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on its debt any time in the next ten years and bondholders recovered nothing. It was a zero-sum bet: If you made $100 million, the guy who had sold you the credit default swap lost $100 million. It was also an asymmetric bet, like laying down money on a number in roulette. The most you could lose were the chips you put on the table; but if your number came up you made thirty, forty, even fifty times your money. "Credit default swaps remedied the problem of open-ended risk for me," said Burry. "If I bought a credit default swap, my downside was defined and certain, and the upside was many multiples of it."

He was already in the market for corporate credit default swaps. In 2004 he began to buy insurance on companies he thought might suffer in a real estate downturn: mortgage lenders, mortgage insurers, and so on. This wasn't entirely satisfying. A real estate market meltdown might cause these companies to lose money; there was no guarantee that they would actually go bankrupt. He wanted a more direct tool for betting against subprime mortgage lending. On March 19, 2005, alone in his office with the door closed and the shades drawn, reading an abstruse textbook on credit derivatives, Michael Burry got an idea: credit default swaps on subprime mortgage bonds.

The idea hit him as he read a book about the evolution of the U.S. bond market and the creation, in the mid-1990s, at J.P. Morgan, of the first corporate credit default swaps. He came to a passage explaining why banks felt they needed credit default swaps at all. It wasn't immediately obvious--after all, the best way to avoid the risk of General Electric's defaulting on its debt was not to lend to General Electric in the first place. In the beginning, credit default swaps had been a tool for hedging: Some bank had loaned more than they wanted to General Electric because GE had asked for it, and they feared alienating a long-standing client; another bank changed its mind about the wisdom of lending to GE at all. Very quickly, however, the new derivatives became tools for speculation: A lot of people wanted to make bets on the likelihood of GE's defaulting. It struck Burry: Wall Street is bound to do the same thing with subprime mortgage bonds, too. Given what was happening in the real estate market--and given what subprime mortgage lenders were doing--a lot of smart people eventually were going to want to make side bets on subprime mortgage bonds. And the only way to do it would be to buy a credit default swap.

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.

The only problem was that there was no such thing as a credit default swap on a subprime mortgage bond, not that he could see. He'd need to prod the big Wall Street firms to create them. But which firms? If he was right and the housing market crashed, these firms in the middle of the market were sure to lose a lot of money. There was no point buying insurance from a bank that went out of business the minute the insurance became valuable. He didn't even