Michael Burry: The Prediction of the Housing Market Crash of 2007

Christian Bale as Michael Burry in his work office from The Big Short | Courtesy of Quora

Michael Burry was a stock investor in San Jose, California. In 2004, he immersed himself in the bond market for the first time. He became an expert on how money was borrowed and lent in the US. This soon became an obsession of his. Burry would sit in his office alone for hours upon hours, reading articles, books, and financial filings. His biggest question at the time was about how subprime mortgage bonds worked. He wanted to short subprime mortgage bonds. Burry spent months looking into these bonds and investigating. He found that the pool of mortgages being issued, packaged, and sold were worsening in quality; there was a higher percentage of interest-only mortgages being sold. Since 2004, the decline in lending standards was visible to anyone looking into it. However, for Burry, these standards were not just on the decline; they had already hit rock bottom. According to Michael Lewis, the author of the book The Big Short, this bottom bond was referred to as “the pay option negatively-amortizing adjustable-rate mortgage.”1

The Big Short, the film based on Michael Burry and his discovery of the housing market bubble. | Courtesy of 1stDibs

This type of bond gave the home-buyer an option of having no payment and rolling the interest owed to the bank into a higher principal balance. The main target for this type of loan was people who had no current income. Burry struggled to wrap his head around the logic of this type of mortgage, but he couldn’t quite grasp why someone whose job was to lend money would want to extend this type of loan to individuals who were already bad bets on paying that money back. Burry claims that the thing to watch out for the most is when lenders lose their restraint, he says borrowers will be more than willing take loan risks beyond their means. However, it is usually up to the lenders to keep risks of bad debt from becoming a risk to the lender. In 2005, Burry was certain that lenders had lost it. This is when Burry began to suspect that the housing market might be on the verge on a catastrophic crash. In all of Wall Street, Michael Burry, as far as he knew, was the only one who was seeing this for what it was.2

Michael Burry (left) was portrayed by Christian Bale (right) in the 2015 film The Big Short. | Courtesy of NYMag

Burry continued looking for other signs. He began to check out “credit default swaps” as a financial vehicle for taking a short position in the housing bubble. He decided to make sure he wouldn’t be affected if anything were to happen to the economy. Burry began to buy insurance on companies he suspected would suffer in any real estate downfall. He came up with an idea that he believed would help, which was to buy “credit default swaps” on subprime mortgage bonds. The problem with that idea was that there was no such thing as a credit default swap on a subprime mortgage bond. Burry would need to get the powerful Wall Street banks to make them. If his theory was correct and the housing market did indeed crash, the firms in the middle would lose catastrophic amounts of money. He began to call all the banks that he believed were most likely to survive a crash. None of them paid any attention to what Burry was telling them.

By the end of 2007, Wall Street knew Burry’s theory was right. The banks stopped answering his calls as they knew they owed him millions on his “Credit default swap” instruments, and the people started to panic. The great investment firm Lehman Brothers went bankrupt, and other financial institutions were bought up by other solvent banks. Since Burry had predicted this early on and made sure to economically prepare himself for this crash, he made millions on the demise of the housing bubble.3

Dr. Michael Burry posing in his office at home | Courtesy of Harvest Exchange

As a result of this economic crash, many Americans were out of jobs. Many lost their houses because they couldn’t afford to pay any more.4 Many major companies went bankrupt. It took the United States many years to recover from the losses. Because of the apparent boom, the crash caught many off guard.5

  1.  Michael Lewis, The Big Short: Inside the Doomsday Machine (W. W. Norton & Company, 2010), 28.
  2.  Michael Lewis, The Big Short: Inside the Doomsday Machine (W. W. Norton & Company, 2010), 26-39.
  3.  St. James Encyclopedia of Popular Culture, 2013, s.v. “The Great Recession.”
  4. Social Welfare: Fighting Poverty and Homelessness, 2014, s.v. “The Housing Problem,” by Mark Lane.
  5. Encyclopedia Britannica, January 2010, s.v. “The Great Recession of 2008-2009,” by Joel Havemann.
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1 Comment

  • This is a prime example of someone using his smarts to his benefit. I don’t know that much about economics, but this article explained the story behind Michael Burry very well. This article actually gave me an idea for one of my own articles this semester. This story amazes me because this guy was just someone who had an interest in the stock market, yet he was able to predict the future.

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