Billion Dollar Man

Actually he's more like a 6-10 billion dollar man. John Paulson knew what most smart people without herd mentality knew: [real estate valuation growth rates are not going to last, it is highly irrationanl, there will be an imminent decline, and when that happens who will be affected first? ding- the buyers who will have the most trouble paying. who? ding- subprime borrowers. Who else? ding- everything else guilty by association]

This was obvious, but neither I nor anyone else I knew had a good idea how to take full advantage of it. Sure, I bundled up some puts on big lenders and got some short financial etfs. But equity markets are public and emotional to start, and these bets don't work so well when laissez faire is hijacked by big strong government bailout hype (for now).

John Paulson found a much more clever avenue. I punch myself for still not knowing more about fixed income trading . Even if I did, I wonder if I would've found a similar strategy because if I had, I would be in an unthinkably different place by now. His plan netted him an estimated $3.5 Billion in 2007 according to Trader monthly, the highest earners issue. Hindsight on good opportunities are 20/15, but the hardest question is always, "but how much would you have risked?" The answer in this case, for this particular strategy, is salivating-ly easy (continued below). What interests me about John Paulson is his seeming humbleness which i think is cool, but maybe it's because he never doubted his outcome. His lowly beginning includes graduating first in his class at NYU and HBS.

I also like his daring (or calculated) decision to switch gears from a good career in M&A to money management. It's a very big shift that takes a lot of personal risk (large $), and he wouldn't be where he is today if he hadn't taken the turn. Not only does he have strong instincts, but he also executes actively and timely.

Cheers to John Paulson. I hope he remains his own maker of future decisions.

His Strategy in a nutshell: 1% risk for 100% return:

Are you tired of talking about subprime mortgages yet? (July 2007)
No, I’m still excited about it. I think we’ve got a winner with this. It’s been a very profitable investment for us, but we think we have only realized 25% of the (potential) that we expect to make in this area. The investment is very much consistent with our overall philosophy that if you watch the downside, the upside will take care of itself. What attracted us to this particular position is that overall, we feel that we are in a credit bubble. We feel that there is too much risk going long (in) credit instruments since spreads are so tight. So we concluded that the best opportunities were on the short side. The beauty of shorting a bond is that the maximum you can lose is the spread over the benchmark; yet if the bond defaults, you can potentially make more. So it’s an asymmetrical risk-return tradeoff. In the case of subprime securities, we targeted the triple-B bonds, which are the lowest tranches in the subprime securitization. In a typical securitization, you have 18 to 20 different tranches with the lowest … taking the first loss. The triple-B bond has about 5% subordination, meaning that if the loss is greater than 5%, the bond will be impaired. And if it’s more than 6%, the bond will be extinguished. The yield was only 1% over LIBOR (the London interbank offered rate) so by shorting this particular bond, if I was wrong, I could lose 1%, but if I was right, I could make 100%. The downside was very limited but it had very substantial upside, and we like those types of investments.

Full Interview with John Paulson July 9, 2007, before he made most of his killing