Burry’s big short question


  • Dupa

    I just watched the Big Short and started reading up on that. There’s one question that keeps nagging me and I can’t seem to find an answer to.

    In the movie, Burry mentions that the crisis will begin in H2 of 2007, I believe he cites interest rates for that?

    In his op-ed he says that too:

    Back in 2005 and 2006, I argued as forcefully as I could, in letters to clients of my investment firm, Scion Capital, that the mortgage market would melt down in the second half of 2007, causing substantial damage to the economy.

    But he doesn’t cite a reason there. If memory serves me well and he indeed meant that interest rates would rise, how would he know that? I don’t believe that the Fed plans interest rates 2 years forward.

    I have 2 other ideas:

    • that his models showed him that delinquency rate would be so high in H2 2007 that it would lead to the crisis
    • that the amount of interest-only mortgages, that would not be possible to convert them to classic mortgages, would be so high in H2 2007
    • that a lot of mortgages with “tease rates” would go to normal rates and this would cause the crash in H2 2007.

    Or combination of these, basically that enough people would default in their loans in H2 2007 for a crash to happen.

    But these are just theories. Do you know the real reason?



  • @kt_ said in Burry’s big short question:

    But these are just theories. Do you know the real reason?

    Here is my theory: Someone is always predicting this sort of thing. Eventually it happens and the guy who got lucky on the timing looks like a genius.

    Not that there weren't warning signs or anything, but we can't even agree now on what the causes were so it's difficult to be certain that someone had figured it all out back then.


  • Dupa

    @boomzilla said in Burry’s big short question:

    @kt_ said in Burry’s big short question:

    But these are just theories. Do you know the real reason?

    Here is my theory: Someone is always predicting this sort of thing. Eventually it happens and the guy who got lucky on the timing looks like a genius.

    Not that there weren't warning signs or anything, but we can't even agree now on what the causes were so it's difficult to be certain that someone had figured it all out back then.

    I’m asking for the reason why Burry believed it would be the second half o 2007. He was very specific about that, reading up a bit about him, he must have had a reason.

    What do you mean by “we can’t agree now on what the causes were”?



  • @kt_ said in Burry’s big short question:

    What do you mean by “we can’t agree now on what the causes were”?

    Like, if you asked 5 economists what caused it, you'd get 7 different answers.


  • Dupa

    @boomzilla said in Burry’s big short question:

    @kt_ said in Burry’s big short question:

    What do you mean by “we can’t agree now on what the causes were”?

    Like, if you asked 5 economists what caused it, you'd get 7 different answers.

    What level of the “cause” are you looking for? Because the direct cause is obvious, MBS made of subprime mortgages. Right?



  • @kt_ said in Burry’s big short question:

    What level of the “cause” are you looking for? Because the direct cause is obvious, MBS made of subprime mortgages. Right?

    I might call that the how rather than the why.


  • Dupa

    @boomzilla said in Burry’s big short question:

    @kt_ said in Burry’s big short question:

    What level of the “cause” are you looking for? Because the direct cause is obvious, MBS made of subprime mortgages. Right?

    I might call that the how rather than the why.

    Ah, ok. Then we’re on the same page.


  • Dupa

    Found it!

    The crisis, in my view, would start no later than 2007, by which time teaser rate periods on the vast majority of these new types of mortgages would expire, or reset, for a population of homebuyers trapped in a mortgage they could no longer afford. And on the way down, housing would take consumer spending and jobs with it, setting up a positive feedback loop of a very damaging variety.


  • Grade A Premium Asshole

    The Big Short is an amazing movie but it does a very bad job at actually explaining things. I remember how they explained what a short was and it was completely useless. Some horseshit about "betting against the market". Bleh.

    You found the answer I was going to give to you - rate readjustments hitting people who signed up for (initially) low rate mortgages they could barely afford at those low rates. IIRC it's mentioned in the movie, after the new guy Burry hired ("I like your haircut, did you do it yourself?") gets him that huge spreadsheet, but I felt like the movie really didn't focus on that very much.

    Also I think we're about to hit the same problem a couple years from now, interest rates on mortgages have been extremely low for the last few years. I have one now as well and I made sure that I could still afford to pay it even if the interest shot up from my current 1.89% PA to 5%, but I don't think most people who took low-rate mortgages in the last couple of years followed a similar train of thought...


  • Dupa

    @blek said in Burry’s big short question:

    The Big Short is an amazing movie but it does a very bad job at actually explaining things. I remember how they explained what a short was and it was completely useless. Some horseshit about "betting against the market". Bleh.

    Yeah, I work in banking and I’ve heard about CDS, but I had to read up a lot to understand what MBS, CDS and CDOs were and put it all together. Also, the large number of different kinds of mortgages. Woah!

    You found the answer I was going to give to you - rate readjustments hitting people who signed up for (initially) low rate mortgages they could barely afford at those low rates. IIRC it's mentioned in the movie, after the new guy Burry hired ("I like your haircut, did you do it yourself?") gets him that huge spreadsheet, but I felt like the movie really didn't focus on that very much.

    It still does much better job than Margin Call, a much better movie (as in, more well made), but they really wanted the viewer to not to have to bother about the intricacies of VaRs and what they meant.

    Also I think we're about to hit the same problem a couple years from now, interest rates on mortgages have been extremely low for the last few years. I have one now as well and I made sure that I could still afford to pay it even if the interest shot up from my current 1.89% PA to 5%, but I don't think most people who took low-rate mortgages in the last couple of years followed a similar train of thought...

    That’s one thing. But from what I read, the real issue was the type of mortgages that was offered. Interest-only variable rate mortgages with teaser rates close to zero: that’s what made this whole thing possible. Also, the shenaningans of rating agencies.

    I know that after 2007 Basel III introduced a lot of good concepts. That banks need to have larger reserves (based on RWAs) and extented stress testing. So, things are in a better shape regulatory-wise. Other than that, I’m no expert.



  • @kt_ said in Burry’s big short question:

    The crisis, in my view, would start no later than 2007, by which time teaser rate periods on the vast majority of these new types of mortgages would expire, or reset, for a population of homebuyers trapped in a mortgage they could no longer afford.

    But that's just begging the question of why they could no longer afford the mortgages. The reason they couldn't is that home prices went down, so they couldn't flip the house or refinance based on the appreciated value. So why did prices go down then?

    I mean, it was clearly a bubble, but there's still the matter of timing.



  • @kt_ said in Burry’s big short question:

    That’s one thing. But from what I read, the real issue was the type of mortgages that was offered. Interest-only variable rate mortgages with teaser rates close to zero: that’s what made this whole thing possible. Also, the shenaningans of rating agencies.

    And the stimulus of Fannie and Freddie snapping them up like crazy. And those two being viewed as riskless because they were backed by the US government.


  • Dupa

    @boomzilla said in Burry’s big short question:

    @kt_ said in Burry’s big short question:

    The crisis, in my view, would start no later than 2007, by which time teaser rate periods on the vast majority of these new types of mortgages would expire, or reset, for a population of homebuyers trapped in a mortgage they could no longer afford.

    But that's just begging the question of why they could no longer afford the mortgages. The reason they couldn't is that home prices went down, so they couldn't flip the house or refinance based on the appreciated value. So why did prices go down then?

    Not really. Teaser rates where near zero. They couldn’t refinance, because (at least according to the Big Short) the contracts (on interest-only variable index mortgages) were formulated in a way that prevented that from happening. So, when the higher rates kicked in, they would not be able to afford them and would default on them.

    So the houses from defaulted loans go on market. There’s more and more of them. Their value starts dropping because of saturation.

    ETA so the question here was: when would the higher interest rates kick in for enough of the subprime mortgages for the default rate to rise sufficiently for the market to break.

    Actually, to me it sounds plausible, but hey! again, I’m not an expert.


  • Dupa

    @kt_ @boomzilla

    Yup, found it:

    Credit-damaged home buyers could obtain a 2/28 hybrid ARM with affordable fixed-rate (teaser-rate) payments for two years before they reset at higher, floating rates.

    At the end of two years, borrowers would ideally have made regular payments, demonstrated their credit-worthiness and raised their credit scores. They could then easily then refinance into an affordable fixed-rate loan.

    Another kind of ARM borrower is the prosperous, low credit risk and financial savvy customer who chose the low initial interest rates on hybrid ARMs to free up cash for other purposes. When rates reset, they have the financial wherewithal to pay off loans or refinance into a fixed rate or another bargain-rate ARM.

    But there is a third class of ARM users whose numbers grew during the most recent boom. They're the ones who chose ARMs because they couldn't finance their purchases any other way, and they gambled that soaring prices would make the deals work.

    — snip —

    Many bought with very small down payments of about 5 percent or less. In a market like San Diego, single-family houses fell 6.3 percent in value between September 2005 and March 2007, according to statistics from the Case Shiller home price index. And prices are likely to decline further through the year.
    So anyone who bought in San Diego in 2005 with 5 percent down will actually owe more on the house than than its' worth.

    Lenders are not too eager to refinance under conditions like that, so owners can get stuck paying the higher, reset mortgage payments. And interest rates have been on the rise, making those payments even worse.

    Forgot source: http://money.cnn.com/2007/06/20/real_estate/when_ARMs_reset/index.htm



  • @kt_ said in Burry’s big short question:

    Not really. Teaser rates where near zero. They couldn’t refinance, because (at least according to the Big Short) the contracts (on interest-only variable index mortgages) were formulated in a way that prevented that from happening. So, when the higher rates kicked in, they would not be able to afford them and would default on them.

    Yes, but if the value went up they could sell the house and pay off the mortgage and have money left over (i.e., flip the house).



  • @kt_ said in Burry’s big short question:

    Yup, found it:

    OK, that's a plausible explanation.


  • Dupa

    @boomzilla said in Burry’s big short question:

    @kt_ said in Burry’s big short question:

    Not really. Teaser rates where near zero. They couldn’t refinance, because (at least according to the Big Short) the contracts (on interest-only variable index mortgages) were formulated in a way that prevented that from happening. So, when the higher rates kicked in, they would not be able to afford them and would default on them.

    Yes, but if the value went up they could sell the house and pay off the mortgage and have money left over (i.e., flip the house).

    That’s a good point. As I understand it, the prices were already falling in 2006, what could be the reason for that is a rising default rate that would increase the number of houses available on the market. I have no data to back this idea up, though.


  • Impossible Mission Players - A

    Holy carp there's a lot of acronyms in this thread! Should I be scared?


  • Dupa

    @tsaukpaetra said in Burry’s big short question:

    Holy carp there's a lot of acronyms in this thread! Should I be scared?

    Well, yes. But i found the movie “Big Short” to be a good starting point to understanding this. It’s a fun movie and there is a bit of theory explained there. From there, you can go off to google that stuff up! 😉

    Filed under: Obviously, TLAs are awful



  • @kt_ said in Burry’s big short question:

    That’s a good point. As I understand it, the prices were already falling in 2006, what could be the reason for that is a rising default rate that would increase the number of houses available on the market. I have no data to back this idea up, though.

    That's probably true in some markets. I bought my current house in 2007 😢 just as prices were starting to come down. But I couldn't sell my previous house, so we rented it out for several years until we could sell it. Ugh.


  • Dupa

    On th other hand, this invalidates the point about teaser rates:

    The average subprime hybrid mortgage rates at origination were in the 7.3â€"9.7 percent range for the years 2001-2007, compared to average prime hybrid mortgage rates at origination of around 2-3 percent. The subprime figures are hardly "teaser rates."

    They were of course still lower than they normally would, but they don’t say by how much. So maybe not?

    There are a few issues I have with this article. Like how they measure FRMs and ARMs default rate into account, but although they do note that ARMs are usually reset after 2-3 years, they decided to compare default rates 1 year into the contract, while ARMs should have a higher default rate 2 years into the contract.

    Link: http://www.businessinsider.com/10-myths-about-the-subprime-crisis-2009-7?IR=T


  • Dupa

    @boomzilla said in Burry’s big short question:

    @kt_ said in Burry’s big short question:

    That’s a good point. As I understand it, the prices were already falling in 2006, what could be the reason for that is a rising default rate that would increase the number of houses available on the market. I have no data to back this idea up, though.

    That's probably true in some markets. I bought my current house in 2007 😢 just as prices were starting to come down. But I couldn't sell my previous house, so we rented it out for several years until we could sell it. Ugh.

    Sounds awful! I think there are only a few things that are worse than renting houses or apartments. 😕

    “Just as prices started to come down” - does this mean you already managed to buy it a bit cheaper, or that you missed it altogether?



  • @kt_ said in Burry’s big short question:

    They were of course still lower than they normally would, but they don’t say by how much. So maybe not?

    I'm sure it was a cause. But there's no single point of failure. It was a whole system of suck.

    @kt_ said in Burry’s big short question:

    Sounds awful! I think there are only a few things that are worse than renting houses or apartments.

    Yes.

    @kt_ said in Burry’s big short question:

    “Just as prices started to come down” - does this mean you already managed to buy it a bit cheaper, or that you missed it altogether?

    The house had been on the market for a few months. We offered under the list price, which had been reduced a bit from its peak, and the price we paid was a bit less than recent local sales, but we were waaay underwater for several years. Like, 40% or so. Which wasn't really a problem for us, since we were planning on staying there (still here, BTW) and we could afford the mortgage (since refinanced for a lower rate - 3.99%, 30 year fixed - no, I don't remember the original rate off the top of my head).

    The main effect of the market drop was that our property taxes went down a bunch, since in VA they evaluate your taxable value every year based on the local market.



  • @boomzilla Especially since, IIRC, the crash actually began with the defaults of several major overseas loans made by large commercial banks (i.e., ones which had nothing to do with housing loans) to governments and large corporations back in the 1980s and 1990s, and the sub-prime crash was actually secondary in effect. But as was said, no one actually agrees on this,



  • @scholrlea said in Burry’s big short question:

    Especially since, IIRC, the crash actually began with the defaults of several major overseas loans made by large commercial banks

    I do not recall having heard this before. Do you have any links?



  • @boomzilla Unfortunately, I don't, nor do I recall where I heard this from. However, my understanding - again, without reference - is that most of the major bank failures were in commercial banks, not ones dealing in housing in the US. While the biggest ones such as WaMu were doing both, my impression was that Washington Mutual specifically failed due to international loans, primarily ones they had taken over from banks they had absorbed, or which they had purchased the marker (?) on from other banks which has been liquidating them for ready cash following the S&L crisis of the early 1990s.

    Institutional debt is generally far, far larger than even a lot of small personal debts, and tends to have a long tail in the interest payments. Hell, the UK is still paying off debts incurred while fixing the South Seas Company bubble crisis of the 1710.



  • @scholrlea Hmm...I mean...the big failures didn't start until 2008, IIRC, with Lehman Brothers and then Bear Sterns.

    The bank had become so deeply involved in mortgage origination that it had effectively become a real estate hedge fund disguised as an investment bank.

    But both of those have always been tied to mortgages.



  • @boomzilla I dunno. All I can say is that at least two different sources I'd heard not long after claimed that the sub-prime loans was just a small part of it, and that it was mostly about international business and government loans. My point is really that there are a lot of factors involved, and, as you said, no one agrees on what all of them were, never mind which ones affected what.

    Then again, I have also heard that the Great Depression had been going on in Europe for almost a year when the NYSE took a dive in 1929, and that they main factor of that was the default of loans made to Germany, which in turn were mostly redirected to cover defaulted private loans by German, British, and Dutch businessmen, mostly to parties in Russia - some were funneling money the White Army, while others had floated illegal loans the the Red Army on the incorrect assumption that some sort of gratitude would be in order. I don't recall where I heard that (I think it was a television program, but I have no idea which), and no one else I've seen has mentioned that except vague mentions of German bank failures, which lead me to believe that the source was overstating things at the very least.

    I really only know two things on this: jack and shit. I'm not sure if anyone else is in a better position to say or not.

    Filed Under: I've also heard that the main reason for 'deinstitutionalization' in the 1970s and 1908s was neither government cutbacks nor legal cases about patient rights, but were a result of the drop in private donations to mental hospitals, as the introduction of psychopharmacology led many older donors to believe they wouldn't be needed any more. Funny how that narrative is entirewly at odds with the two competing ones you usually hear, yet makes far more sense than either of them.


  • Discourse touched me in a no-no place

    @boomzilla said in Burry’s big short question:

    Not that there weren't warning signs or anything, but we can't even agree now on what the causes were so it's difficult to be certain that someone had figured it all out back then.

    Are we talking the fuel or the trigger? The fuel was definitely the large scale bad lending in the real estate market, all of which only made sense when that market was rising and defaults not correlated, so when prices dropped (as was bound to happen eventually) it all went to shit. You can point fingers of blame all over for that, but ultimately it came down to a loss of belief in the ability of many people to repay big loans.

    But the trigger was something else. Not sure what, nor do I think it matters. Financial markets are naturally noisy (and also have a lot of thundering herd syndrome, with everyone trying to copy everyone else most of the time) so that it was this trigger or that trigger wasn't really important. With a forest fire, it doesn't really matter which tree was struck by lightning to set it off; what matters is that there's fuel about to turn a small incident into an inferno.

    FWIW, economists widely knew that there was a problem ahead of the collapse of the BS and Lehmans. (I had copies of the Economist from across a few years before, and they were all warning that something really bad was going to happen in the real estate market.) The hyper-abundance of fuel was obvious. But the location and timing of the spark, and who was going to get burned? Nobody knew. Chasing it down won't teach you anything, since it (almost certainly) will be different next time. Want to prevent problems? Stop the buildup of fuel.



  • @scholrlea said in Burry’s big short question:

    and no one else I've seen has mentioned that except vague mentions of German bank failures, which lead me to believe that the source was overstating things at the very least.

    No, I've read about that quite a bit. It was definitely one of the things that lead to the disaster of the Weimar Republic and then to all of the protectionism, etc, which just served to intensify and worsen other problems.



  • @boomzilla Come to think of it, I think one of those source was a book by Bill Fawcett (not 100 Mistakes that Changed History, or at least not the current edition; it was an earlier book from the 1990s which I can't seem to find a listing of or recall the title of) and while I thought it was an interesting read, I really question it's accuracy on several other points. shrug


  • Dupa

    @boomzilla said in Burry’s big short question:

    @kt_ said in Burry’s big short question:

    They were of course still lower than they normally would, but they don’t say by how much. So maybe not?

    I'm sure it was a cause. But there's no single point of failure. It was a whole system of suck.

    Oh yeah, definitely. Of suck, stupidity and even fraud.

    @kt_ said in Burry’s big short question:

    “Just as prices started to come down” - does this mean you already managed to buy it a bit cheaper, or that you missed it altogether?

    The house had been on the market for a few months. We offered under the list price, which had been reduced a bit from its peak, and the price we paid was a bit less than recent local sales, but we were waaay underwater for several years. Like, 40% or so. Which wasn't really a problem for us, since we were planning on staying there (still here, BTW) and we could afford the mortgage (since refinanced for a lower rate - 3.99%, 30 year fixed - no, I don't remember the original rate off the top of my head).

    The main effect of the market drop was that our property taxes went down a bunch, since in VA they evaluate your taxable value every year based on the local market.

    Not that bad, then. Glad to hear that. 🙂



  • @boomzilla said in Burry’s big short question:

    Here is my theory: Someone is always predicting this sort of thing. Eventually it happens and the guy who got lucky on the timing looks like a genius.

    The stock market has forecast nine of the last five recessions.

    And that was 1966. It's been tweaked numerous times since.


  • Impossible Mission - B

    @boomzilla said in Burry’s big short question:

    That's probably true in some markets. I bought my current house in 2007 😢 just as prices were starting to come down. But I couldn't sell my previous house, so we rented it out for several years until we could sell it. Ugh.

    The opposite happened to my parents. The house got completely wrecked due to the highly infortuitous combination of 1) a pipe breaking in the upstairs bathroom 2) while they were away on vacation. This was somewhere in 2002/2003 (I don't remember exactly,) right when the housing bubble was just getting started. The house was completely unliveable by this point, so they bought a new one, intending to take the insurance money, fix up the old house quickly, and sell it to pay off the mortgage.

    Well... that didn't quite happen. The insurance company, being an insurance company, decided to dig in their heels, obstruct the whole process, deny legitimate claims, and just generally do everything possible to avoid paying out, including taking some actions that made things much worse. It took a couple years of fighting with them before they finally had the money to fix the house up. Which meant that, ironically enough, they ended up doing so and finally selling it right at the top of the housing bubble, so they seriously (completely by accident) cashed in on it!



  • @masonwheeler said in Burry’s big short question:

    1. a pipe breaking in the upstairs bathroom 2) while they were away on vacation

    Ugh...had this happen, although it was downstairs in the kitchen. Fortunately it was just a pinhole leak and the damage wasn't too too bad.


  • Impossible Mission - B

    @boomzilla Yeah. If only. This was a full-on rupture, which no one noticed until enough water built up that the pressure broke a window downstairs and water came pouring out, at which point they got a panicky phone call from the neighbors.



  • @masonwheeler said in Burry’s big short question:

    1. a pipe breaking in the upstairs bathroom 2) while they were away on vacation.

    I just came across this picture on FB:

    0_1515799587243_b0e995be-e7c1-48dc-96e2-1964cad94a52-image.png



  • @masonwheeler said in Burry’s big short question:

    1. a pipe breaking in the upstairs bathroom 2) while they were away on vacation.

    Why I turn off the water main when I am going to be gone from my house for an extended period of time.



  • @boomzilla said in Burry’s big short question:

    @masonwheeler said in Burry’s big short question:

    1. a pipe breaking in the upstairs bathroom 2) while they were away on vacation

    Ugh...had this happen, although it was downstairs in the kitchen. Fortunately it was just a pinhole leak and the damage wasn't too too bad.

    Yeah. Newly remodeled kitchen. Copper water line to the dishwasher cracked when the dishwasher was put in place. Wrecked a few hundred dollars worth of brand new wood laminate flooring.


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