The Greatest Trade Ever

by Gregory Zuckerman

  Referring to Paulson’s huge gains in 2007 and 2008, Simons said, “I didn’t have that kind of wisdom.”

  As he left the hearing, Paulson looked relieved.

  “It went pretty well today,” he told Waldorf at Washington’s Union Station. “I felt good.”

  Paulson then said good-bye and boarded a late-afternoon Amtrak train to head home.

  epilogue

  There is no intoxicant more dangerous than cheap money and excessive credit.

  —Benjamin M. Anderson, economist, 1929

  GREG LIPPMANN’S SUCCESS BROUGHT WIDESPREAD RECOGNITION on Wall Street. Salesmen at Deutsche Bank took to introducing their star trader to potential clients, trying to impress them. Lippman usually didn’t let them down.

  “If it wasn’t for me, Deutsche Bank would be UBS,” he told one prospective client in early 2009, as a salesman looked on, beaming with pride. “I made more than one billion dollars for Deutsche in 2007 and another billion in 2008.”

  But as it became clear how much damage Wall Street had inflicted on the broader economy, a backlash developed against those like Lippmann who created the derivative products at the heart of the collapse. He had helped introduce “synthetic” mortgages that acted like subprime mortgages, enabling more banks and investors to own this toxic product.

  Lippmann’s clients made more than $25 billion by betting against these investments. Phil Falcone, who had adopted Lippmann’s trade after a pitch that lasted less than an hour, racked up several billion dollars for his firm.

  But for every hedge fund that Lippmann convinced to short these risky mortgage securities, an investor or bank was found to take the other side, usually leading to losses. And Deutsche Bank sold subprime mortgage products to various investors, even as Lippmann and his team were shorting them, angering some. The moves led to an investigation in late 2008 by the New York Attorney General’s office, even though the buyers all were sophisticated investors who should have known better and never were forced to open their wallets.

  Scathing letters were sent to reporters blaming Lippmann for wagering against risky mortgage debt even as his firm was creating more of it. One Web site posted Lippmann’s picture, saying that Lippmann was “a ‘Number 1 Asshole’ in creating the ‘Financial Engineering’ behind the debacle.” As the financial problems grew in early 2009, Lippmann assumed a lower profile, refusing to talk with reporters, worried that he was being painted a scapegoat. Rather than defend himself publicly, Lippmann griped to friends that all he did was help create a product and show hedge funds how to use it to profit from a crisis he saw coming.

  “I didn’t create the mortgages, I was just the guy who said the emperor has no clothes,” Lippmann told one friend.

  Others won more acclaim. On the West Coast, word got out about Jeffrey Greene’s success, and the more than $500 million that he pocketed from his trade. That was partly because he hired a public-relations pro to spread the news, resulting in glowing features on Nightline and CNBC.

  Soon, Greene fielded phone calls from longtime friends and acquaintances asking for financial advice. For the first time, they paid full attention to Greene’s answers. Mike Tyson and a few others heeded Greene’s caution and held off on various real estate purchases. In early 2009, Greene helped check out an upscale home that a friend, film director Oliver Stone, was considering purchasing. It didn’t take long for Greene to weigh in with his decision.

  “Don’t buy it, Oliver,” Greene told Stone. “We’re still in the early stages” of a housing meltdown.

  As Greene spoke, he noticed Stone had pulled out a pen and was writing down what Greene was saying. It was as if Greene had suddenly been transformed into the E.F. Hutton of the Hollywood set, his every utterance worthy of rapt attention.

  “Now, when I say things off the cuff, people listen,” says Greene with some amazement. “It’s scary.”

  He doesn’t have as much time to check out real estate, though. Greene and his wife now spend most of their time on their yacht or in a new home in Miami, as they await the birth of their first child. Sometimes, though, they fly a newly purchased G5 plane to visit their California houses, keeping tabs on real estate in the area.

  Others who discovered the greatest trade in history found themselves largely ignored. In Southern California, Andrew Lahde turned increasingly bitter about the nation’s troubles, ranting to friends about the heavy contributions made by oil and financial companies to political candidates and blaming Congress for failing to curb predatory lending despite plenty of warnings. After he failed to get some journalists to focus on Congress’s culpability, Lahde complained that the nation seemed to care less about fixing the political system than it did “about Britney Spears’s vagina.”

  In late 2008, he threw himself into the writings of his longtime hero Timothy Leary, the 1960s counterculture icon and advocate of psychedelic-drug research. He began to warm to the idea of dropping out, as Leary advised, saying it was “baffling” that Paulson was still so focused on investing. Lahde found a distant island and leased a beachfront home. He snorkels most days while searching for a suitable young female partner to join him on his adventure.

  After Lahde closed his firm and arranged to mail the last checks to his investors, there was only one thing left to do: stick it to everyone who had ever pissed him off. Lahde sent an open letter to his clients that quickly circulated throughout the investing world, a Jerry Maguire–like mission statement for the Wall Street set, the kind of farewell that more than a few traders said they wished they’d had the gumption to issue:

  October 27, 2008

  Today I write not to gloat. Given the pain that nearly everyone is experiencing, that would be entirely inappropriate. Nor am I writing to make further predictions, as most of my forecasts in previous letters have unfolded or are in the process of unfolding. Instead, I am writing to say good-bye.

  … I was in this game for the money. The low-hanging fruit, i.e., idiots whose parents paid for prep school, Yale, and then the Harvard MBA, was there for the taking. These people who were (often) truly not worthy of the education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns, and Lehman Brothers and all levels of our government. All of this behavior supporting the Aristocracy only ended up making it easier for me to find people stupid enough to take the other side of my trades. God bless America.

  There are far too many people for me to sincerely thank for my success. However, I do not want to sound like a Hollywood actor accepting an award. The money was reward enough.…

  I will no longer manage money for other people or institutions. I have enough of my own wealth to manage. Some people, who think they have arrived at a reasonable estimate of my net worth, might be surprised that I would call it quits with such a small war chest. That is fine; I am content with my rewards. Moreover, I will let others try to amass nine, ten, or eleven-figure net worths. Meanwhile, their lives suck. Appointments back to back, booked solid for the next three months, they look forward to their two-week vacation in January during which they will likely be glued to their BlackBerries or other such devices. What is the point? They will all be forgotten in fifty years anyway. Steve Ballmer, Steven Cohen, and Larry Ellison will all be forgotten. I do not understand the legacy thing. Nearly everyone will be forgotten. Give up on leaving your mark. Throw the BlackBerry away and enjoy life.

  So this is it. With all due respect, I am dropping out.… I truly do not have a strong opinion about any market right now, other than to say that things will continue to get worse for some time, probably years. I am content sitting on the sidelines and waiting. After all, sitting and waiting is how we made money from the subprime debacle.…

  On the issue of the U.S. Government, I would like to make a modest proposal. First, I point out the obvious flaws, whereby legislation was repeatedly brought forth to Congress over the past eight years, which would have reined in the predatory lending practices of now mostly defunct institut
ions. These institutions regularly filled the coffers of both parties in return for voting down all of this legislation designed to protect the common citizen. This is an outrage, yet no one seems to know or care about it. Since Thomas Jefferson and Adam Smith passed, I would argue that there has been a dearth of worthy philosophers in this country, at least ones focused on improving government. Capitalism worked for two hundred years, but times change, and systems become corrupt. George Soros, a man of staggering wealth, has stated that he would like to be remembered as a philosopher. My suggestion is that this great man start and sponsor a forum for great minds to come together to create a new system of government that truly represents the common man’s interest, while at the same time creating rewards great enough to attract the best and brightest minds to serve in government roles without having to rely on corruption to further their interests or lifestyles.… I believe there is an answer, but for now the system is clearly broken.…

  Lastly, while I still have an audience, I would like to bring attention to an alternative food and energy source … hemp.… At a time when rhetoric is flying about becoming more self-sufficient in terms of energy, why is it illegal to grow this plant in this country? Ah, the female. The evil female plant—marijuana. It gets you high, it makes you laugh, it does not produce a hangover.… My only conclusion as to why it is illegal, is that Corporate America, which owns Congress, would rather sell you Paxil, Zoloft, Xanax, and other addictive drugs, than allow you to grow a plant in your home without some of the profits going into their coffers. This policy is ludicrous.… With that I say good-bye and good luck.

  All the best,

  Andrew Lahde

  LIKE LAHDE, Paolo Pellegrini figured that his success would give him a voice in the financial world. As the markets melted in late 2008, Pellegrini developed ways to potentially stabilize the housing market. He reached out to a leading congressman, hoping he might embrace the ideas. The meeting was rescheduled a few times, but Pellegrini finally scored an appointment. A driving snowstorm delayed him by about ten minutes, but Pellegrini arrived at the office brimming with confidence.

  He wasn’t greeted with much enthusiasm, however.

  “You’re late,” the congressman said when Pellegrini made it to his office. “Don’t you know I’m going to have dinner with my wife?”

  Pellegrini watched as his host walked past him and right out the door.

  Later, Pellegrini wrote an elaborate opinion piece arguing for auctions of distressed home mortgages and subsidized funding for buyers. Pellegrini hired Rubenstein & Co., a high-powered public relations firm, to shop his editorial to newspapers, including The Wall Street Journal. But Pellegrini received rejection after rejection. The only outlet willing to publish the piece was a blog site run by the New York Times. The piece was largely ignored on Wall Street and in Washington.

  Pellegrini wasn’t making much more progress within Paulson & Co. Andrew Hoine and others on the research team were helping John Paulson develop a gutsy new strategy. For all his success developing the greatest trade in history, Pellegrini again was overlooked and didn’t see much future at the hedge fund. On December 31, 2008, Pellegrini resigned to start his own fund to focus on currencies and larger economic trends, using $100 million or so of his own money to get it off the ground. Paulson wished him well.

  Investors and competitors once scoffed at John Paulson. But he found newfound power, along with adulation and even envy, as a result of his big trade. Reaping about $6 billion over two years, the biggest sum of money ever made by a single person in the history of financial markets, along with $20 billion or so for his firm and its clients, tends to do that.

  When news emerged in the summer of 2009 that Paulson & Co. had purchased $100 million worth of shares of CB Richard Ellis, shares of the real estate broker immediately surged 15 percent, leading to a quick $15 million profit, a sign of the Midas touch accorded to him. In August, news that Paulson was buying shares of Bank of America sent shares soaring and tongues wagging. New York magazine’s online blog even introduced a periodic column called “If We Were Friends with John Paulson.” It features snippets of imagined conversations between Paulson and a reporter who at one point asks Paulson: “Have you ever thought about adopting a child? Like, an adult one?”

  Rather than celebrate, Paulson found that the trade meant more work. By the beginning of 2009, he managed $36 billion of clients’ money. He and his firm quickly pocketed more than $400 million—including almost $70 million in one twenty-five-minute period—betting against shares of big British banks. Paulson appeared more tired than he had in years but at the same time he seemed energized by this new chapter in his career. He moved his firm to prime office space across from Radio City Music Hall, choosing soothing beige and white colors throughout the firm.

  Paulson turned more protective of his private life, filing an application to beef up the hedges on the approach to his $41.3 million Southampton home as a security precaution.1 He turned reticent about sharing seemingly innocuous information about his private life. Asked when he had begun collecting Calders, Paulson wouldn’t say, other than to note that they were gouaches, a type of watercolor.

  But in many other ways, Paulson hadn’t changed at all—it was as if the trade hadn’t taken place. At one point, a friend was shocked to bump into him in a supermarket in Southampton wheeling a shopping cart full of store-brand groceries. Paulson continues to arrive at his Manhattan office early, wearing a dark suit and a tie, and leaving around 6 p.m. for his short commute home. When it rains and he can’t find a cab, Paulson still hops on a New York City bus.

  “I only need transportation to go to work in the morning and when I come home,” Paulson says, explaining why he doesn’t have a car and driver. “It would be kind of a waste with nothing to do in between, as I rarely leave the office during the day.”

  Others who experienced the collapse of the housing market and the deepest economic downturn since World War II didn’t have the luxury of choosing their method of transport. After many delays, the Monteses, the home owners in Orange County who faced a skyrocketing interest rate on a house they no longer could afford, finally received a loan modification from their lender that lowered their payments. They cut out vacations and nights out, and pulled their daughters out of Catholic school, but still were left very stretched. In mid 2009, they were hoping for another loan modification under a plan unveiled by President Obama but weren’t making much progress.

  “We don’t have much of a life,” says Mario, whose wife now cuts his hair as well as her own. “We’re one plumbing problem away from default.”

  JOHN PAULSON profited from one of the biggest financial bubbles in history. But another bubble inevitably awaits. Veteran investor Jeremy Grantham has identified twenty-eight bubbles in various global markets since 1920; the past decade alone has witnessed historic bubbles in Asian currencies, Internet stocks, real estate, and commodity prices, as if markets are becoming less efficient, not more so. Ever more furious competition among investors, and the growing ease with which they quickly can shift cash to almost any kind of market around the globe, may be partly responsible for the change.

  Extremely low interest rates, a key ingredient in past bubbles, have the potential to inflate the next one. The appetite to lend likely has been sated for a while, but it won’t be long before bankers convince themselves of the next easy way to score sure profits. Perhaps massive increases in public-sector borrowing, which likely will prove harder to reduce than they were to expand, will sow the seeds of the next financial bubble. Growth stemming from bank credit and government deficits seems more unstable than an expansion driven by innovation and rising productivity.

  George Soros and others have encouraged regulators to step in to tame budding asset expansions. But it seems unlikely that any group of bankers, academics, or bureaucrats will be any better at predicting, or even identifying, future bubbles in time to help curtail them.

  That so much trading today involves
complex financial products in markets with little transparency makes it more challenging for professional investors, let alone individuals, who likely will find it hard to track arcane and yet crucial instruments such as distressed debt, credit-default swaps, and other derivatives that top traders increasingly focus on.

  And yet, just as John Paulson and the group of investors who discovered how to profit from the housing collapse were largely outsiders to the mortgage and real estate game, amateurs may have the best opportunity to identify and profit from future bubbles. Financial pros increasingly form their views by watching the same business-television broadcasts and reading the same articles, creating an opening for those on the outside willing to challenge the conventional wisdom.

  It may be no coincidence that the housing bubble burst around the time that products emerged to allow bearish renegades like John Paulson and others to bet against the real estate market. It would suggest that dissidents who dare to raise questions and wager against markets should be encouraged, rather than scorned.

  BY EARLY 2009, John Paulson itched to start buying investments again. He was never very comfortable as a short seller. Making money was his passion, not sticking with any particular dogma. As Paulson pored over the balance sheets of the financial companies that he had spent more than three years betting against, he concluded that they had fallen too far in price. Paulson ordered his traders to begin purchasing the debt of troubled companies, securities backed by home and commercial mortgages, shares of banks, and other investments.

  It was a slow accumulation and well below the radar screen, but by August he owned a huge cache of about $20 billion of these investments, convinced that the economy had regained its footing. The step earned his firm about $3 billion in the first half of the year as financial markets began to show some life.