The Greatest Trade Ever

by Gregory Zuckerman

  Pellegrini tried to judge his boss’s reaction, and whether he was out of line. But Paulson liked to encourage his staff to develop novel approaches to problems, and he seemed intrigued, a small smile forming on his face. He asked Pellegrini to research how the firm could buy CDS contracts on financial companies, which Paulson was especially worried about due to all their borrowed money.

  In truth, Pellegrini didn’t know that much about how credit-default swaps were traded, other than watching others do it at Tricadia. So he arranged for tutorials by various brokerage firms on the ins and outs of credit-default swaps. The fund made its first purchase of CDS protection on a company called MBIA, Inc., which insured all those mortgage bonds backed by aggressive loans. The annual cost of insuring $100 million of MBIA’s debt was a puny $500,000. In other words, if MBIA ran into problems and its debt became worthless, Paulson would get paid $100 million thanks to CDS protection that cost just $500,000 annually. It seemed a no-brainer to Paulson.

  Over the next two months, MBIA’s profits climbed, and the price of its debt remained strong, making it clear to Paulson and Pellegrini how difficult it could be to take a stance against a single company. Soon, their position faced some small losses. They discovered that the value of CDS protection falls as the underlying debt gets closer to maturity. Paulson and Pellegrini were dipping their toes into the water, still figuring out how to bet against the housing market.

  But in Northern California, far from Wall Street’s frenzied trading desks, an obscure investor already was zeroing in on real estate, well ahead of Paulson & Co., certain that he had discovered the trade of a lifetime.

  4.

  WHEN MICHAEL BURRY WAS BORN, IN 1971, HIS STEEL BLUE eyes seemed crossed in an unusual way, drawing immediate concern from his parents. A local pediatrician in Johnson City, New York, a suburb of Binghamton, dismissed the Burrys’ worries, assuring them that the boy had a lazy left eye that would improve with time. But James Burry couldn’t shake a feeling that something was wrong with his son.

  Over the next year, he and his wife, Marion, brought Michael from doctor to doctor, searching for a better explanation. Finally, an ophthalmologist diagnosed retinoblastoma, a dangerous cancer that strikes one in twenty thousand children. They drove three hours to Columbia Presbyterian Medical Center in New York City, where doctors removed the boy’s left eye, to prevent the tumor from spreading.

  Before he turned two, Michael was fitted with a glass prosthesis. It was an approximation of his natural eye, the best they could produce at the time, but it had no movement, making it quite obvious.

  Later, Michael had difficulty adjusting to the artificial eye. His depth perception was poor. Intense pain in the socket often forced him to leave class to visit the school nurse. One day in second grade, older children gathered around, cheering Burry to “take it out, take it out.” Reluctantly, he complied, drawing even more unwanted attention.

  In 1977, when Burry was almost seven, his father landed a transfer to an IBM plant in Northern California. The family, which by then included three more sons, moved to South San Jose, a middle-class city in Silicon Valley. An IQ test at his public school showed that Michael was highly intelligent, and he was placed in advanced science and math classes. Reading came slowly to him, but he persisted and soon was devouring books, especially escapist fantasies and biographies of sports heroes.

  Burry was forced to wear safety glasses to protect his eye. Frustrated and embarrassed, he sometimes would smash the glasses, which slid down on his nose and sometimes obstructed his field of vision, telling his parents they had broken during a game, hoping the glasses wouldn’t be replaced.

  Marion, who had been raised in a poor, Catholic family in Wilkes-Barre, Pennsylvania, sometimes dressed her sons in discount clothing from a local Kmart. They became a focus of derision for his middle-school classmates, who were children of engineers and other employees of local technology companies. Michael turned shy around some of them.

  “I never had more than one or two friends, if that,” Burry recalls. “I always was a bit of an outsider.”

  His father often worked late, and his mother, a biology major in college who had returned to school to pursue a master’s degree, holed up in the library most afternoons. So after school, Burry was left to pick up his three brothers at the homes of various friends, warm a tray of TV dinners, and help with their homework.

  Michael’s parents frequently argued loudly as he huddled in a bedroom listening. They divorced during the summer after he finished fifth grade, and Michael and his brothers moved with their father to a nearby town. His father, the first in his family to graduate from college, was a stern disciplinarian who hated to see his sons idling, especially in front of a television. Some afternoons, he made the boys carry piles of bricks from the backyard of the house to the side. The next day, they’d haul the bricks right back to the backyard, just so James could keep them occupied. Most weekends, he would lock the boys out of the house, forcing them to play outdoors.

  Each summer, James brought his sons camping in the Sierra Nevada Mountains, where they lived in an army-surplus tent for weeks at a time, sharing it with their black Labrador retriever. The former Marine taught his boys to shoot deer with a bow and arrow and to ride a Yamaha 80cc motorcycle on mountain trails and dirt access roads. One night during each trip, they emerged from the woods to dine at a nearby restaurant, drawing stares for their scruffy appearance. Burry lugged a stack of books to the campsite and read for hours by the fire, avoiding gathering wood or cleaning the tent, a dereliction of duty that infuriated his father. James Burry respected education but was suspicious of any act that required a lot of sitting around.

  One day, Michael noticed the stock quotations in the business section of the local newspaper and asked his father to explain them. James was skeptical of the stock market but pointed to the symbol for American Motors, the maker of army jeeps, then trading at $4 ⅝ a share. He piqued the interest of his son, and Michael tracked American Motors shares every day for more than a year, fascinated by each little move, and the fortunes that his father explained were made and lost along with them.

  Michael quickly became enamored with making money. Sometimes he’d wash dollar bills, drying them off with a towel and placing them between the pages of thick books on his shelf to make them look crisp and new. Working odd jobs on Sundays and holidays, including an $11-an-hour stint at a local IBM research lab, he built a small savings account that he began to invest in mutual funds. Once, when the funds dropped sharply and he struggled to figure out why, his father wagged a finger.

  “I told you, I told you,” James Burry said. “They’re going to take all your money.”

  His parents had remarried each other by the time Michael began Santa Teresa High, though the squabbling continued. As an outlet, he turned to sports, joining South Valley Aquatics, a prestigious local swimming club. He embraced the team’s daily regimen, waking at 4:30 a.m. for practice and doing five hours of laps each day. He discovered a fierce competitive streak and relished his coach’s positive feedback.

  At school, Burry became more comfortable airing his opinions. The better his grades became, the later his father let him stay out at night. Michael soon began to equate academic achievement with freedom. He reckoned that if his grades were good enough, he’d be allowed to choose a college far away. That was all the incentive he needed; he scored As in almost every subject and aced the SATs, the college aptitude test. As he grew, his body adjusted to the artificial eye and he became more adept at taking care of it, another boon to the young man’s self-assurance.

  At a local swim meet, Burry’s coach talked him up to Harvard University’s swim coach, who suggested that Burry had a great shot to gain acceptance to Harvard. With help from a supportive English teacher, Burry sent in an application. But his guidance counselor submitted an incomplete form and Harvard rejected him. Burry was dejected for weeks, despite gaining admission to UCLA.

  Partly to please hi
s father, Michael enrolled in premed courses at UCLA, like many of his classmates. But he couldn’t seem to blend in with the other students, feeling out of place in sunny Southern California. On most nights, classmates headed out to party while Burry waved good-bye from the dorm’s study area.

  Burry seemed cocky and tactless to some, and he couldn’t figure out how to change the perception. It was as if he were missing some sensitivity chip. During his freshman year, he remarked that the school’s premed classes seemed too easy. Other times he suggested that most of the undergraduate body was lazy, and he ridiculed the lengths that classmates took to be accepted by various fraternities and sororities.

  He forced himself to listen rather than dominate conversations but continued to feel strangely disconnected from his classmates. Years later, Burry would be diagnosed with Asperger’s syndrome, a variant of autism characterized by difficulties in social interactions.

  His relationships with UCLA’s faculty sometimes were just as strained. As a junior majoring in English, he was accused by a teaching assistant of plagiarizing a term paper. The instructor didn’t have any proof; he simply said, “All I know is an undergraduate didn’t write this.”

  Around this time, Burry rediscovered a passion for the stock market, drawn by what he considered to be the meritocracy of investing. It didn’t matter if a mutual-fund manager was perceived as arrogant or was socially awkward, Burry figured, just as long as he produced good returns. Making a lot of money seemed among the most concrete and objective signs of success.

  He opened a brokerage account with his summer earnings and skipped lectures to focus on his portfolio, purchasing class notes near the end of each quarter to help cram before final exams.

  Burry soon switched his major to economics, while still juggling premed courses. In 1991, Burry was accepted to Vanderbilt University’s medical school, where he thrived. A local ocular plastic surgeon succeeded in attaching his long-dormant extraocular muscles to a hydroxy-apatite ball implanted in his left socket, and a more natural-looking artificial eye was made to fit over the ball. The result was realistic movement in the eye for the first time.

  During Burry’s third year of medical school, his father died after a short battle with lung cancer. The death was so sudden that Burry never had a chance to say good-bye; he was unable to hold back tears long enough to speak at the funeral.

  In the wake of his father’s death, Burry adopted a detached aloofness. Classmates saw him as unapproachable, and he did little to try to change the perception.

  “Everyone there was incredibly good-looking and superintelligent; I felt like a lower quintile as a person,” he recalls.

  Instead of using inheritance money to pay off mounting student loans, Burry poured it into the market, finding comfort and profit in his investments. Eager to share his budding investing views, Burry started an early Web site to discuss stocks, posting lengthy pieces several times a week. Several months later, an executive of the MSN online network came across Burry’s site and offered him $1 a word if he’d become an MSN columnist.

  “A dollar a word? I can write a lot of words,” Burry joked, hungry for extra cash. He became known as “The Value Doc,” weighing in on various stocks.

  Burry’s writing was raw, and his knowledge of the market had gaping holes. But he conducted valuable research on overlooked stocks and his insights seemed to resonate with readers.

  Many evenings, Burry wandered into a local Office Depot, rummaging through the new items. He was imagining what it might be like to run his own business. His behavior drew stares from the stores’ employees, though they soon learned Burry was harmless and better left alone. Burry’s life became a grueling mix of stock research, online postings, and a demanding medical internship. He avoided spending much time with fellow students.

  Burry finished medical school in 1997, facing $150,000 of tuition-related debt. He accepted a residency in pathology at Stanford University Hospital and moved back to his childhood home in San Jose, claiming a bedroom down the hall from his brother.

  That fall, on a dare from a friend, Burry placed a personal ad on Match.com. He chose a blunt approach: “I’m single and have one eye and a lot of debt.” Just minutes after posting the ad, Burry received an e-mail from Anh-Thi Le, a woman who worked in corporate finance in nearby Palo Alto and was thrilled to find someone downplaying his qualities rather than exaggerating them. A whirlwind, three-week courtship and an engagement with Anh-Thi Le ensued.

  Burry soon suspected that he didn’t measure up against his more-focused medical colleagues. But he was making thousands of dollars a month through his trading and the online column, enough to buy a black Dodge Dakota truck and enjoy some extra spending money.

  On his way to the hospital each morning, Burry drove through the heart of Silicon Valley, passing the world’s most prestigious venture-capital firms. The local technology industry was humming, but Burry felt strangely out of place. One afternoon in 1999, a dozen doctors crowded around a small computer terminal in the clinic, almost cheering as shares of the latest technology wonder, Atmel Corp., soared. They debated which high-tech stock was more attractive, Applied Materials, Cisco Systems, or Polycom. Burry, who by then had switched to become a neurology resident, and at night was posting online columns arguing that all those stocks were wildly overpriced, bit his lip, wary of letting them know about his side job.

  This isn’t going to end well. Sell! Sell! Sell!

  The bursting of the dot-com bubble in the spring of 2000, and the sudden losses suffered by his fellow doctors, confirmed to Burry the tendency of markets to go to extremes. By then he was posting late-night articles on a Web site of his own, valuestocks.net, after a long day tending to patients.

  By the time his residency ended in June 2000, Burry, twenty-nine, had had enough of medicine. He had married Anh-Thi, and she, too, had moved into his parents’ house, where the couple lived with Burry’s brother.

  Although Burry didn’t know what a hedge fund was, he had read how Warren Buffett began his career with a partnership, to invest for himself and others. Burry figured he’d do the same. He obtained a one-year forbearance on his loans, and his family agreed to buy small stakes in his firm, giving Burry time to make a go of it. Anh-Thi emptied her retirement account to give her new husband more cash to invest. His broker at Bank of America, Alison Sanger, set him up with an account, and Burry’s hedge-fund career was under way.

  Two weeks later, a New York investor named Joel Greenblatt called Burry, disturbing the quiet of his living-room office, next to the drum set.

  “Michael, I’ve been reading your work for a while, and I read that you’re leaving medicine,” Greenblatt said. It turned out that Greenblatt had been monitoring Burry’s Web site. “You’re a really talented analyst. My firm would like to make money from your ideas.”

  Greenblatt, who managed his own hedge fund and had published an investing book with a cult following, flew Burry and his wife to New York for a meeting, putting them up in the penthouse suite of the Intercontinental Hotel. A friend urged Burry to dress up for the meeting, so he stopped at a Tie Rack store and struggled to put on a blue tie as he rode the elevator. Greenblatt greeted him wearing an open-collar shirt; his partner, Rob Goldstein, was dressed in a sweater and jeans, putting Burry immediately at ease.

  Greenblatt skipped the chitchat. He told Burry that he wanted a stake in his new business.

  “I want to give you a million dollars,” Greenblatt told him, pausing for effect.

  Without missing a beat, Burry replied: “After tax.”

  Burry sold Greenblatt a 22.5 percent piece of the business, using the proceeds to pay off his school loans. He named his firm Scion Capital, inspired by The Scions of Shannara, a Terry Brooks fantasy novel. Burry would be a scion of investing greats such as Buffett and Benjamin Graham, although he would chart his own path. Back in California, he eventually rented a small office in a suburban office park, blocks from the headquarters of Apple Computer. T
he office once had been Apple cofounder Steve Wozniak’s, which Burry took as an auspicious sign.

  Burry wasn’t very good at courting clients, but he figured if his results were strong enough investors would line up. Early on in his fund, after top executives of Avanti Software were charged with stealing secrets from a rival and the stock plunged to $2 per share, Burry determined that customers still were relying on Avanti’s products. So he bought all the shares he could afford. Just months later, he watched the stock shoot up to $22, his first coup.

  As WorldCom weakened, Burry’s clients urged him to buy the discounted shares. But he resisted, unable to figure out why the telecom giant’s profits were so much fatter than those of its competitors. The company must be fudging its accounting, he concluded. In the summer of 2002, WorldCom admitted to accounting fraud and filed for bankruptcy, vindicating Burry. He beat himself up, though, for not profiting from the shares’ collapse. He kept asking himself, what could I have done differently?

  Leafing through the finance section of a local bookstore, Burry found a particularly dense tome, Credit Derivatives & Synthetic Structures: A Guide to Instruments and Applications, that explained the knotty world of credit-default swaps, or CDS. The terminology sounded complex, and it was a slow slog getting through the jargon. But for Burry, it was like stumbling into an alternative world he never knew existed, one rife with possibility. While CDS contracts rarely garnered any mention in newspapers or on financial television, and most stock-focused investors hardly knew of them, Burry discovered that the CDS market had soared to $2 trillion from about $100 billion the previous decade, becoming among the world’s largest financial markets.

  Burry quickly realized CDS contracts were not very different from everyday insurance contracts. A buyer of a CDS contract agreed to pay a premium, in regular installments, as with any insurance contract, in exchange for protection sold by the seller of the CDS. But instead of guarding against damage to a house or car, CDS contracts offered a relatively easy way to prevent damage to an investment portfolio resulting from a company running into problems paying its debts.