From FT Alphaville's post "Subprime short, from the beginning":
Go here for the superb tale of a Milton Friedman-reading , subprime-shorting, one-eyed hedge fund manager, as excerpted by Vanity Fair.
Michael Burry, one of the subjects of Liar’s Poker-playing Michael Lewis’ new book, The Big Short, chronicles the thinking behind Burry’s big US housing bet. According to the book, the man, who founded Scion Capital, was the first to start shorting subprime mortgages via credit default swaps (CDS).
The whole thing is worth reading but the reaction from the investment banks Burry was dealing with at the time is of particular interest, and something that’s already been picked out by the likes of Reuters columnist Felix Salmon.
Here’s a quick summary:
The only problem was that there was no such thing as a credit-default swap on a subprime-mortgage bond, not that he could see. He’d need to prod the big Wall Street firms to create them. But which firms? If he was right and the housing market crashed, these firms in the middle of the market were sure to lose a lot of money. There was no point buying insurance from a bank that went out of business the minute the insurance became valuable. He didn’t even bother calling Bear Stearns and Lehman Brothers, as they were more exposed to the mortgage-bond market than the other firms. Goldman Sachs, Morgan Stanley, Deutsche Bank, Bank of America, UBS, Merrill Lynch, and Citigroup were, to his mind, the most likely to survive a crash. He called them all. Five of them had no idea what he was talking about; two came back and said that, while the market didn’t exist, it might one day. Inside of three years, credit-default swaps on subprime-mortgage bonds would become a trillion-dollar market and precipitate hundreds of billions of losses inside big Wall Street firms. Yet, when Michael Burry pestered the firms in the beginning of 2005, only Deutsche Bank and Goldman Sachs had any real interest in continuing the conversation. No one on Wall Street, as far as he could tell, saw what he was seeing.
Deutsche Bank and Goldman became the first two firms to start selling Burry CDS on subprime asset-back securities, with the hedge funder basically picking and choosing which tranches to insure at will. As Burry puts it, banks like Deutsche “didn’t seem to care” which bonds he wanted to bet against....MUCH MORE
