John Paulson: Wall Street Visionary

Before 2007, not many people knew about John Paulson, a Wall Street junior whose firm, Paulson &Co. has 60 employees and manages a $1 billion hedge fund.

But John Paulson's name is now revered on Wall Street, with titles such as "the God of money" and "the first hedge fund" attached to him; Soros, the financial tycoon, invited him to dinner; Henry Paulson, America's Treasury secretary, who happens to share his surname, has to be called "the other Paulson" to make a difference.

All this is because John Paulson made money during the turbulent subprime mortgage crisis and the financial crisis that followed, and he made money with the highest efficiency in Wall Street history - $3.7 billion in 2007 alone, making him the biggest fund manager of the year. And the money he made was built on the misery of most people because he bet wildly against the U.S. stock and housing markets that Americans couldn't afford to live in their homes, and he won.

Like Warren Buffett, who bucked the market to buy small bankrupt companies in the 1970s, and Wilbur Ross, the "bankruptcy king", who restructured the steel industry in early 2000, Mr. Paulson succeeded by thinking outside the box.

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At the beginning of 2006, the conventional wisdom on Wall Street was that, while lax credit standards were a cause for alarm, they wouldn't cause major trouble in the housing and credit markets. Many of Wall Street's biggest institutions and banks are in this optimistic camp.

"A lot of people said that home prices would never go down nationally and that the investment bonds tied to the housing market had never been a problem. Lending experts were blinded by the housing boom." "Paulson said.

As early as 2005, Paulson was worried that the U.S. economy was headed for recession, so he began shorting the bonds of companies like auto suppliers, betting that their value would fall. Yet even as the companies' bonds have gone through bankruptcy proceedings, their prices have continued to rise.

"This is crazy! Paulson said to one of the company's analysts. He urged his broker to find a way to protect his investment and profits. The question Mr. Paulson threw at brokers was: "Where are the bubbles we can short?"

Agents finally found the answer: the housing market. At the time, housing experts repeatedly declared that home prices would never fall nationwide and that even if they did, the Fed would rescue the market by slashing interest rates.

For the real estate lending market, Wall Street financiers invented two new investment instruments: collateralized debt obligations (CDOs), which are products that repackage and sell mortgage bonds according to different risks; Credit Default Swap (CDS), a derivative product used to insure the risk of a mortgage bond.

The relationship between the two products is that the riskier the CDO, the higher the value of the collateral, the CDS. If default rates, or the expectation of default, rise, the value of CDS rises. But during the housing boom, most people didn't think CDOs were risky, so the price of the collateral, the CDS, was very low.

After analyzing a lot of data, Paulson was convinced that investors were vastly underestimating the risks in the mortgage market. He bet that the market would collapse. "I've never been in a trade where so many people are long and so few are short."

So Paulson devised a complex fund operation and began making bold bond-trading gambles, betting against dangerous CDOs while buying cheap CDS. "We have to make the most of people's blind optimism about real estate." In mid-2005, Paulson said to his men.