Angry Investor: “So, Mike Burry, a guy who gets his hair cut at Supercuts and doesn’t wear shoes, knows more than Alan Greenspan and Hank Paulson?!”
Burry: “Yeah. Doctor Mike Burry. Yes. He does.”
Any choice you make, someone else smarter and more experienced than you has come to the opposite conclusion and is on the other side of the trade. It doesn’t matter whether you pick your own stocks, buy focused mutual funds, or hold indexed ETFs. It requires a generous amount of chutzpah to conclude that what you’re doing makes perfect sense while holding that the chairman of the Federal Reserve and the secretary of the Treasury don’t know as much as we think they do — the brilliant point of that exchange from “The Big Short.”
When asked what qualities give someone an edge in investing, Warren Buffett didn’t say intelligence or experience. He didn’t say connections or access to research. And he didn’t say knowledge of complicated algorithms using massive data processing power. He said: “The ones that have the edge are the ones who really have the temperament to look at a business, look at an industry and not care what the person next to them thinks about it, not care what they read about it in the newspaper, not care what they hear about it on the television, not listen to people who say, ‘This is going to happen,’ or, ‘That’s going to happen.’”
Doctor Michael Burry had done his research. He knew that the AAA mortgage securities flooding the market were stuffed with mortgages of homeowners who had little to no financial capacity to pay them. Not only that, he had identified the catalyst that would begin the ultimate cascade of defaults: the sub-prime mortgages in these pools came with abnormally low “teaser” rates that would expire in less than two years, after which the monthly mortgage payments would double or even triple.
Burry didn’t care what his clients thought. He didn’t care what Alan Greenspan or Hank Paulson thought. In fact, he didn’t care what anyone else in the world thought. He cared only about whether the data and his research were accurate and reliable. If they were, Burry had eliminated the “if” and he knew the “when.”
There is plenty of risk in the investment world. However, unless a catalyst comes along, observable risk can exist almost indefinitely without actualizing. When a catalyst is identified, the risk turns into a threat. And when the trigger to a catalyst is identified, the threat becomes a call to action. That is what motivated Burry.
As I was watching the movie, it was hard to comprehend how so many otherwise intelligent and informed investors could be so blind. Yet in the real world, even if you have hard data — even if you have the catalyst and the trigger — the social need for validation and the historical fact that the crowd (i.e. the market) is mostly reliable, is enough for most of us to feel confidence in going with the flow.
Further, the way we experience present day reality is qualitatively different from the way we consider the past. In looking back we feel none of the social pressure, none of the potential for alternative outcomes and none of the negative financial consequences or self-doubt that affects thinking and decision-making in real time.
History doesn’t repeat itself in the sense that events don’t align themselves in exactly the same way; but it does repeat itself, almost perfectly, if we observe the history of investor behavior. That is why a more careful consideration of how we are perceiving a risk may be as important, perhaps even more important, than the risk itself.
Within that context let’s see if we can reframe a current risk, one that has been receiving a lot of attention: bond market liquidity.