A knack for predictions
Kyle Bass is one of the rare breed of contrarian investors who predicted the subprime mortgage crisis. What truly set Bass apart is the fact that he then asked; what will happen next?
Common sense dictates that it is more or less impossible to foresee the future. Though, from time to time predictions do come true. Hollywood movies provide fascinating examples such as the Newspad featured in the 1968 movie 2001: A Space Odyssey. The resemblance to the iPad is unquestionable. A less accurate example is Back to the Future from 1985. It predicted what life would look like in October 2015 – and flying cars and hover boards still seem some way off.
Not just predictions
Anyone can make a wild guess and be right, but it doesn't mean that the analysis was particularly thorough or good. It's like the old saying – a broken watch shows the correct time twice a day. So predicting that the markets will go down is probably a prediction that sooner or later will prove to be right.
According to author Michael Lewis, however, only about fifteen investors did more than just talk about it and actually made strong bets against the subprime mortgage market. One of them was Kyle Bass, a former bond salesman at Bear Stearns, who had set up Hayman Capital in 2006, a hedge fund based in Dallas.
When Michael Lewis met Kyle Bass at the end of 2008, the subprime bond market had just collapsed and Kyle Bass was at the time preoccupied with how governments were faring in the midst of the turmoil. The Federal Reserve had just absorbed nearly USD 2 trillion in questionable securities. Worldwide debts had exploded from USD 84 to 195 trillion in the years between the dot.com crash and the Lehman crash. Banks now looked like extensions of their local governments, sure to be bailed out and Bass was trying to figure out how big these banking systems were – especially in relation to government revenues. Ireland, for example, had amassed debts of more than twenty-five times its annual tax revenues.
Who was paying attention?
Kyle Bass sought out the leading expert on national financial collapse, Harvard professor Kenneth Rogoff, and walked him through the numbers that he had collected. Rogoff's reaction was that of surprise – in turn making Kyle Bass think that if Rogoff wasn't aware of the situation – who was? Who was paying attention?
The moment investors ceased thinking of western government debt as risk free – which is the default perception – they would demand a higher risk premium when lending money. Insurance on Greek government debt cost Kyle Bass 11 basis points at the time. In other words, he had to pay 1100 dollars to insure 1 million dollars of debt (without having to invest in the underlying Greek debt). Bass guessed that when Greece defaulted, as he thought it inevitably would, the country would have to pay about 70 percent of its debt, meaning that the 1100 dollar bet would return 700 000 dollars.
Met with scepticism
Back to Michael Lewis' first meeting with Kyle Bass in 2008. Lewis was at the time analysing what had just happened to America. Bass on the other hand was focusing on what would happen next. All his theories of government debt and potential world disorder made Lewis somewhat sceptical and Kyle Bass was in the end barely mentioned in Lewis' soon-to-be-published book about the US subprime crisis, The Big Short. Michael Lewis thought that a man like Kyle Bass – who had been so dramatically right on the subprime mortgage collapse – might be fooling himself into thinking he had a knack for predicting the future.
It took another two and a half years before Lewis returned to Dallas to meet with Kyle Bass again, for his book Boomerang that chronicled the world's financial crisis. The price of Greek credit default swaps had now gone up from 11 basis points to 2300 – and Kyle Bass did in fact seem to have a knack for predictions.
SKAGEN Funds are happy to welcome Kyle Bass as one of our key note speakers at the 2015 New Year's Conference. His presentation is entitled: Japan vs Argentina: Polar Opposites.