There’s money, and then there’s real money.
Paulson made it his business to learn about the arcane world of mortgage-backed securities trading. Before your eyes glaze over, know this: In one year (2007) he made $15 billion for his firm, and $4 billion personally. That far eclipses better known traders like George Soros (who gained initial fame for earning a mere one billion dollars betting on currency fluctuations years earlier). The next year, Paulson made another $5 billion betting against companies with exposure to housing. And he “wasn’t even a mortgage or housing guy,” according to accounts of those who knew him.
For every loser in the subprime debacle, there was at least one winner – Mr. Paulson.
He did it making what, in hindsight, was a very simple bet: that housing would fall. That even the dearly valued U.S. housing market could not keep up the bubble of expansion that had begun years earlier, and that some of the world’s smartest financial minds inexplicably thought would just keep rising.
Paulson, using CDSs (Credit Default Swaps), basically a form of financial insurance, bet against the bright minds, and mined his billions. In one trade alone he was said to have profited to the tune of $500 million.
Studying the real estate market and home values, one key Paulson staffer, analyst Michael Pellegrini (who had himself suffered a string of career disappointments), had used trend lines and regression analysis (to smooth the bumps in the trend line) and came to a radically simple conclusion. Pellegrini calculated that between 1975 and 2000, home values had increased about 1.4% annually (absent inflation). But in 2005 he noticed that in the past five years, they had soared to 7%. Prices would have to fall by nearly 40% to return to their normal trendline.
“This is unbelievable,” were Mr. Paulson’s words the next day, after Mr. Pellegrini revealed his findings. The story of what they did with their knowledge and how they turned it into billions is told in Zuckerman’s book.