.  There’s just too much money chasing the stock!

What Dr. Michael Burry Knows But Won’t Tell You!

In the curious case of continued financial market crashes, the cycle repeats itself with regularity because the investors believe that the new assets on offer are somehow different from the old assets.  These ones are better!  Fresher!  Now with better taste and more flavor!  The salesperson said so!  Ok… ok… I will take the cynicism down a bit and go just back to bashing Burry.  Since HE won’t tell us how to defend ourselves from market irrationality, I will put in my two cents.  And three points:

1)  FASBs are easily gamed

The Financial Accounting Standards Board sets out the generally accepted rules for accounting known as FASBs (pronounced “faz bees”).  There are a lot of FASBs, and they are complicated, which is why you need to take a really hard test to become a Certified Public Accountant (CPA).  But one thing that is apparently every bit as exciting as watching the stock-ticker is figuring out ways to get around the FASBs.  If you have ever heard the term “creative accounting” you might want to interpret that as “gaming the FASBs”.  Of course, the FASBs must be flexible to allow for business judgement, but the way they are worded allows a CFO to use poor judgement just as easily as good judgement.  If a company is in need of more earnings (to meet projections, of course), they merely need to reallocate some of the cash they have coming in or going out to another account.  If a company wants to hold off on marking its assets to their true market value, they can redefine the assets to put off alerting their investors to the gains or losses.  Accounting slight-of-hand abounds in the public-corporation world and even those investors who have a fairly sophisticated understanding of accounting would find it difficult to tease apart some of the manipulations and gyrations of this numismatic magic.

One way to help thwart a future financial crash would be to make it WAY less easy to consider ANYTHING “off balance sheet”.   In the CDO/Default Swap debacle, the investment banks were able to hide all of the assets by holding them off balance sheet.  This was allowed because, under FASB rules, since the bonds were hedged against default by the “insurance” of a credit default swap, the CFOs judged the assets to be “riskless” and, therefore, not truly assets to the company.  Seriously.  They did that.  Why no one seems to be calling out the accounting practices that serve to hide assets is beyond me.  I was hoping to find a crusader in Burry, but instead he’s probably using knowledge of the FASBs to his advantage in more ways than one.

Many corporations of various sizes and in varying industries use “off balance sheet” accounting to reduce the value of their assets and make it appear as though their return on assets (ROA) is higher than it actually is.  The use of “synthetic leases” has been common among companies that hold a lot of real estate, for example.  And creating a new legal entity that is only nominally owned by the originating company is another way to get things off the books. “Oh!  But Ms. Verrilli,” I hear you CFOs protesting, “all corporations must disclose their off-balance-sheet assets in the footnotes of their quarterly and annual reports.  All one need do is look there to read how the assets are treated.”  That’s what Burry and Buffet do.  I have, in fact, read several areas of the very small print of company financial reports, and I have often had to re-read them several times in order to even begin to understand what they are trying to convey.  It's small print for a reason – nobody wants you to attempt to read it, let alone understand it.  And this brings me to my next point.

2)     Small print should be in BIG, BOLD LETTERS!

Information asymmetries are generally at the heart of most people feeling like they got taken to the cleaners, or worse.  The fine print on the labels of drug canisters describing the potential side effects is the easiest example to point to, and probably the hardest to read for those of us over 40.  At this stage of my life, I have heard of many people being harmed by a drug, but, because the potential side effect was disclosed (in legalese, mind you) in the fine print on the jar or in an insert, along with the legal a priori assumption that taking any drug poses a risk, people are often not compensated for their harm.  And this seems fair.  Even over-the-counter analgesics have been shown to pose a risk.  But it is very clear to me that very often a doctor prescribes a drug and leaves the label-reading up to the patient.  The drug company that makes the drug may be the only entity in the equation that actually knows about the potential side effects.  In one instance of which I am aware, an individual’s nerves were permanently damaged by a common drug.  It was disclosed on the drug packaging that this happened in less than 1% of the cases of individuals taking the drug.  The doctor had been made aware that this was a potential side effect, but did not disclose it to the patient because the odds were “obviously very low” that this patient would fall into the 1%.  In this case, the individual was able to sue for damages, but I’d bet they’d rather have their nerves intact or at least have had the opportunity to decide to take the gamble on the 1%.

Examples of information asymmetries as market inefficiencies abound, and they don’t even have to involve small print.  The PRESERVATION AND MAINTENANCE OF PROPERTY clause in a mortgage document is a prime example, here.  When someone is buying a home, especially their first one, they are never thinking about home maintenance.  They are thinking about what colors the walls should be, how to organize the tools in the garage, and making sure the movers don’t mishandle the dining table.  But if you fail to maintain your house, and the bank deems that it could be sold for more than the mortgage amount, and you default even technically, this clause could be used to take away your home.  Unlikely scenario?  So is global financial market meltdown, no?

Whenever you are undertaking a transaction, create your own BOLD PRINT disclosures to see if you would still undertake the transaction.  Here are some good ones to start off with:

·        A HOME OF THIS PRICE COSTS AN AVERAGE OF $2,500 ANNUALLY TO MAINTAIN, AND THE EXPENSES CAN OFTEN COME IN LARGE CHUNKS UNEXPECTEDLY.  FAILURE TO MAINTAIN THE PROPERTY IN ITS CURRENT CONDITION CAN RESULT IN FORECLOSURE.

·        THERE IS A 0.8% CHANCE THAT YOU WILL SUFFER PERMANENT NERVE DAMAGE INVOLVING PAIN AND/OR THE LOSS OF THE USE OF LIMBS WHILE TAKING THIS DRUG.

·        THIS STOCK IS CURRENTLY CLIMBING BECAUSE TECH STOCKS ARE IN FAVOR.

·        THIS SUPPLEMENT HAS NOT BEEN PROVEN TO PROVIDE ANY BENEFIT WHATSOEVER BUT STILL COSTS $30 A JAR.

·        THIS IS A SINGLE-FUNCTION KITCHEN GADGET THAT YOU MAY USE AVIDLY FOR 3 MONTHS AND  IT WILL THEREAFTER TAKE UP SPACE IN YOUR CUPBOARDS UNTIL YOU DONATE IT TO A CHARITY.  IT MAY BE EASILY REPLACED BY A KNIFE YOU ALREADY OWN.

Drug makers, home and stock brokers, and businesses of all types want you to spend your money on their products and services.  They create them to provide a benefit to consumers, for sure, but “Buyer Beware” is not sufficient to mitigate information asymmetries for you as an individual.  It takes LOTS of time for you and your doctor or lawyer or salesperson (or your less impulsive self) to go through each facet of every transaction.  DO IT ANYWAY!!  Asking questions of yourself and others and doing your own research until you completely understand a transaction empowers you against information asymmetries.  Will you ever get the coveted “perfect information” that is an economist’s dream?  No.  BUT TRY ANYWAY.  I hope you enjoyed all the bold print in this point.

3)     Fear the acronym!

CDO stands for Collateralized Debt Obligation.  REMIC stands for Real Estate Mortgage Investment Conduit.  IPO stands for Initial Public Offering.  EDITDA stands for Earnings Before Interest Taxes Debt Service and Amortization.  EIQ stands for Emotional Intelligence Quotient.  LOL stands for Laugh Out Loud.  LMFAO is the name of a band, and also happens to be what I do whenever I hear a new acronym come out of Corporate America or Wall Street.  Let’s just take a quick look at the reality behind the letters CDO, shall we?  Collateralized Debt Obligations are created as follows:

1.  Originate mortgage loans (don't worry about the quality of the loans because...),
2.  Sell mortgage loans to other entities like investment banks (get them “off the books”).
3.  Investments banks put all the loans into an aggregated “pool” and create bonds or Mortgage Backed Securities (MBS) (oh, yes, we must have an acronym here!).
4.  Get MBS bonds rated by a rating agency to get a percentage of the bonds blessed as “AAA” rated (WOW! Triple A!  They must be good!), and a percentage of them rated “AA”, and so on.  Give “AAA” rated bonds the lowest interest rates, since they are the most secure, and give “BBB” rated bonds (which still sounds pretty good, doesn’t it?) higher interest rates since they are more risky.  The percentage left unrated used to actually be honestly-named “junk bonds”.
5.  Sell bonds to investors. This is where all the good small print and legalese gets inserted into the documents with statements like “these investments were rated by a third party and do not imply or reflect the opinion of the issuer as to the quality of the investment” and “the underlying cash flows from these investments is drawn from a pool of residential mortgages originated at institutions other than the issuer…”
6.  Take all the bonds that don’t sell (including the junk) and re-bundle them into a CDO!!!!!!!!!!!!!!  Let’s recap up to this point.  The original loan payments on mortgages that went into the MBSs are now re-pooled and re-bonded.  So, a CDO is a bond made up of cash flow off of bonds made up of the cash flow off of mortgage loans that were originated and sold by a bank.  You still with me?  OK.  Good.  Cause then…
7.  Have the CDO rated by an agency to see what percentage will be deemed “AAA” “AA” “A”… and sell those, too.  Or hold onto them since they have fairly high interest rates as well as high ratings!
8.  Sell people like Dr. Michael Burry “swaps” to make extra money and create “riskless” assets and get those CDO/Swap combos “off the books”.

Seriously.  They did that.

I, and Dr. Burry, believe that the investment banks basically just started drinking their own kool-aid.  Their own acronyms and jargon got them so confused that they no longer understood what they were doing – they just saw huge sums of cash coming in.

Acronyms and jargon are super-efficient in meetings and reports where everyone is already “in the know” on the obfuscation.  But whenever you hear or read an acronym, jargon, or some seemingly innocuous words thrown into a sentence that act to trivialize the discussion, you should instantly be wary and be prompted to ask this “stupid” question:

·        I’m sorry, I haven’t heard that acronym (or term) before; what does it stand for (mean)? (if reading, Google it)

Then ask this follow-up question more than once:

·        And what exactly does that actually mean? (Google that, too)

Acronyms, jargon, and trivializing colloquialisms are a sure sign that someone is trying to appear “in the know” and therefore, outsmart you.  The funniest part of this is that often times the individual using the acronym or jargon does not actually understand the underlying fundamentals upon which the acronym or jargon is based.  If they do, they should have no issues with explaining them to you.  If you read The Big Short you will find that Dr. Michael Burry is an unabashed questioner when things don’t make complete sense.  Take that lesson to heart, everyone!!

Back to Burry Bashing

Dr. Burry is at it again, taking advantage of market inefficiencies at his new-ish firm, Scion Asset Management, and I do applaud him for it.  Making more money for wealthy people is not a bad thing in and of itself, and the fact that the wealthy people often don’t spend their excess funds (or even pay taxes on them) is not technically Burry’s problem, nor is it his fault.  The issue I take with Burry is that, as a super-smart guy who now has literally more money than he knows what to do with, he took the easy path and went after more money.  Has the devil gotten his soul, too?  Look, I know it’s fun for him to research the crap out of companies and financial instruments and figure out what the “play” is given the prevailing economic environment.  It’s hard to fight your passions.  Believe me, I get that, being the Geekonomist, myself.  But at the very least Dr. Michael Burry could have taken the time to help out the poor schleps who dabble in the markets buying mostly S&P pegged mutual funds.  He calls us “the little guys” meaning “the people who are hopelessly under-educated in finance” and, because we are uninformed and lacking in the interest, know-how, or time to do anything but our jobs, raise kids, and have some fun in our lives, we remain the financially bullied. Burry knows we’ll just sit and take it because there is no big-shouldered body-guard on the playground (Elizabeth Warren notwithstanding).  The Big Short left me feeling like he and the other “shorters” should be standing up for us since they have recognized the main issues, some of which I have put forth here.  I don’t know about the other guys, but Burry is back at facilitating liquidity and I think that that makes him The Big Short’s Biggest Jerk.  Thanks for nothin’, pal.