The Big Short: Inside the Doomsday Machine (7 page)

Mike Burry couldn't see exactly who was following his financial moves, but he could tell which domains they came from. In the beginning his readers came from EarthLink and AOL. Just random individuals. Pretty soon, however, they weren't. People were coming to his site from mutual funds like Fidelity and big Wall Street investment banks like Morgan Stanley. One day he lit into Vanguard's index funds and almost instantly received a cease and desist order from Vanguard's attorneys. Burry suspected that serious investors might even be acting on his blog posts, but he had no clear idea who they might be. "The market found him," says the Philadelphia mutual fund manager. "He was recognizing patterns no one else was seeing."

By the time Burry moved to Stanford Hospital in 1998 to take up his residency in neurology, the work he had done between midnight and three in the morning had made him a minor but meaningful hub in the land of value investing. By this time the craze for Internet stocks was completely out of control and had infected the Stanford University medical community. "The residents in particular, and some of the faculty, were captivated by the dot-com bubble," said Burry. "A decent minority of them were buying and discussing everything--Polycom, Corel, Razorfish, Pets.com, TIBCO, Microsoft, Dell, Intel are the ones I specifically remember, but areyoukiddingme-dot-com was how my brain filtered a lot of it.... I would just keep my mouth shut, because I didn't want anybody there knowing what I was doing on the side. I felt I could get in big trouble if the doctors there saw I wasn't one hundred and ten percent committed to medicine."

People who worry about seeming sufficiently committed to medicine probably aren't sufficiently committed to medicine. The deeper he got into his medical career, the more Burry felt constrained by his problems with other people in the flesh. He briefly tried to hide in pathology, where the people had the decency to be dead, but that didn't work. ("Dead people, dead parts. More dead people, more dead parts. I thought, I want something more cerebral.")

He'd moved back to San Jose, buried his father, remarried, and been misdiagnosed by experts as bipolar when he shut down his Web site and announced he was quitting neurology to become a money manager. The chairman of the Stanford Department of Neurology thought he'd lost his mind and told him to take a year to think it over, but he'd already thought it over. "I found it fascinating and seemingly true," he said, "that if I could run a portfolio well, then I could achieve success in life, and that it wouldn't matter what kind of person I was perceived to be, even though I felt I was a good person deep down." His $40,000 in assets against $145,000 in student loans posed the question of exactly what portfolio he would run. His father had died after another misdiagnosis: A doctor had failed to spot the cancer on an X-ray, and the family had received a small settlement. The father disapproved of the stock market, but the payout from his death funded his son into it. His mother was able to kick in $20,000 from her settlement, his three brothers kicked in $10,000 each of theirs. With that, Dr. Michael Burry opened Scion Capital. (As a boy he'd loved the book
The Scions of Shannara
.) He created a grandiose memo to lure people not related to him by blood. "The minimum net worth for investors should be $15 million," it said, which was interesting, as it excluded not only himself but basically everyone he'd ever known.

As he scrambled to find office space, buy furniture, and open a brokerage account, he received a pair of surprising phone calls. The first came from a big investment fund in New York City, Gotham Capital. Gotham was founded by a value investment guru named Joel Greenblatt. Burry had read Greenblatt's book
You Can Be a Stock Market Genius
. ("I hated the title but liked the book.") Greenblatt's people told him that they had been making money off his ideas for some time and wanted to continue to do so--might Mike Burry consider allowing Gotham to invest in his fund? "Joel Greenblatt himself called and said, 'I've been waiting for you to leave medicine.'" Gotham flew Burry and his wife to New York--and it was the first time Michael Burry had flown to New York or flown first-class--and put him up in a suite at the Intercontinental Hotel.

On his way to his meeting with Greenblatt, Burry was wracked with the anxiety that always plagued him before face-to-face encounters with people. He took some comfort in the fact that the Gotham people seemed to have read so much of what he had written. "If you read what I wrote first, and then meet me, the meeting goes fine," he said. "People who meet me who haven't read what I wrote--it almost never goes well. Even in high school it was like that--even with teachers." He was a walking blind taste test: You had to decide if you approved of him before you laid eyes on him. In this case he was at a serious disadvantage, as he had no clue how big-time money managers dressed. "He calls me the day before the meeting," says one of his e-mail friends, himself a professional money manager. "And he asks, 'What should I wear?' He didn't own a tie. He had one blue sports coat, for funerals." This was another quirk of Mike Burry's. In writing he presented himself formally, even a bit stuffily, but he dressed for the beach. Walking to Gotham's office, he panicked and ducked into a Tie Rack and bought a tie.

He arrived at the big New York money management firm as formally attired as he had ever been in his entire life to find its partners in t-shirts and sweatpants. The exchange went something like this.

"We'd like to give you a million dollars."

"Excuse me?"

"We want to buy a quarter of your new hedge fund. For a million dollars."

"You do?"

"Yes. We're offering a million dollars."

"After tax!"

Somehow Burry had it in his mind that one day he wanted to be worth a million dollars, after tax. At any rate, he'd just blurted that last bit out before he fully understood what they were after. And they gave it to him! At that moment, on the basis of what he'd written on his blog, he went from being an indebted medical student with a net worth of minus $105,000 to a millionaire with a few outstanding loans. Burry didn't know it, but it was the first time Joel Greenblatt had done such a thing. "He was just obviously this brilliant guy, and there aren't that many of them," says Greenblatt.

Shortly after that odd encounter, he had a call from the insurance holding company White Mountains. White Mountains was run by Jack Byrne, a member of Warren Buffett's inner circle, and they had spoken to Gotham Capital. "We didn't know you were selling part of your firm," they said--and Burry explained that he didn't realize it either until a few days earlier, when someone offered a million dollars, after tax, for it. It turned out that White Mountains, too, had been watching Michael Burry closely. "What intrigued us more than anything was that he was a neurology resident," says Kip Oberting, then at White Mountains. "When the hell was he doing this?" From White Mountains he extracted $600,000 for a smaller piece of his fund, plus a promise to send him $10 million to invest. "And yes," said Oberting, "he was the only person we found on the Internet and cold-called and gave him money."

In Dr. Mike Burry's first year in business, he grappled briefly with the social dimension of running money. "Generally you don't raise any money unless you have a good meeting with people," he said, "and generally I don't want to be around people. And people who are with me generally figure that out." He went to a conference thrown by Bank of America to introduce new fund managers to wealthy investors, and those who attended figured that out. He gave a talk in which he argued that the way they measured risk was completely idiotic. They measured risk by volatility: how much a stock or bond happened to have jumped around in the past few years. Real risk was not volatility; real risk was stupid investment decisions. "By and large," he later put it, "the wealthiest of the wealthy and their representatives have accepted that most managers are average, and the better ones are able to achieve average returns while exhibiting below-average volatility. By this logic a dollar selling for fifty cents one day, sixty cents the next day, and forty cents the next somehow becomes worth less than a dollar selling for fifty cents all three days. I would argue that the ability to buy at forty cents presents opportunity, not risk, and that the dollar is still worth a dollar." He was greeted by silence and ate lunch alone. He sat at one of the big round tables just watching the people at the other tables happily jabber away.

When he spoke to people in the flesh, he could never tell what had put them off, his message or his person. He'd made a close study of Warren Buffett, who had somehow managed to be both wildly popular and hugely successful. Buffett had had trouble with people, too, in his youth. He'd used a Dale Carnegie course to learn how to interact more profitably with his fellow human beings. Mike Burry came of age in a different money culture. The Internet had displaced Dale Carnegie. He didn't need to meet people. He could explain himself online and wait for investors to find him. He could write up his elaborate thoughts and wait for people to read them and wire him their money to handle. "Buffett was too popular for me," said Burry. "I won't ever be a kindly grandfather figure."

This method of attracting funds suited Mike Burry. More to the point, it worked. He'd started Scion Capital with a bit more than a million dollars--the money from his mother and brothers and his own million, after tax. In his first full year, 2001, the S&P 500 fell 11.88 percent. Scion was up 55 percent. The next year, the S&P 500 fell again, by 22.1 percent, and yet Scion was up again: 16 percent. The next year, 2003, the stock market finally turned around and rose 28.69 percent, but Mike Burry beat it again--his investments rose by 50 percent. By the end of 2004, Mike Burry was managing $600 million and turning money away. "If he'd run his fund to maximize the amount he had under management, he'd have been running many, many billions of dollars," says a New York hedge fund manager who watched Burry's performance with growing incredulity. "He designed Scion so it was bad for business but good for investing."

"While capital raising may be a popularity contest," Burry wrote to his investors, perhaps to reassure them that it didn't matter if they loved their money manager, or even knew him, "intelligent investment is quite the opposite."

Warren Buffett had an acerbic partner, Charlie Munger, who evidently cared a lot less than Buffett did about whether people liked him. Back in 1995, Munger had given a talk at Harvard Business School called "The Psychology of Human Misjudgment." If you wanted to predict how people would behave, Munger said, you only had to look at their incentives. FedEx couldn't get its night shift to finish on time; they tried everything to speed it up but nothing worked--until they stopped paying night shift workers by the hour and started to pay them by the shift. Xerox created a new, better machine only to have it sell less well than the inferior older ones--until they figured out the salesmen got a bigger commission for selling the older one. "Well, you can say, 'Everybody knows that,'" said Munger. "I think I've been in the top five percent of my age cohort all my life in understanding the power of incentives, and all my life I've underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther."

Munger's remarks articulated a great deal of what Mike Burry, too, believed about markets and the people who comprised them. "I read that speech and I said, I agree with every single word of that," Burry said, adding, "Munger also has a fake eye." Burry had his own angle on this same subject, derived from the time he'd spent in medicine. Even in life or death situations, doctors, nurses, and patients all responded to bad incentives. In hospitals in which the reimbursement rates for appendectomies ran higher, for instance, the surgeons removed more appendixes. The evolution of eye surgery was another great example. In the 1990s, the ophthalmologists were building careers on performing cataract procedures. They'd take half an hour or less, and yet Medicare would reimburse them $1,700 a pop. In the late 1990s, Medicare slashed reimbursement levels to around $450 per procedure, and the incomes of the surgically minded ophthalmologists fell. Across America, ophthalmologists rediscovered an obscure and risky procedure called radial keratotomy, and there was a boom in surgery to correct small impairments of vision. The inadequately studied procedure was marketed as a cure for the suffering of contact lens wearers. "In reality," says Burry, "the incentive was to maintain their high, often one-to two-million-dollar incomes, and the justification followed. The industry rushed to come up with something less dangerous than radial keratotomy, and Lasik was eventually born."

Thus when Mike Burry went into business he made sure that he had the proper incentives. He disapproved of the typical hedge fund manager's deal. Taking 2 percent of assets off the top, as most did, meant the hedge fund manager got paid simply for amassing vast amounts of other people's money. Scion Capital charged investors only its actual expenses--which typically ran well below 1 percent of the assets. To make the first nickel for himself, he had to make investors' money grow. "Think about the genesis of Scion," says one of his early investors. "The guy has no money and he chooses to forgo a fee that any other hedge fund takes for granted. It was unheard of."

Right from the start, Scion Capital was madly, almost comically, successful. By the middle of 2005, over a period in which the broad stock market index had fallen by 6.84 percent, Burry's fund was up 242 percent and he was turning away investors. To his swelling audience, it didn't seem to matter whether the stock market rose or fell; Mike Burry found places to invest money shrewdly. He used no leverage and avoided shorting stocks. He was doing nothing more promising than buying common stocks and nothing more complicated than sitting in a room reading financial statements. For roughly $100 a year he became a subscriber to 10-K Wizard. Scion Capital's decision-making apparatus consisted of one guy in a room, with the door closed and the shades drawn, poring over publicly available information and data on 10-K Wizard. He went looking for court rulings, deal completions, or government regulatory changes--anything that might change the value of a company.