Suppose I'm the manager of a giant hedge fund. Suppose I'm soliciting you to come into my fund with a few billion of your $100 billion net worth.
Suppose we're good friends.
You want to come in because you trust me and you know I know how to make money.
However, you'll only come in if I tell you how the secret trade I'm working really works.
Okay, I'll tell you. But you can't tell a soul. Not because what I'm doing is illegal, but because only a few other guys are doing this, and we all know each other, and we're kind of all in this together - wink, wink - and we don't want anyone else in our game.
Come a little closer... you're not going to believe this...
Return of the Vultures
First of all, we can't lose money. Not only are we making money on the way up, but when the bottom drops out - and it will, we will make it drop out - we'll make money on the other side too.
We came up with this trade after analyzing what went wrong leading up to 2008.
Here's what we figured out.
Back in the buildup of the mortgage bubble, we knew it was a bubble, we knew it was going to break. We were all playing the game, but we didn't realize we didn't control the ultimate default rate, and we couldn't time it, which was the worst thing.
We also know a couple of guys who bet against the bubble and made mega-billions. They didn't just guess that stuff was going to crash - they had banks make crappy mortgage pools designed to crash and they bet against those. We learned from them, too.
I'll get to that, and you're going to love it.
So we're doing it differently this time. Yep, you heard that right - this time is different.
You see, after the crash settled, when all the people who still had tons of money needed something to believe in, we went to them and said, "Housing."
And they said, "What! Are you kidding?"
"Distressed housing," we said.
And they smiled. "We love you vulture guys," they said.
So, on account of the Federal Reserve System making the cost of borrowing essentially zero, we go out and borrow a ton of money from big banks that aren't lending to little schmucks to buy houses, or to idiots who want a loan to start a small business that isn't going to make it in a crappy economy, which the banks know is crappy.
They lend us a ton of money. And we also go out into the bond market and borrow really cheaply. Because, you know, those institutional investors will buy anything with a dollop of yield above what they're getting anywhere else.
All that money we raised, that's called leverage.
So, we take all this money and we buy up distressed housing stock around the country. We concentrate our buying in the hard-hit areas.
Now, here's the beauty of the upside of this trade...
We're paying cash. And the banks aren't lending to private borrowers on account of raising their loan standards and not wanting to have to bother with them defaulting again.
So, we buy low and keep buying. You get it. We're raising the value of the prices of the homes we've already bought by buying all the other distressed homes around them.
Now, get this. The people who can't afford a house, even the ones who can afford a house but can't get a mortgage, they have to rent. And who do they have to rent from?
Us.
The House Always Wins
We own the homes and rent them out. And we can keep raising rents because we're taking so much of the housing stock off the market.
So, as housing prices are rising, because we're making them rise, and the value of our stock is going up, guess what? We can raise rents.
People think those areas are recovering and are good places to move to, so they come back in droves. And we rent to them, because they still can't get mortgages.
I know what you're thinking. You're thinking, "How come they can't get mortgages in areas where housing prices are rising rapidly? Don't the banks want to lend to them in those areas?"
No. The prices have gone up so quickly that new buyers won't get much appreciation out of their new purchase, because we're wringing it all out ourselves, lifting the equity value of our stock. So the banks aren't bending over backward to give them money.
I'm laughing because I know what you're thinking by the way you're looking at me.
You're wondering how we're going to get out of this giant million-dollar trade if there are no buyers for the houses we bought because people can't get mortgages?
Good question.
Here's the beauty of it. We're packaging these rental homes and selling the securities to those institutional-investor guys looking for yield.
And the ultimate beauty - that would be the government. We own it.
Those lapdogs are doing what we want. They're loosening up standards on Fannie Mae and Freddie Mac government-guaranteed loans, and they've lowered the insurance that premium buyers who go through the Federal Housing Administration have to pay.
You see, all the tough talk about the government getting out of the mortgage business after it had to bail out big Fannie and Freddie and the FHA became essentially insolvent - well, that was all talk.
You know, free-market stuff.
The truth is the government is our partner in this game. They're making it easier for people to get mortgages again. Really soon, they're going to make it even easier. Just wait and see.
When people can get mortgages, we'll start selling our inflated housing stock to them.
But there won't be any equity left to build into the value of their homes.
It's the American Dream.
Why is it the dream? Because we're going to short against the rental securities we sold. We're going to buy credit default swaps (CDS), tons of them - and, man, I mean tons of them. Of course our counterparties will be all the big banks that can still trade derivatives.
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You remember that, right? That was part of our plan too. We got Congress to pass a provision in the last budget funding kerfuffle that screws Dodd-Frank and lets deposit-taking banks still trade derivatives.
It's great!
So they will be the counterparties on all our CDS, because, you know, they're too big to fail and they'll pay up.
Do you get it?
When everything is in place, we'll just dump all our housing stock, whatever we have left.
Prices will crash, but we'll make a fortune, because we'll be short 10 times what we own.
Oh, and as far as the United States goes, don't worry. Don't feel bad. It will be rough for a while, but the government will just make more money available and we'll start the trade all over again.
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About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.