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Bernanke Will Fail in Bid to Use `Poison as Cure,' Ex-Fund Head Burry Says

Michael Burry, the former hedge-fund manager who predicted the housing market’s plunge, said Federal Reserve Chairman Ben S. Bernanke is trying to use “poison as the cure” by pumping more cash into the economy to spur growth.

Bernanke’s Fed pledged this week to use $600 billion in additional Treasury purchases to help lower a 9.6 percent unemployment rate, close to a 26-year high, and to avert deflation.

The attempt to bolster growth is reminiscent of Alan Greenspan’s actions to revive the economy after 2001, Burry said in a telephone interview from Cupertino, California. The former Fed chairman helped create an unsustainable boom in U.S. property prices with his policies, leading to the worst global financial crisis since the Great Depression, he said.

Boosting the economy “was the point of inflating the housing bubble,” Burry said yesterday. “It was the intent that the house would become the ATM machine, and help us through those rough times, post-dot-com, -Enron, -WorldCom, -Iraq and - 9/11. That’s why I say they’re using the poison as the cure.”

Burry, as head of Scion Capital LLC, prodded Wall Street banks in early 2005 to create credit-default swaps to bet against bonds backed by the riskiest home loans. The strategy paid off as borrowers defaulted, letting his investors more than quintuple their money from 2000 to 2008, according to Michael Lewis’s book “The Big Short” (Norton/Allen Lane). The former resident in neurology was also featured in Gregory Zuckerman’s “The Greatest Trade Ever” (Broadway Books).

Repeating Behavior

The Fed’s support for asset values isn’t helping the “real” economy, and is creating “dangerous signs of a potential free fall” in the dollar and will be unsustainable, he said in the interview. It’s also probably causing investors, including fixed-income buyers, to take too much risk, in a repeat of their behavior in the period before markets began to collapse in 2007, he said.

The bad decisions then included investments in so-called collateralized debt obligations filled with default swaps tied to subprime mortgages, which helped to hobble some of the world’s biggest financial companies, he said. Banks and insurers through so-called synthetic CDOs wagered on homeowners making their payments, while firms such as Scion Capital and John Paulson’s Paulson & Co. took the opposite side of the trades.

“All those synthetic CDOs were a product of the stretch for yield,” he said.

Greenspan’s ‘Conundrum’

This year, sales of high-yield corporate bonds have jumped to a record as the Fed held short-term interest rates near zero and completed purchases of $1.7 trillion of long-term debt, according to data compiled by Bloomberg. Some securities backed by risky mortgages have extended gains to almost double their lows in 2009, Barclays Capital data show.

Under Greenspan, the Fed lowered its benchmark interest rate to 1.75 percent from 6.5 percent in 2001 and cut the rate to 1 percent in June 2003. The central bank kept the federal funds rate, or overnight interbank lending rate, at 1 percent for a year before raising it at a “measured pace” of quarter- point increments over two years, from 2004 to 2006.

Bernanke has argued that the Fed didn’t create the housing bubble with that policy. In a Jan. 3, speech he assigned more responsibility to lax lending standards and regulators’ failure to combat them.

Home Prices

Greenspan said in 2005 that he faced a “conundrum” in which long-term rates remained low even as he forced short-term rates higher amid a global savings glut as China, Russia and other emerging market economies earned more money on exports than they could easily invest. He also co-wrote a paper studying how homeowners’ were putting the home equity they were withdrawing to use in the economy.

U.S. home prices soared 63 percent from the end of 2001 through mid-2006, before tumbling 32 percent before bottoming last year, according to S&P/Case-Shiller index data.

In a Nov. 4 op-ed in the Washington Post, Bernanke wrote that “low and falling” inflation indicate “there is scope for monetary policy to support further gains in employment without risking economic overheating.” Inflating bond and equity prices will help the economy, he said.

“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending” along with consumers refinancing at lower rates to lower their mortgage payments, Bernanke wrote. “Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

Rivelle, Biggs

The Fed may fail because Americans’ housing “wealth is gone and so is the consumption, and you can’t bring it back,” Tad Rivelle, head of fixed-income investment at Los Angeles- based TCW Group Inc., which oversees about $115 billion, said in an interview after the central bank’s Nov. 3 announcement.

Bernanke’s decision was “absolutely right,” hedge-fund manager Barton Biggs said today.

“We still are in a very precarious situation,” Biggs, the managing partner of New York-based Traxis Partners LLC and former chairman of Morgan Stanley Asset Management, said in an interview with Betty Liu on Bloomberg Television’s “In the Loop.” “The economy could easily tip back into a double dip, and Bernanke did what he had to do.”

Farmable Land, Gold

Burry, who now manages his own money after shuttering his fund in 2008, said in a Sept. 6 interview with Bloomberg Television that he was investing in farmable land and gold, as well as small technology companies. He said yesterday he hasn’t changed his tactics as a result of recent events, including the Fed’s second round of so-called quantitative easing, dubbed QE2.

“I’ve expected Bernanke to act as he’s acting,” he said. “So with QE2, anything I was doing I expect will work even better.”

While it would damage the economy in the short-term, Burry said he would focus on curbing government spending to prevent harsher measures later.

“It was the problem with the housing bubble, when do you prick it? The earlier you pricked it, the better it would have been for all of us,” he said.

Burry isn’t necessarily a supporter of the so-called Tea Party movement, which helped Republicans gain control of the House this week and whose goals include trimming the size of government.

“I’m not a big fan of populism at either the extreme right or extreme left,” he said. “Hard choices can’t be made when everyone is screaming at each other.”

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

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