Know about the mortgage crisis in 2008: If you consider yourself a veteran investor in the stock market, you must have heard a lot about the 2007-2008 financial crisis. This Global Financial Crisis was the most severe crisis since the Great Depression.

The 2007-2008 financial crisis was a financial and economic collapse, costing several ordinary people their respective jobs, savings, homes, or, in some cases, all three. Several American homeowners found themselves owning way more on their mortgages than what their homes were worth. 

While trillions of dollars went down the drain during the Global mortgage crisis in 2008, Dr. Michael Burry made a fortune from the collapse. He not only saw this impending crisis coming, but he positioned himself to benefit from the global collapse. 

2008 Financial Crisis image

Dr Michael Burry, a physician turned investor, thinks of himself as a value investor and considers Benjamin Graham and Warren Buffett as his mentors. He started his hedge fund, Scion Capital, in 2000.

In 2005, he turned his focus to the subprime market. He carefully analyzed mortgage lending practices that were being followed in 2003 and 2004. Observing this he began warning his clients in 2005 about the tragic meltdown. Burry predicted that the real estate bubble would burst in 2007.

Dr. Burry’s research convinced him that subprime mortgages, principally the ones having lower rates, and bonds based on these mortgages, will start to lose value at the time when original rates were restored by significantly higher ones.

Therefore, he decided to short the market and persuaded big investment firms to sell him CDSs against risky subprime deals. 

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How did Michael Burry predict the 2008 housing bubble?

He saw the first red flag in 2003 when he noticed that mortgages were offered to subprime borrowers at an increasing pace. Subprime borrowers are borrowers who represent a higher risk to the lending parties. They are the ones with lower credit scores. Therefore, loans offered to them are considered risky. 

Coming back to our discussion, risky loans which were offered were then bundled together. Later, they were passed on to market as mortgage-backed securities. Mortgage-backed securities, also known as MBS, are the bonds that are secured by the home and other real estate loans.

Dr. Burry saw an opportunity and decided to bet. By 2005, he became confident about this collapse and shorted the housing market through the creation of a financial derivative instrument named credit default swap.

This was a derivative instrument and was a tool against the housing market. It acted as an insurance product, and Dr. Burry had to pay a premium as it insured him against a payout if the real estate market starts to deteriorate. 

Initially, the premiums he was paying were impacting returns generated by his company. Due to this, he suffered investor revolt as some investors feared his predictions and demanded their capital be withdrawn.

Later, in 2007, the situation started to unfold as Dr. Burry predicted. His bet against the housing market led to him earning $100 million, while his investors earned $700 million.

According to him, credit-rating agencies were being complacent and he anticipated that this nature will cost them big time. Agencies graded the riskiest parts of securities as “BBB” or investment-grade, and they gave an “AAA” rating to the safest 80% even though they were so-called “subprime structures”.

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Dr Michael Burry viewed that 20% of securities were attached with interest-only mortgages, while 50%-70% were attached to cash-out refinancing and homeowners swapped their mortgages with even the bigger ones.

Finally, 30%-40% of borrowers who were involved had FICO credit scores of less than 600. Dr Michael Burry viewed that between ~15%-25% of home loans were having above 90% LTV. He went on to say that ~40% of loans were having second liens.

This means another loan will be paid first in case the borrower becomes bankrupt. Spreads on “BBB” securities were ~150 bps against ~300 bps in the prior year. This means that investors were not viewing these products as risky ones. 

On numerous occasions, Dr Michael Burry was able to benefit by placing contrarian bets. In the year 2001, when S&P 500 declined by ~11.88%, his hedge fund, Scion Capital, increased by ~55%.

These stellar returns were achieved off the back of contrarian bets. He shorted overvalued tech stocks when the internet bubble was at its peak. In the next year, his hedge fund was again up by ~16%, while S&P 500 fell by ~22.1%.

In 2003, the stock market delivered a stellar performance as the S&P 500 was up ~28.69%. This time again Dr. Michael Burry’s hedge fund, Scion Capital, outpaced the market by delivering returns of ~50%. 

Dr. Michael Burry has been making headlines lately as he thinks that the stock market can soon fall to historically low levels.

Why Did Everyone Lose Their Homes In 2008?

The 2008 crisis saw millions of homeowners defaulting on their mortgages, due to the burst of the housing bubble. Most homeowners were paying mortgages that were worth more than the house they bought.

That’s pretty much it on Mortgage Crisis in 2008 and how did Michael Burry predict the 2008 housing bubble. We hope you enjoyed reading it. Happy investing!

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