How Michael Burry made millions during the housing crash of 2008: A deep dive

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By Oliver Rahman

Michael Burry saw the housing bubble as early as 2005! He decided to put a majority of his hedge funds capital (scion capital) into something called credit default swaps.


What exactly are credit default swaps though? They sound complicated but aren't really.


Imagine a company (let's say Netflix) issues 1 million dollars' worth of bonds to raise capital. Investor X purchases 1 million dollars' worth of bonds from Netflix. Another investor, investor Y, sees that Netflix might fail to pay interest or principal on the bond) meaning investor x would lose money. So, Investor Y goes to an insurance company to bet against investor X's bonds. Investor Y says he will pay a premium each year of $10,000 (meaning he pays the insurance company $10,000 each year) on the bond every year the bonds don't default. In exchange, the insurance company agrees to pay investor Y difference of the bond value if the bonds default.


Now, let's say Netflix defaults on its 1 million in bonds after one year, and the company is liquidated. $300,000 of value are given to investor X, but $700,000 is still missing. So, the insurance company must pay investor Y (who bet the bonds were going to collapse) $700,000! Even though investor Y only paid $10,000 in premiums. That means Investor Y made $690,000 from a bond defaulting! Or a 6900% gain (nice).


Credit default swaps were common in other areas, mainly to protect scared investors or to safeguard investments, but there were none for bonds in the housing market because they were seen as a "safe investment". Michael Burry manipulated the idea of these swaps to make a lot of money (in other terms: he wanted the bonds to fail, unlike investor X). So, Michael Burry told the banks (the insurers) to create hundreds of millions of dollars of credit default swaps for him, and the banks gladly agreed since they thought there was no chance of the housing market crashing. Basically, the banks thought they would be getting tens of millions in premiums each year for no risk!


When the bonds defaulted a couple years later, the banks were required to pay BILLIONS since the majority of the bonds defaulted and companies went under. And Michael Burry only had to pay tens of millions in premiums before then. This ended up netting him a 500% gain! Almost unheard of even for hedge funds. If you want more info about this, I really recommend watching the movie "The Big Short"!


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IMPORTANT CORRECTION! 8/19/2025


I corrected a minor mistake, the investor (investor Y) who makes money on the bonds is the one that does not own the bonds directly, but bets on bonds.


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