What can you learn today from the geniuses who foresaw the financial crisis?

I recently reread Michael Lewis’s book The Big Short.

I was amazed at how much I learned from rereading it with my investor’s eyes over ten years after it was released (I previously read it as a business journalist)

Here are the 10 most important and relevant takeaways from the book.

1. A Blog Is a Good Starting Point

Well-known investor Michael Burry, who was the first to predict the financial crisis, actually started his investing career by blogging.

He began with a thread called “Value Investing” on techstocks.com, before opening his own website in 1998.

In 2000, he launched his fund with just over a million dollars (interesting fact: the one million came from the value investor Joel Greenblatt, the author of You Can Be a Stock Market Genius, who had been following his blog for a while).

After he set up the fund and people saw how skilled he was, investors were willing to battle with crocodiles to get in on his fund.

This is how he managed:

  • In 2021, S&P fell by almost 12%, while Michael Burry received a positive return of 55%.
  • The following year, S&P fell 22.1%, but he was up 16%.
  • In 2003, S&P rose almost 29%, and Michael Burry had a return of 50%.
  • And so it continued.

By 2006, he had invested 600 million USD – and he rejected people at the door.

It’s amazing how quickly he developed as a blogger and as an investor.

2. You Don’t Need to Be an Economist to Get It

Do you need to have an Ivy League business degree to become a good investor?

Several of the main characters in The Big Short – those who foresaw the financial crisis – had no financial education at all.

Some people think you need to have studied finance to be able to invest for other people.

But keep in mind, the talented investors who predicted the meltdown (as described in The Big Short) were:

Michael Burry, a trained physician

Steve Eisman, a trained lawyer

One of these two young guys from Cornwall Capital left college without graduating.

Good investors come from all sorts of backgrounds. It’s academic snobbery to think that one must have a certain education to be able to figure it out.

3. Beware of Bubbles.

Be careful when people say stuff like “it always goes up over time.”

There was a lot of bias and euphoria before 2008.

At the time, it was focused on real estate.

Now people say the same crazy stuff about all kinds of things.

What do you hear people say about stocks? Crypto? NFTs?

Look at the price of real estate. Isn’t it at the same level now in many urban areas?

What makes it different this time?

Think twice before you throw your money at something that popular sentiment says “always rises over time.”

It’s usually a sign of a bubble.

4. Most of The People Who Predicted the Financial Crisis Were Value Investors

I’m a bit like a soccer fan watching her favorite team score when I say this:

The geniuses in The Big Short were mostly value investors.

Michael Burry and Steve Eisman were among the very first to see the financial tsunami before the financial crisis. They were both analytical and clear-sighted… and they were both value investors.

Michael Burry became a value investor in the midst of the IT bubble.

“The late nineties almost forced me to identify myself as a value investor, because I thought what everybody else was doing was insane,” says Michael Burry (on page 35).

I’m not really surprised. Of course the first skeptics were value investors.

Value investors tend to look at the facts and see things for what they really are.

Value investors open documents and read them.

Value investors look beneath the hood and kick the tires before buying the used car.

5. A Single Talented Analyst Can Beat the Market

The Big Short contains good stories about the underdog against the big system.

It’s a story about a few independent individuals who realized what was happening with subprime, while the big financial houses did not.

Michael Burry was completely convinced that the whole financial system was wrong – and that he himself was right.

The good story is that he was actually right.

“I have always believed that a single talented analyst, working very hard, can cover an amazing amount of investment landscape, and this remains unchallenged in my mind,” says Michael Burry (p. 192).

6. Don’t Discuss Your Investment Ideas

Michael Burry had a hard time while shorting the subprime market because his investors didn’t agree with his strategy.

They argued that the real estate market would always rise over time, and they believed subprime bonds were very safe investments, and that it was insane to short them.

Many demanded their money back, which would have ruined the bet as it required a bit of patience.

He repeatedly defended himself and explained subprimes over and over again.

In general, he disliked discussing his investment ideas.

“I hated discussing ideas with investors because I then become a Defender of the Idea, and that influences your thought process.” (p. 56)

Once you become a defender of a case, it is difficult for you to change your mind about it.

What does this mean for you as a private investor?

You should only talk about your investment ideas with a select bunch of like-minded people, like a study group of value investors.

Be careful about being very open about your investment ideas. Don’t tell Uncle Bill.

7. Sell When Your Home Is at More Than Twenty X the Gross Rental

There is a funny scene in the book (it’s not in the movie), where Ben Hockett – played by Brad Pitt – disappears for two months.

When he realizes that there is a bubble in the real estate market, he disconnects.

“I got off the phone and I realized, I have to sell my house. Right now,” says Ben Hockett (p. 120).

His house was worth at least a million USD, and it would rent for no more than 2,500 USD.

“It was trading more than thirty times gross rental. The rule of thumb is that you buy at ten and sell at twenty” (still p. 120).

What kind of math is he talking about here?

He just takes the monthly rent and multiplies it by 12 to get a year and then multiply by 10 to find the purchase price and 20 to see the level at which he will consider selling.

What does that calculation look like for your own house?

I moved to Portugal last summer. The house I live in was for sale for 800,000 euros and was for rent for 3,000 euros.

I had the option to buy or rent, and I chose to rent which, I can see now is a decision Ben Hockett would applaud.

8. It’s Okay to Ignore the Chatter From the Media

The media tends to run with the general market sentiment.

When things are going well, the news rolls with that. When there is a crisis, the headlines are scary.

Listening to business news all day makes it difficult for you to distance yourself from the public mood and to remain a rational investor.

“We turned off CNBC. It became frustrating that they weren’t in touch with reality anymore. If something negative happened, they’d spin it positive. If something positive happened, they’d blow it out of proportion. It alters your mind. You can’t be clouded with shit like that,” says Danny Moses, who was one of Steve Eisman’s employees (p.168).

So it’s entirely okay to tune out of business news.

However, you need to keep up with overall news and especially keep an eye on the facts and reports of the companies you have shares in or are considering investing in.

9. Stay Away From the Financial Sector

The financial crisis showed us how difficult it is to see what’s really on banks’ balance sheets.

In fact, it’s so hard that even the financial institutions can’t see it themselves.

“We had always assumed that they sold the triple-A CDOs to, like, Korean Farmers Corporation. The way they were all blowing up implied they hadn’t. They’d kept it themselves,” says Charley Ledley (p. 244).

Wall Street had become the “dumb money,” the author of the book writes.

The people who ran the big financial institutions on Wall Street didn’t even understand their own business. The regulators understood even less.

What does this mean for you?

That as a private investor you should refrain from investing in financial institutions because it’s simply too complex, and as Warren Buffett says: invest within your field of competence.

In other words, only invest in what you understand.

10. People Are Driven by Incentives

Warren Buffett’s partner Charlie Munger once gave an excellent speech called “The Psychology of Human Misjudgment” (which we will have to address in detail in another future blog post).

That speech inspired Michael Burry to look very closely at how incentive systems work.

Most funds get 2 percent of the entire amount invested… no matter how they perform. The funds make money even though they lose money for the customers. That’s a bad incentive system.

Michael Burry’s fund is constructed in such a way that he only makes money when investors make money (like Warren Buffett’s original partnership).

How can you use this knowledge about the importance of incentives?

You can apply the idea in all areas of your life.

Do you reward yourself when you have done a good job? Or are you going to reward yourself for postponing the work? Do you get the cake when you can’t pull yourself together? Or do you put it off until you’re done?

What about your children? Do they get the iPad when they make noise? Or do they get the iPad when a particular task is done? 

What kind of behavior are you going to consciously or unconsciously reward yourself and others for?

How do you reward yourself when you invest? Do you remember to pamper yourself a bit when you have made a good return?

The idea of ​​thinking strategically about reward systems and incentives can change your life.

What Is the Next Crisis?

After reading the book, it’s very clear that Michael Burry is an analytical and an exceptional talent.

The criticism from his investors caused him to close his fund and withdraw almost entirely from the public eye.

Occasionally, however, he talks.

In recent years, he has given interviews saying that there is a bubble driven by the passive investments in index funds.

This view is unpopular.

Everybody invests in index ETFs, and there is a strong belief that the stock market indices always go up over time (sounds like something we’ve heard before, doesn’t it?).

People who say stuff like that don’t look very far back in history. If they did, they would notice that it took 29 years before the Dow Jones reached the same level as before the crash of 1929 (it didn’t happen until 1959).

Sure, stocks always go up over time, but can you wait 30 years?

The bubble we’re in right now is bigger than the bubble that burst in 1929.

What do you do then?

Do like Michael Burry. Choose to invest with a brain.

Michael Burry didn’t stop investing either (you can follow him on dataroma.com).

He’s still at it, but he invests intelligently. He looks analytically at what he is investing in.

You should do the same.

If you want to learn about value investing, you can download my investment book Free Yourself here.