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How A Few Made Millions Betting Against The Market

Writer Michael Lewis is the author of Moneyball, Liar's Poker, and The Blind Side, books with vastly different subjects but a common theme: outsiders with innovative ideas who find astonishing success. Lewis' newest book continues that narrative. The Big Short: Inside the Doomsday Machine chronicles the 2008 financial collapse through stories of the people who realized what was happening to the U.S. economy while it was happening — and then made vast fortunes by betting against the markets.

"Everybody [on Wall Street] was working with the same set of facts about subprime mortgage lending — about how subprime mortgage loans were turned into bonds and repackaged and turned into CDOs and so on and so forth," Lewis tells Terry Gross. "[And] the vast majority of the people in the markets took those facts and painted one kind of picture with it; it was a very pleasant picture. And a very small handful of people took the same facts and painted a completely different kind of picture with it. [I wanted to find out] 'What is it that enables [the people who bet against the market] to paint that picture?' and 'Why do these people look at the world differently?' "

Dr. Michael Burry

One of the most compelling stories Lewis tells in The Big Short follows a doctor, Michael Burry, who decided to leave his neurology residency after his investment blog attracted attention from money managers across the country. Burry started a hedge fund named Scion Capital, which, Lewis writes, was "madly, almost comically successful" — even when the Standard & Poors index fell.

While investigating stocks to invest for his customers, Burry discovered that the bond market was absorbing subprime mortgage loans in incredible volumes. Soon he realized that the millions of dollars of credit swirling around the market were artificially inflated and almost worthless.

Burry figured that he could bet against pools of these subprime mortgage loans using an instrument called a "credit default swap," essentially insurance on a corporate loan. Burry persuaded the investment banks to create credit default swaps for the subprime mortgage market.

"As the pools of loans that are underneath these bonds start to default," Lewis says, the investment banks that gambled on the subprime mortgage loans were forced to send Burry money daily as the bonds went bad. "Wall Street firms, they were on the other side of the bets."

Charles Ledley and Jaime Mai

Ledley and Mai were two guys in their early 30s who decided to start their own hedge fund with just over $100,000. They quickly made more than $15 million by betting on financial events that are extremely unlikely to occur — and therefore didn't cost much to bet against.

"They thought that Wall Street underestimated the likelihood of really unlikely events," Lewis says. "So they would buy options to buy stocks at prices far, far away from where the stocks were currently trading. They did this with currencies, they did it with commodities. They scoured the world, essentially looking to make bets on extreme things happening."

Soon, Ledley and Mai stumbled into the subprime mortgage market and realized that they could bet against not only the loans but also the financial institutions themselves.

"They're able to piece together a clear picture of what's going on in a matter of months," Lewis says. "They become less interested in the bet than the social implications of what they're learning. They go to the SEC. They go to The Wall Street Journal. They're screaming at the top of their lungs, 'My God, there's fraud in the system.' "

By betting against subprime mortgages, Ledley and Mai's $15 million investment ballooned to $120 million. Soon, Ledley began to experience migraines and anxiety attacks.

"They were stressed about being right," Lewis says. "I think they were so stressed that they realized that this wasn't a bet against a company, this was a bet against an entire system. And it was a bet that arose from their insight that the system had become rigged — that, essentially, Wall Street had become a giant Ponzi scheme."

Lewis says the two men — like Dr. Burry — were able to see the failures of the market before the rest of the world did because they viewed the world differently.

"This is the story of human perception as much as it is anything else. And their attitude toward the financial markets was peculiar," Lewis says. "It was peculiar to be running around the world looking for unlikely things that might happen. ... And it told you something about Wall Street and ... the way the markets were functioning when they were dysfunctional. There weren't enough people thinking this way. There weren't enough people taking into account the real likelihood of extreme change in the world."

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