Friday, April 4, 2014

Credit Default Swap and the Fall of the Housing Market

      Here is another guy to follow, he went from being a doctor at his residency to being a Hedge Fund Manager. He continued to beat the market year over year. His credit default swap (buying insurance on bonds backed by Investment banks and sold to investors as bonds, made him billions when the market crashed, had it not he would just be out the premiums on the insurance he bought, he predicted the crash correctly and made a hell of lot of money). This is how I realized how  it all works without all the financial lingo, basically he bought insurance on a car that was not his (bonds backed by mortgages) and paid his monthly insurance premiums on your car(monthly insurance rates, he was paying a million a mth). He would bet that you would wreck your car and if you didn't the bank or insurance company makes the premium, all good right. But what if the insurance company thinks you are a great driver and will never wreck your car and he thinks it is inevitable you will wreck your car and you are a bad driver. As soon as you wreck it he collects whatever sum he bought the insurance for and agreed with the bank to receive. this is a credit default swap. The issuers of these credit default swaps were some of the worlds major banks like goldman and  lehman brothers. They though their mortgage backed bonds were awesome and they enjoyed receiving a million dollar a month from Mr. Burry. The mortgages were no doc and faulty, soon to be foreclosed on. They would have waitresses making 50k a year buying 450K homes with an ARM mortgage not a fixed rate with very low interest rates, Well here comes 2008 and those loans made in 03-05 are beginning to default AKA (the mortgage meltdown or crisis) This sent the market tumbling and almost destroying many major investment banks (it did bankrupt Lehman). Mr. Burry collected his insurance on these defaulting loans and now was a billionaire, as were most of his clients. I am telling you this because don't always believe and conventional wisdom. If you have a gut feeling or know something isn't right, ask a professional or someone you trust with this knowledge what your are thinking and why. Finance is an art, not a science. Uncertainty in the market can make a chart look like a heart rate monitor.

If you want the whole story, and this book is awesome you probably won't be able to put it down. "The Big Short" is a tell all about credit default swaps and who got rich, who got fired, and went bankrupt because of them. Its funny because be fore Michael Burry approached the investment banks about this idea, there was no such thing as a credit default swap, he essentially created them in partnership with the investment banks and based on the investors and major managers greed

I just wanted to share this and question feel free to ask.

This is his blog.

and here is his bio

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