The big short

FICO score
• FICO Score: A credit score for assessing the credit risk and determine
whether to extend loan to borrowers. FICO score evaluates the
following criteria:
• Payment history : whether one has paid past credit accounts on time
• Amounts owed : owing money not necessarily mean low FICO score i.e. high risk
borrower. However, using a lot of one’s available credit may mean it.
• Length of credit history: long credit history = positive for FICO score
• Credit mix : credit cards, retail accounts, instalment loans, finance company accounts
and mortgage loans
• New Credits etc.
LTV ratio (LVR)
•  Loan-to-value ratio: An assessment of lending risk that financial
institutions and other lenders examine before approving a mortgage.
• Calculated by dividing mortgage amount by appraised property value

where MA= Mortgage amount

APV = Appraised Property value
Findings of M. Burry
• Individuals with Low FICO scores and high LVR were being accepted
loans.
• The defaults in MBSs were soaring high.
• MBSs are filled with extremely risky sub-prime adjustable rate loans
and when adjustable rates would kick in 2007 they wouldbegin to fail,
if they failed above 15%, the whole bond would be worthless.

Conclusion: Lets short the housing market !!!

Shorting the Housing market
• There was no instrument available to short the housing market
• M. Burry went from banks to banks and told them to make him
credit-default swap that will pay off if underlying bond fails.
Rating Anomaly
• CDOs got high rating by rating agencies because of diversification.
Because, in a theoretical perspective, diversification leads to
• Minimizes the risk of loss of overall portfolio.
• Exposes to more opportunities for return.
• Safeguards against adverse market cycles.
• Reduces volatility.
• However, CDOs, even though mostly contained sub-prime MBSs,
rated at 92-93% AAA rating, hence they played a part in the housing
market collapse
• Rating agencies took fee from banks, possible conflict of interest.