The Big Short: Inside the Doomsday Machine

by Michael Lewis

The credit default swap would solve the single biggest problem with Mike Burry’s big idea: timing. The subprime mortgage loans being made in early 2005 were, he felt, almost certain to go bad. But as their interest rates were set artificially low, and didn’t reset for two years, it would be two years before that happened. Subprime mortgages almost always bore floating interest rates, but most of them came with a fixed, two-year “teaser” rate. A mortgage created in early 2005 might have a two-year “fixed” rate of 6 percent that, in 2007, would jump to 11 percent and provoke a wave of defaults. The faint ticking sound of these loans would grow louder with time, until eventually a lot of people would suspect, as he suspected, that they were bombs. Once that happened, no one would be willing to sell insurance on subprime mortgage bonds. He needed to lay his chips on the table now and wait for the casino to wake up and change the odds of the game. A credit default swap on a thirty-year subprime mortgage bond was a bet designed to last for thirty years, in theory. He figured that it would take only three to pay it off.