How Market Crash Helped Hedge Fund Operator

MICHELE NORRIS, Host:

From NPR News, this is ALL THINGS CONSIDERED. I'm Michele Norris.

ROBERT SIEGEL, Host:

And I'm Robert Siegel.

Z: the others tell the stories of smartest guy in the room, Wall Street wizards who cooked up exotic securities and mountains of debt, oblivious to the inevitable crackup that was in the offing.

Zuckerman, who's a Wall Street Journal reporter, doesn't focus on those guys. In his book, "The Greatest Trade Ever," he writes about the small minority of traders who saw it coming and who bet against the house. When the mountain of debt collapsed in one avalanche after another, they made fortunes.

Gregory Zuckerman, welcome to the program.

GREGORY ZUCKERMAN: Great to be here.

SIEGEL: And let's take the biggest winner in all of this, the hedge fund operator, John Paulson - no relation to the former Treasury secretary, how much did he make?

ZUCKERMAN: John Paulson made for his firm $15 billion in 2007, another five billion or so in 2008. For himself, he made in 2007 nearly $4 billion and another just two billion or so in 2008. So, he did pretty well.

SIEGEL: He went from a guy who, as you describe it, had a somewhat middling to good career on Wall Street to being one of the richest investors in America.

ZUCKERMAN: That's exactly right. Only on Wall Street can you be worth tens of millions of dollars and yet be run of the mill. He was sort of a singles hitter and here he comes hitting this big home run.

SIEGEL: Home run - four grand slams. I mean, he really scored.

ZUCKERMAN: Yeah. This is the greatest trade in financial history. By way of comparison, George Soros, when he bet against the British pound in the early '90s made a billion dollars just for his firm. And Paulson made $20 billion over two years.

SIEGEL: Now, whenever a stock is rising very quickly, there's somebody who is short selling it, who's betting that it'll go down instead of go up. That was no fundamentally the method of John Paulson and the others in terms of betting against the mortgage mess. What did they do?

ZUCKERMAN: Well, what happened was housing kept rising and there were a lot of skeptics out there. Conventional wisdom now has it that everyone drank the Kool-Aid, but I would tend to disagree. There were a lot of people actually who were skeptical, but couldn't quite figure out a way to bet against housing.

Around 2005 and 2006 there were these derivatives that were introduced - credit default swaps - in which you could make a more direct bet against subprime mortgages and that's exactly that Paulson did.

SIEGEL: So, even if you had no stake in some big mortgage-backed security, you could buy a credit default swap that was insurance against the collapse of that security. And, in fact, you were betting that it would fail.

ZUCKERMAN: That's exactly right. Credit default swaps sounds sort of fancy and complicated, but in effect they're just insurance policies against the underlying debt. So, if the debt has problems, then this insurance policy rises in price. So, they bought a lot of these credit default swaps - CDS contracts as they're called on Wall Street - at dirt-cheap prices when no one else really wanted them.

SIEGEL: Very interesting moment in your book is as the signs of the mortgage collapse are getting clearer and clearer, these people are still buying these credit default swaps, betting against the mortgage-backed securities. And they wonder: Who's selling us this insurance?

ZUCKERMAN: It's an interesting moment because that leads to the second leg of his trade in which he puts two and two together and realizes that too many financial giants still have exposure to these risky mortgages on their books, because they're selling them all these CDS contracts and they're not finding so many people on the other side, so they must be holding them on their books.

SIEGEL: So, but you're saying that the very banks that had acquired what we came to think of as toxic assets were also selling insurance on those very assets and betting on them again?

ZUCKERMAN: One of the ironies of this whole period to me is that the very people that created these toxic assets are the ones who got hurt by the most. It's sort of like a butcher who has this noxious meat that he has and he doesn't sell it to his customers, but he actually brings it home to his kids. You can question why. And one of the reasons is they sort of believed that the stuff wasn't as risky as people like Paulson did. So, they sort of believed their own stories about these products.

SIEGEL: There are some occasions here when you report on, in addition to all the people and the trades involved, some of the ethical misgivings that some people have. And first of all, the very idea of saying, I found the greatest investment, I'm investing in people being foreclosed and driven out of their homes.

ZUCKERMAN: Yeah. Actually, I found it kind of interesting that really only one of my characters in the book had any ethical qualms. There's a gentleman up in Boston, Jeffrey Liebert(ph), who did some buying of the CDS contracts and he wanted to do more, but he was torn because he knew that what he was rooting for and what he began to root for was for people to see pain and to lose their homes and to have problems making their mortgage payments.

And he was torn. On the one hand, he was convinced he was going to make a lot of money buying this insurance on risky debt, risky mortgages. On the other hand, he had a minister and friends and family members coming to him and saying, what are you doing here? You are actually rooting for people to have problems, and he was torn.

SIEGEL: Now, there's another ethical dilemma. Let's say you're Deutsche Bank, you're a huge financial institution, you have a trader, Gregory Lipman(ph), who's doing what Paulson is doing - he's betting against these securities. Meanwhile, you've been selling people on these securities. People who bought them from him are saying, what's happening? You have a guy who's making a fortune betting against the very thing that you've sold me.

ZUCKERMAN: You can make that argument that there were firms - not just Deutsche Bank, but including Deutsche Bank - that were doing both. They were both betting against these mortgages while they were selling products related to these mortgages.

And, you know, these are big boys, you have to remember as well, who were buying this stuff. We're not talking about individual investors. It's institutions, hedge funds. So, they would argue, well, jeez, we were selling products that people wanted. That we had one trader who was betting against it, well, what are we supposed to do about that? We're allowed to do that.

And other people would argue, well, yeah, these are institutions, but we're including charities and endowments as well and pension funds and is that ethical? It's not for me to decide, but it's a good question.

SIEGEL: John Paulson, the major subject of this book, has evidently read it now. And this is not a blurb for the flyleaf here. He says it contains numerous inaccuracies and fails to capture the essence of the credit bubble. The writing style is indicative of a gossip tabloid rather than respected financial journalism. Unfortunately, the opportunity to create a meaningful documentation of an important time in financial history was lost.

ZUCKERMAN: Yeah, I would just respond by saying that John Paulson was generous enough to share over 50 hours of his time with me discussing the trade. And I understand that he didn't want a book that was colorful and that explored some of the personalities of those who figured out that the housing market was going to collapse.

He wanted a little more of a dry book about what happened in the trade. I think it's important to explore the personalities as well. So, I understand he's got concerns and things he didn't want in the book, but I would argue that there's a need to explore some of those issues.

SIEGEL: Gregory Zuckerman, thank you very much for talking with us.

ZUCKERMAN: It's great to be here. I appreciate it.

SIEGEL: And Gregory Zuckerman's book is called "The Greatest Trade Ever: The Behind the Scenes Story of How John Paulson Defied Wall Street and Made Financial History."

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