Sunday, May 18, 2008

John Paulson: King Bear of US Subprime

John Paulson has emerged as Wall Street's biggest beneficiary of the subprime crisis, gaining so much from foreclosures that George Soros invited him to lunch, to understand how he had laid his bets with instruments that did not exist a few years ago.

Funds Paulson runs were up $15 billion in 2007 - his investors relishing the bet he made against the seemingly unbridled US housing market. Paulson himself has taken home an estimated $3.7 billion, which is believed to be the largest one-day gain by any Wall Street professional.

You will not find much on Paulson, since before this bet, he was a rather unknown, although successful, hedge fund manager. His Paulson & Co firm employs 60 people and its success has centred on a venture called Credit Opportunities Fund, which returned 590 percent last year, according to trade magazine Alpha.

Paulson's gains came from defying conventional wisdom, like so many others before him: Warren Buffet for buying companies cheap in the 70's and Wilbur Ross, who consolidated steel, and George Soros, famous of shorting the British pound and making $1 billion in one day, in 1992.

In 2006, many thought that housing industry and mortgage markets were rock solid against any trouble, despite the loose lending standards in the markets. One major highlight during the housing boom were CDOs (collaterized debt obligations), which were products that had mortgage securities as the underlying, and these were sliced in to various products of differing risk levels, and sold to others, including foreign buyers.

Then to make these safer, insurance companies came up with credit-default swaps which protected buyers of CDOs against defaulting mortgage owners. The higher the risk of CDO slice, the higher the cost of the swap. The risk perception during the housing boom was so low, that these swaps were in fact being sold very cheap.

In betting on it to crumble, Paulson said: "I've never been involved in a trade that had such unlimited upside with a very limited downside." One of his strategy was to short the CDO slices. Another was to buy the credit-default swaps that complacent investors seemed to be pricing too low.

Paulson's most legendary statement depicts what happens in any manic rise: "Most people told us house prices never go down on a national level, and that there had never been a default of an investment-grade-rated mortgage bond," Mr. Paulson says. "Mortgage experts were too caught up" in the housing boom. Another one he had heard was, "You can't short houses."

Paulson's strategy was all about having the right view as much as it was about timing. He did not turn bearish too early, but waited for the correct technical moment. Many other followers of the housing market invested a few years earlier against the market only to have suffered painful losses waiting for a collapse that they finally closed their bearish bets.

As Peter Morici, professor of finance at the University of Maryland, says: "He saw what many of us suspected, but didn't have the courage of our convictions to put our money on."

Paulson's quest always led to asking his team the same question: "Where is the bubble we can short?" And rightly, they found it in housing. At this time, upbeat mortgage specialists kept repeating that home prices never fall on a national basis or that the Fed could save the market by slashing interest rates. The success came from the waiting game. As Paulson said once, quoting Winston Churchill, in an interview: "Never give in, never give in, never give in." Sounds familiar, isn't it?

Read the WSJ story here

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1 Comment:

naresh said...

nice informative and more than anything very encouraging and out of the box kind of thinking article..most of these encouraging kinds of stuff welcome...thanks indeed...




Consider how the crisis has unfolded over the past eighteen months. The proximate cause is to be found in the housing bubble or more exactly in the excesses of the subprime mortgage market. The longer a double-digit rise in house prices lasted, the more lax the lending practices became. In the end, people could borrow 100 percent of inflated house prices with no money down. Insiders referred to subprime loans as ninja loans—no income, no job, no questions asked. - George Soros in latest book

everything’s going up, there’s a feelgood factor and people tell each other how much their houses are going up at dinner parties,” says Professor Mark Stephens of York University’s Centre for Housing Policy. “Then the music stops, as it always does.”

year, Japan was a more attractive market to put money in. If you look at the US, we can now get an internal rate of return of 25% there, so why would anyone want to come to India?” - a senior executive at an international financial services group, who did not wish to be named.

people told us house prices never go down on a national level, and that there had never been a default of an investment-grade-rated mortgage bond, "Mortgage experts were too caught up." - John Paulson, trader, who bet against subprime market and made $15 billion.

most puzzling are the real-estate projects of Parsvnath. Just have a look at the Pride Asia project near Chandigarh. They are asking almost US $300K-$350 K dollars for 2 bed room apartments. They have Villas in this project that costs more than US $1.5 million dollars. It is true that some people in India have that kind of money in India. However most of their wealth is black money and that can not be used to buy these properties. Obviously, these projects have been launched keeping NRIs in mind. - Sanjeev, comment from another site

Desai, aka Bani, the star of Balalji Telefilms's soap, Kasam Se, has been house hunting for over a year. She had almost closed a 2-BHK deal last year for Rs 1.5 crore in a Oberoi Constructions' building located at Andheri, Mumbai, but when she went back to confirm it, she was asked to cough up Rs 2.61 crore. Since then, she is still house hunting. - Mumbai Mirror


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