Why Does Steve Eisman Plan to Short the North?
“We’re going to make the big banks hurt,” Mark Baum, The Big Short
If you’ve seen the movie, The Big Short, you know the sort of shenanigans that helped lead to the big financial crisis of 2008. Millions lost their homes, their jobs, their savings in the giant tornado of financial devastation spurred on by the Wall Street scions who hugely profited off that misery in Scrooge-like fashion while rubbing their hands with glee. They watched their bank accounts expand by hundreds of millions of dollars, a figure unimaginable to those left behind sadly carrying their welcome mats to the moving van they could now barely afford. Bah, Humbug! Some might say.
Greed and the quest for power can lead people to do strange things without consequence of what it might mean to the potential victims on the other side. Guess that’s business, some might say. So, let’s take a look at how some of that business may come about.
One of the main characters in the movie, Mark Baum played by actor Steve Carrell, represents a semi-fictionalized Steve Eisman, one of the scions whose portfolio skyrocketed from $700 million to over $1.5 billion, while over a period of 8 months, 84 real estate lenders in the United States went bankrupt with a giant KABOOM![1]
Now, slightly more than a decade later, Eisman has announced that he plans to look to his polite Northern neighbors and short the Canadian banks. That’s right. Some of Canada’s most stalwart institutions have a giant red circle on them, specifically the Royal Bank of Canada (RBC), the Canadian Imperial Bank of Commerce (CIBC) and the Laurentian Bank. In his opinion, bank stocks are set for a 20+% decline as economic conditions worsen and loan losses increase. [2] On top of that, he has to pay the dividends (about 4%) as he has shorted the banks.
Eisman is basing his theory on a faltering housing market and a sluggish economy combined with the fact that credit normalisation has not occurred in Canada for 20 years.[3]
While Eisman acknowledges that he doesn’t see the same drastic gut-wrenching housing crash that the US saw in 2008, in his words, “This is not ‘The Big Short: Canada’ — I’m not calling for a housing collapse,”[4] he clearly sees an opportunity in some form. It seems he has decided to put reality into his semi-fictional character’s words. And it will still hurt the banks and by default individuals when the bandages are ripped off.
He may have a point. While Canada’s housing market has been fairly healthy over the past years, in Toronto and Vancouver houses have become so pricey that on a typical salary many people may not be able to reasonably afford to buy. It is possible that over time this may spread to other cities, causing people to either over-extend themselves or simply not enter the market at all, which may cause further problems in the housing market, leading to further economic issues and so on and so on.
Add to that the steady rise of Canadian household debt that has slowly seeped into a giant waterfall cascading to $2trillion in 2018, with approximately three-quarters of that debt sitting in mortgages[5] and you don’t need to have a degree in economics to figure out that things could go wrong.
Learning by example is a great way to do it, so let’s take a look at how things partly evolved in the US. Household debt was massive. Anybody and their dog were granted mortgages, no matter what the risk. Many homeowners were holding adjustable rate subprime mortgages. When the banks raised the rates, people who were just barely managing to make their mortgage payments found themselves on the phone arranging to rent a moving van. The rate of foreclosure skyrocketed in some States to over 100% with Arizona suffering a 203% rise.[6] House pricings came crashing down. People were now living in homes on which they owed much more than what the home was worth. Too often the only option was to give in to foreclosure. On top of that with the behemoth amount of jobs that were lost, it was the worst financial crisis the US had endured.
While Canada may not suffer to the same degree, Eisman is not the only one counting on the Canadian banks trending downwards in profitability and stock values. Based on financial positions analytics conducted by S3 Partners, bets against Canadian banks have risen 19% in 2019 to worth $12.3 billion. [7]
With the 2008 crash, Eisman apparently starting planning for it in 2004 when a bug entered his ear at a conference in Las Vegas. Over the next 3 years, he identified dubious loans and decided to bet they would fall. He managed to convince Goldman Sachs and Deutsche Bank to issue Credit-Default swaps. Then like a pro poker player stone-facedly guarding his cards, he watched it start in 2007. Mortgage defaults started to pile up and investors pulled out of the real estate market. The US was thrown into an economic crisis. And the millions started rolling in for Eisman and his cronies. While I’ll bet that he had some tense moments wondering if his gamble was going to pay off, in the end, the dealer won.[8]
As far as timing with the Canadian banks, I feel it is more like 2021/22 when things will start to head south, but it will not be near the epic gut-wrenching proportions of 2008. It will be more geo-political as well as some socio-economic. Eisman’s name will likely be tied to it, as it is tied to the 2008 crisis.
In Charles Dickens’ classic work, A Christmas Carol, Ebenezer Scrooge, a banker of sorts finds himself confronted by three ghosts. “Are these the shadows of the things that Will be, or are they shadows of things that May be, only?” Ebenezer Scrooge to the Ghost of Christmas Yet to Come, who is pointing to a grave bearing his own name.
Well, that’s one way to have your name engraved. Another is to do something so historically meaningful that your name is also etched in another way in memory. Eisman has already managed to achieve that once. Looks like he is going for the second round.
As always, do your due diligence.
Happy Investing!
Dr. Kal Kotecha
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[1] France 24 (September 2018) Steve Eisman, the ‘big short’ investor who bet on the crash : https://www.france24.com/en/20180902-steve-eisman-big-short-investor-who-bet-crash
[2] Doug Alexander (April 2019) : Eisman sees ‘20% Plus’ Drop in Canadian Banks on Short Call : https://www.bloomberg.com/news/articles/2019-04-09/eisman-sees-20-plus-drop-in-canada-bank-stocks-on-short-call
[3] Richard Henderson/Lindsay Fortado (March 2019) : The Big Short’s Steve Eisman raises bets against Canadian banks https://www.ft.com/content/40a2eae4-4b2b-11e9-8b7f-d49067e0f50d
[4] Reference FT 1
[5] Stephen S. Poloz (May 2018) Canada’s Economy and Household Debt: How Big is the Problem?
[6] Les Christie (January 2009) : Foreclosures up a record 81% in 2008 https://money.cnn.com/2009/01/15/real_estate/millions_in_foreclosure/
[7] Callum Burroughs (March 2019) : A star investor in ‘The Big Short’ is betting against Canadian banks : https://money.cnn.com/2009/01/15/real_estate/millions_in_foreclosure/
[8] France 24 (September 2018) Steve Eisman, the ‘big short’ investor who bet on the crash : https://www.france24.com/en/20180902-steve-eisman-big-short-investor-who-bet-crash
