
Interview with Michael Burry, Real-Life Market Genius From The Big Short - prostoalex
http://nymag.com/daily/intelligencer/2015/12/big-short-genius-says-another-crisis-is-coming.html#
======
paulpauper
Mathematically speaking though, Michael Berry's success may have been more to
do with luck than skill:

1\. Nowadays, options are priced in such a manner that the expected value of
buying OTM hedges is almost always negative. This is due to the inflated
volatility for out-of-money put options and other factors.

2\. It just so happened that the subprime mortgage meltdown coincided with his
career; for the period between 1935-2007, his strategy would not have worked.
It also would not have worked between 2008-present. (maybe it worked have
worked in 1987, so we're talking three instances out of a century). Right now,
the evidence suggests bank have reformed their lending practices, with higher
credit scores for new homeowners, so the odds of another financial meltdown
are slim.

3\. The fed balance sheet is big, but interest rates are very low.

The fed has posted a large profit , a 30% gain in 2015 for a profit over over
$100 billion, which is sent back to the treasury

[http://money.cnn.com/2015/03/20/investing/fed-profit-
balance...](http://money.cnn.com/2015/03/20/investing/fed-profit-balance-
sheet/)

And the evidence due to the mathematics of the yield curve and the composition
of the fed's holdings suggests the the odds of the fed losing money on it
holdings is very low:

[http://blogs.wsj.com/economics/2011/04/11/odds-of-fed-
losing...](http://blogs.wsj.com/economics/2011/04/11/odds-of-fed-losing-money-
on-balance-sheet-are-low/)

“Short-term interest rates would have to rise rapidly to quite high levels —
in the neighborhood of 7% — for the Fed’s interest expenses to surpass its
interest income. Such an outcome appears very unlikely,” the paper said. In
the event that the Fed did face a loss, it could simply hand no money back to
the Treasury and, “in the most extreme case, future remittances would also be
reduced (and recorded as a change in deferred credit), but the Fed’s capital
base and financial position still would remain completely secure.”

Japan has a much bigger debt, they seem to be doing fine. Low interest and
srong dollar is due to reserve currency status, flight to safety, emerging
market weakness, commodity weakness, petro dollar, the large size of the US
economy, and other factors.

~~~
YuriNiyazov
With regards to 1: So?

Buying options is buying insurance. From the point of view of the purchaser,
the expected value of buying insurance is always negative (otherwise insurance
sellers would be out of business). However, insurance is not bought due to its
EV, it is bought due to its variance-minimizing properties.

~~~
ucaetano
Not really, insurance is bought by people because of the non-linear utility
function of money: losing $1 million has a far more negative utility that 1000
times the utility of losing $1000.

The same with lottery tickets. People don't buy them because they're stupid,
but because they value $100M far more than 50M times the value of $2.

~~~
msandford
I love that you think there is one and only one reason to buy insurance. I
suspect that people buy insurance for _both_ reasons. Which is to say that
you're both right, and both a little bit wrong.

~~~
ucaetano
Oh no, I don't think there's ever a single reason for anything. People don't
buy insurance to reduce variability, since people don't care about positive
variability, only negative (as in the lottery example).

Some people buy just because other people tell them to, some because they are
afraid of losing something, and so on, there are a thousand reasons why
individuals do it. But the general trigger of insurance for people is the non-
linear utility function.

~~~
msandford
> But the general trigger of insurance for people is the non-linear utility
> function.

I would respectfully disagree. Homeowners insurance is a great example. Most
people buy it and never make a claim, and they "lose" insofar as their
premiums are gone for no monetary return. But some people who buy it "win" and
get to collect enough money to roughly replace their house, belongings, etc
when a hurricane, tornado or whatever destroys it all.

Not all insurance is the kind where you pay the same amount whether you make
1000 small payments or one big one.

~~~
ucaetano
"Not all insurance is the kind where you pay the same amount whether you make
1000 small payments or one big one."

But I never said that! It's just like the lottery, the payout of the lottery
is smaller than the price divided by the odds (that's why a lot of people call
it a tax on people who don't know math), but as the utility function of money
isn't linear, for most people a small chance of gaining a lot of money is more
valuable than a little bit of money.

The same is valid for insurance. The value of losing a lot of money is far
more negative than the cost of it, even when taking the risk in account.

That's because the utility function doesn't depend only on the gain, but also
on how much you have. A billionaire might not care about home insurance for a
100k shack.

~~~
msandford
Even if the utility function was linear, I'd still prefer to insure some
things, even with a negative expected value, for the sake of smoothing
variance.

EDIT: I'll clarify this to mean; even if the EV of insurance was exactly
neutral, I'd still buy it for smoothing. And even if the EV was negative, I'd
_still_ buy it for smoothing. There's a difference between smoothing and loss
aversion.

~~~
ucaetano
Not for smoothing variance, as you don't care about positive veriations. You'd
buy it to limit your downside.

If people would buy it to minimize variance, they would also pay an insurance
against winning the lottery.

~~~
msandford
Some people choose to take 20 years of monthly payments from lottery winning
rather than one lump sum. "Rationally" anyone who does that is a fool, and yet
people constantly do that. Perhaps there's value to variance minimization,
aside from the non-linear utility function of money?

------
matdrewin
My favourite quote:

"The caveat is that it is technology that should be a tool making lives better
in the real world, and in line with the American spirit of getting better and
better at something, whether it’s curing cancer or creating a better taxi
service. I am less impressed with the market values assigned to technology
that enhances distraction."

------
littletimmy
The financial crisis that is looming ahead is either a massive asset price
crash, or permanent debt slavery for most of the population, as a result of
the massive economic distortion created by the Fed. For some years now,
orthodox economists have been puzzled (and liberal economists like Krugman
delighted) about how the Fed's massive money printing exercise has resulted in
next-to-none consumer price inflation. What they failed to realize is, the Fed
assumed that the money newly printed would circulate in the economy.

What has happened instead is that money has been packed out of circulation,
mainly due corporations and the wealthy hoarding massive amounts of cash (and
investing in stuff like junk bonds in trying to chase yields). This has
created massive asset-price inflation, which has distorted the economy to the
point of oblivion.

What is going to happen now is that consumer spending will remain really low,
and to spur spending the Fed is going to make policies to ease borrowing,
which will push people into debt, thereby creating a perpetual debt
enslavement of the masses to the wealthy classes. That's the future. Either a
massive asset price crash, or debt slavery for most of us.

There is still a way out of it. The government should impose a wealth tax -
take back the money that was gifted to the rich. They shouldn't have a problem
with it because they didn't earn it in the first place - it was an artifact of
monetary policy. Invest that money in building infrastructure, life sciences
research, and forgiving student loans. Only a massive redistribution will
correct this farce of an economy.

TL;DR The Fed has created huge asset price bubbles, which has distorted the
economy into comical levels of inequality. We need massive wealth distribution
if we don't want the masses to be debt slaves.

------
xt00
So what's the next crisis? actually read the article and this article does not
really expound upon some sort of next crisis.. I guess the crisis is that
interest rates are so low?? awesome click-bait apparently..

~~~
adventured
There are very few likely possibilities.

1) Some kind of dollar, global reserve crisis that rocks the global economy
for a while. Spurred on by the US debt and projected near future large budget
deficits due to welfare and entitlement spending.

2) Broader bond market. I think this is a well understood threat, and doesn't
require much elaboration.

3) A specific junk corporate debt crisis. About half of the major corporate
defaults in 2015 were US companies, which have levered up significantly on the
back of the Fed's super easy money policies.

4) Another significant drop backwards in the asset bubbles the Fed just got
done re-inflating. If the Fed's policies fail to provide enough to sustain
those huge asset classes (real estate and equities primarily), then when they
tip over it'll pull the US economy down into a protracted recession. The
global economy is practically in a rolling recession as it is, if the US goes
next it would cause a lot more global pain (including amplifying the problems
in China and Japan, both big exporters to the US). There's a real debate to be
had about whether the Fed can ever actually create a scenario in which the
intentionally inflated assets can sustain (stand alone without Fed props), or
if they have to always deflate backwards with a hefty penalty for the market
manipulation / forced capital misallocation (which then prompts even more
dramatic action at each turn, to try to re-inflate).

~~~
paulpauper
cooperate profits are at record highs. A bond crisis would require either a
crash in profits or a spike in rates, neither which show any signs of
occurring.

~~~
marcusgarvey
This is not as it seems. [http://www.businessinsider.com/baml-warns-of-gaps-
in-sales-a...](http://www.businessinsider.com/baml-warns-of-gaps-in-sales-and-
earnings-2015-12)

------
honksillet
"Interest rates are used to price risk, and so in the current environment, the
risk-pricing mechanism is broken." This is the money quote.

~~~
unknown_apostle
Absolutely. While most people are looking at an expensive stock market (median
price to earnings for S&P500 is higher than in 2000), the real action next
time may happen in the broad bond markets.

Just verbal speculation of course, but it remains hard to swallow that Italy
borrowing for 10 years at 1.61% or Japan at 0.27% accurately reflects the full
long-term risk of the single-point-of-failure policy of central bank buying.

~~~
lintiness
where do you get your median pe ratio?

[http://www.multpl.com/](http://www.multpl.com/)

that's the spu's total pe ratio, and it's about half what it was in 2000.

~~~
unknown_apostle
Be careful with "raw" PE ratio. It peaks when earnings have already collapsed
due to the denominator effect.

Median of S&P500 price/sales (not quite the same as median of price/earnings
of course): [http://mebfaber.com/2015/03/13/stocks-are-the-most-
expensive...](http://mebfaber.com/2015/03/13/stocks-are-the-most-expensive-
since-the-1960s/)

Median of price/earnings for the broad NYSE universe:
[http://www.hussmanfunds.com/wmc/wmc150112.htm](http://www.hussmanfunds.com/wmc/wmc150112.htm)

I don't think it's controversial to state that high valuations in equities are
more broadly carried. (Hussman's weekly column is an interesting source of
opinions on where these broad valuation measures stand at any given time.)

Obviously, that doesn't automatically imply that any sort of deep loss is
imminent. I believe it does say something about what you can reasonably expect
in terms of long term total returns.

------
snowwrestler
In fact he does not say this, but he does have a lot of interesting things to
say about troubling trends in banking and regulation.

Article is worth a read despite the clickbait headline.

~~~
dang
Ok, we changed the title to just say "Interview with".

------
henrik_w
I'm currently taking the Coursera course "The Global Financial Crisis" [1]
(from Yale) and quite enjoying it. Their answer to what caused the crisis is
bubble thinking from all involved, not moral hazard on sub-prime loans or
government failure. They back their finding up various studies, which seem
convincing to me (but I'm a beginner, so don't take my word for it).

[1] [https://www.coursera.org/learn/global-financial-
crisis](https://www.coursera.org/learn/global-financial-crisis)

~~~
tinco
The bubble thinking is not mutually exclusive with subprime loans and
government failure. Bubble thinking makes banks take risks that they are blind
to. I'm not super familiar with how debt is regulated in the US, but in The
Netherlands the mortgage industry has been much more tightly regulated since
2008. If it is the governments task to regulate debt, then a mass default of
course implies that they failed to do that properly.

If it was harder for banks to supply subprime loans, then that would have
tempered the fire feeding the bubble, and the crisis could have been smaller.

Of course, you could also take a more liberal viewpoint and not blame it on
under-regulation of the government, but instead on mistakes of the big banks.
I'm not that liberal though, so perhaps someone else can explain how liberals
think debt crises should be averted. If I'd have to guess the simple answer
would be that they would say the banks should've fallen so that the healthy
banks would be the only ones left standing, so the whole event could be a
proper free market process (so they also would say the government failed by
bailing out some of the banks).

~~~
henrik_w
The evidence they present points to bubble thinking, not the other two
reasons. The material in question is here:
[https://www.coursera.org/learn/global-financial-
crisis/home/...](https://www.coursera.org/learn/global-financial-
crisis/home/week/4)

------
monochromatic
Reminds me of my friend who's correctly predicted 10 out of the last 2 stock
market crashes.

~~~
oconnore
If his 10, uh, "preparations" hurt less than the 2 actual crashes, he might
have a good thing going.

~~~
JoshTriplett
Thinking you can predict the market, either up _or_ down, is a good way to
find yourself buying high and selling low.

"Buy an appropriate index fund and wait, and don't pay any attention to what
the market does" is far better advice for just about everyone.

------
karambahh
Can someone explain the "invest on food because of water"? As many others I
was startled by the mention at the end of the movie.

I understand the reasoning behind "water cannot be easily transported".

But this part:

 _What became clear to me is that food is the way to invest in water. That is,
grow food in water-rich areas and transport it for sale in water-poor areas.
This is the method for redistributing water that is least contentious, and
ultimately it can be profitable, which will ensure that this redistribution is
sustainable._

With such a broad definition of "investing in water", my understanding is that
his strategy becomes "invest in nearly everything". Water is needed for food
production (which is already a very broad area for investment) but also in
countless industrial processes: paper production, silicon chip, anything that
uses water a solvent or as a way to cut through things...

My reasoning can not be right because it would basically mean "invest in
anything". Can someone please help me make sense of this?

~~~
msandford
I think the idea is to invest in geographical regions that have plenty of
water. I would read that as investing in land, actually, because in places
with plenty of water the land is going to appreciate versus places without
plenty of water.

~~~
pitt1980
I don't have an opinion on whether that is or isn't a good strategy

what I find interesting is that seems to be the converse of the historical
trend of the last 30 years or so

Rust Belt places like Michigan and Upstate New York, actually have a lot of
water and have been losing population to places like CA, AZ, and Las Vegas
which don't

it seems like more people are less connected to water than they ever have been

maybe there is a correction coming, maybe there isn't, I don't feel confident
asserting a guess either way as to that

~~~
msandford
That the water rich places have been losing population to water poor areas
would allow you to buy real estate in those locations below historical norms.
If you buy into the "water will be more important in the future" hypothesis
then it's probably a good bet.

I agree that it's hard to know if a correction is coming. I suspect that it
_eventually_ will happen, but how far away that eventually is I don't want to
speculate. Might be a couple of years, might be a couple of decades.

------
chejazi
Thought it was interesting that Growth was at the center of both of the
following:

> What makes you most nervous about the future? Debt. The idea that growth
> will remedy our debts is so addictive for politicians, but the citizens end
> up paying the price.

> What, if anything, makes you hopeful about the future? Innovation,
> especially in America, is continuing at a breakneck pace, even in areas
> facing substantial political or regulatory headwinds.

------
cconcepts
Currently reading The Big Short and struggling to get my head around what
actually happened - now its supposedly happening again?

EDIT: I came back from reading the article a second time and was relieved to
see that the speculative title had been changed.

------
jpeg_hero
Broken clock right twice a day.

A classic case of a "short/crash/doomsday personality" hitting his perfect
moment.

Kudos to him, but I'll look elsewhere for insight on the next
cricis/opportunity.

~~~
enraged_camel
>>I'll look elsewhere for insight on the next cricis/opportunity.

Where?

------
puranjay
"If The Big Short, Adam McKay’s adaptation of Michael Lewis’s book about the
2008 financial crisis and the subject of last month’s Vulture cover story, got
you all worked up over the holidays, you’re probably wondering what Michael
Burry, the economic soothsayer portrayed by Christian Bale who’s always just a
few steps ahead of everyone else, is up to these days"

Wow, use some periods maybe?

------
Animats
I used to write on investing from a fundamentals perspective. I saw the
housing crash coming in 2004. See my
"[http://www.downside.com/news.html"](http://www.downside.com/news.html"),
where I wrote:

 _" The next crash looks to be housing-related. Fannie Mae is in trouble. But
not because of their accounting irregularities. The problem is more
fundamental. They borrow short, lend long, and paper over the resulting
interest rate risk with derivatives. In a credit crunch, the counterparties
will be squeezed hard. The numbers are huge. And there's no public record of
who those counterparties are._

 _Derivatives allow the creation of securities with a low probability of loss
coupled with a very high but unlikely loss. When unlikely events are
uncorrected, as with domestic fire insurance, this is a viable model. When
unlikely events are correlated, as with interest rate risk, everything breaks
at once. Remember "portfolio insurance"? Same problem._

 _Mortgage financing is so tied to public policy that predictions based on
fundamentals are not possible. All we can do is to point out that huge
stresses are accumulating in that sector. At some point, as interest rates
increase, something will break in a big way. The result may look like the
1980s S &L debacle."_

In 2006 I wrote:

 _" Interest-only loans as a percentage of new loans. (Graph) (Data from Loan
performance)

People with these loans are not homeowners. They're renters, with an option to
buy. One interest-rate spike and they're out on the street."_

It took longer for this to crash than I expected. Mostly because the Fed
pushed out cheap money to delay the crash. I was expecting an interest rate
spike, but that didn't happen. I also didn't expect the thing to cascade so
badly; I though the problem was going to be comparable to the 1980s S&L mess,
not worse.

A key number to watch is the ratio of median house price to median income.
Historically, that runs around 2.7. Above 3, trouble begins; people can't make
their house payments. In the last bubble, it passed 4 for the US nationwide,
and 10 for California. For that graph, see [1]. Click on "Price to Income".
Look at the line for "United States". It's about 3.3 now; it hit about 4.1
before the last crash, then dropped to 3.0. Look at the graphs for California
cities; they're much higher. But not as high as last time, yet. Keep watching
those numbers; they're a leading indicator of a housing bubble/crash.

The problem with speculating on this is market timing. You can see the
stresses building up, but it's hard to tell when the system will break. Those
way-out-of-the-money option strategies hit this - you lose money every year as
you wait for the big event. Burry almost ran out of time and money that way.
Taleb, the "black swan" guy, doesn't release the results for his Empirica
hedge fund for years other than the one year he hit the jackpot. His people
got really upset when someone leaked them, they made it into Wikipedia, and he
didn't look so good.

(On other fronts, I expected peak oil to be a bigger problem than it was;
fracking fixed that, for now. And I thought Bitcoin would collapse long ago;
instead, its use case for getting money out of China made it valuable.)

[1]
[http://www.economist.com/blogs/graphicdetail/2015/11/daily-c...](http://www.economist.com/blogs/graphicdetail/2015/11/daily-
chart-0)

~~~
paulpauper
Contrary to popular belief, a lot of pundits were actually bearish on housing
in 2005-2007. Given the enormity of the crash, it makes these predictions seem
more prescient than they really were, but such predictions were hardly unique.
A Google headline search from 2004-2007 shows many calls for a bubble or crash
in housing. Also, the vast majority of pundit predictions are wrong (like all
those predictions between 2009-present for the stock market to crash and or
for a double dip recession). Being right once is hardly a reprieve.

