The King of Big Short, John Paulson, made $26 Billion in 2008 crisis
In the movie Big Short, we saw how several individuals profited immensely by betting against the housing market. However, the person who made the biggest profit in 2008, John Paulson, isn’t even mentioned in the movie. His hedge fund, Paulson & Company, made over $20 billion, and he personally made $6 billion, surpassing the combined profits of Michael Burry and others. He almost made $10 million per day during the crisis year.
Contents
History of John Paulson
John Paulson founded his hedge fund with $2 million in 1994, and he had grown it to $4 billion by 2005. Despite his success, Paulson was considered an outsider on Wall Street due to his specialisation in mergers and acquisitions rather than stocks, bonds, or commodities.
Just after the dot-com bubble, the government slashed the interest rate, and banks started giving out loans to anyone and everyone. These reckless loans given by the banks resulted in a huge catastrophe. Low interest rates made borrowing money for a home very attractive. As banks were providing easy loans to everyone, it created a huge demand for houses in the market. Everyone was taking out a loan and buying houses. Because of this, housing prices rose very quickly.
John’s doubt of Crisis
Even John Paulson did not anticipate that this housing crisis would impact the whole US economy. At the peak of the crisis, more than 30% of house owners had mortgages greater than the value of their house.
While all this was happening, wages were stagnant, which made people borrow even more. As the real estate market was growing, one of Paulson’s friends purchased forty-five acres of land from a farmer for $3 million and flipped it for $9 million. Then the same farm land was sold for $25 million. This rapid price appreciation seemed artificial to Paulson. He tried to warn his friend about his real estate investments, but he ignored him. This crazy growth in the housing market made everyone believe that housing prices would keep going up.
During the years 2004 and 2005, when the housing market was growing crazily, John Paulson suspected that something was wrong with the housing market. But he didn’t know what exactly was wrong with it.
And Paulson kept saying that “’This growth in the housing market isn’t sustainable,’’ but no one listened to him. One of the reasons Paulson had grown concerned about real estate was that the Federal Reserve had finally begun to raise interest rates, which eventually would have pushed borrowing rates higher. Paulson used to ask his employees, “Who’s the most vulnerable to higher interest rates?”. Basically, he kind of figured out that once interest rates start rising, the people who borrowed will most likely default on their loans.
Why Michael Burry was sure of Crisis?
A similar thing was discovered by Michael Burry. But Burry had directly studied the mortgage bonds, which had thousands of loans. Burry’s conclusion was that once the interest rates started rising, people would start defaulting on their loans. Then all these mortgage-backed securities would collapse.
Paulson was a hedge fund manager specializing in mergers; he had no expertise in investing in the real estate market. By this time, Paulson was just guessing the market movement from his experience and instincts.
Hiring Paolo Pellegrini
Paulson’s big historical profit wouldn’t have been possible without his one employee. This one employee had changed everything for Paulson. The name of the employee was Pellegrini. Pellegrini joined Paulson’s hedge fund as an analyst at the age of 43. Because of his age factor, he had to compete with other analysts in the firm who were much younger than him and were in their late 20s. So to stand out against them and in the fear of losing his job, Pellegrini used to work extra hard on the task, but it wasn’t working well for him.
So out of competitiveness with his colleagues and to show extraordinary performance to Paulson, Pellergini started studying the housing market. When he finished analyzing and presented the result to Paulson, Paulson was impressed, and his conviction that something was wrong with the housing market grew even stronger.’
Shorting the housing market
The real problem Paulson faced at the time was that he didn’t know how to short or bet against the housing market. At that time, everyone thought that the housing market was stable and never fell, so nobody cared or even thought about betting against it. Because of that, there was no method or instrument to bet against the housing market.
So Paulson started to look into buying protection for his firm if all the loans given by the banks started defaulting. He also thought of shorting the shares of some financial companies. But as Paulson would bet, many companies in that business would receive takeover offers, which made the stock price of those companies rise.
Because of this, Paulson was looking for a better way to short the housing market. One day, Pellegrini suggested using credit default swaps. It’s not like Pellegrini knew everything about credit default swaps. He only watched others trade credit default swaps at his previous job. Paulson agreed to the idea of CDS.
Buying Credit Default Swaps
Before making a purchase, Pellegrini had to learn everything about credit default swaps. After that, Paulson’s fund made its first purchase of CDS.
Basically, swaps are insurance protection contracts. Let’s say there is a company named ABC. You bet money that if the ABC company fails, you will get $100 million, and you will pay a yearly premium of $1 million until that happens. If you don’t know how credit default swaps work we have explained them in this article.
The first few purchases of CDS were a failure for Paulson. After this, Pauslon again started to doubt their bet and was looking for another way to short the housing market. But he still kept buying those CDS against these individual companies. Which were not doing much for his firm. Most of them were making losses.
Actually, Paulson was on the right path, but he was betting on individual companies. Whenever they would bet on any company, if that company was about to fail, then it would mostly get acquired by another big firm, and Paulson’s bet would go into losses.
Michael Burry’s bet
Michael Burry, on the other hand, did exactly the opposite, and he had a bet against the mortgage bonds that were made of these bad loans, so it didn’t matter to Burry how an individual company was performing as he knew the underlying loans would still default over time.
Because of this, Michael Burry was sure that there was a housing bubble. But Paulson was not sure whether there was an actual bubble. This was because Paulson was unaware of the improper lending practices of the banks.
So Paulson told Pellegrini to study the market more. This time, Pellegrini spent a lot of time analysing housing market data all the way until 1975. After analysing the data, he figured out that from 1975 to 2000, housing prices rose by 1.4% each year. But from 2000 to 2005, it rose by 7%. Pallgrini figured out that if the housing market had to crash, the housing prices would have to stop rising and have to fall 40% to reach their real value.
A similar analysis and conclusion were made by Greg Lippmann, aka Jared Vennet. His analysis also showed that if housing prices just stopped rising, there would be more than 8% of loans that could default on those MBS bonds, and then the market would fall.
As people were able to refinance their homes, this made Paulson more doubtful, as people would keep refinancing their homes. This would result in housing prices going up continuously.
Confirmation of the bubble
After looking at Pellegrini’s analysis, Paulson was sure that the housing market was going to collapse but didn’t know when exactly. And he knew falling home prices would put a quick end to all the mortgage refinancing by subprime borrowers.
So Paulson started to buy huge chunks of credit-default swaps. When Michael Burry learned about the CDS demand in the market, he was not worried at all. All he thought was that it would boost the price of the positions he had already taken.
Paulson focused on the institutions that had large quantities of subprime or poorly performing mortgages. He shorted New Century, Fannie Mae, Freddie Mac, Citibank, Washington Mutual, IndyMac, Bear Stearns, and Lehman Brothers mortgage bonds. While making these bets, they focused mostly on the triple-BBB-rated tranches of the bonds. The triple-B tranches were cheap; it would cost them only $10 million a year in premium to buy a contract worth $1 billion.
When Paulson found out about CDOs, he realised they were also bound to collapse. He shorted the CDO’s as well.
Profiting from the swaps
Paulson wanted to raise funds to do this trade on a very large scale, but he had a really tough time convincing people. His idea was that if he could raise a specific hedge fund dedicated to betting against housing, he could make a fortune. But most investors were still hesitant. Paulson still managed to bet on $25 billion worth of credit default swaps.
He had bet of $22 million on Lehman’s bonds; when they failed, it made him around $1 billion.
Paulson held insurance on $25 billion of subprime mortgages. So a 1 percent downward move in the market meant a 1 percent profit for Paulson, which was about $250 million. In 2007, as the default rate rose, there was a 5% downward move in the market. With such a fall, Paulson had made $1.25 billion in just a single day. It was more than what George Soros had made with his legendary bet against the British pound in 1992.
As the markets fell more, Paulson made even more money with his positions. All of Paulson’s investments paid off against the housing market, and John Paulson made for his firm $15 billion in 2007 and another $5 billion in 2008. He personally made $4 billion in 2007 and another $2 billion in 2008. So, overall, John Paulson made $26 billion during the 2008 crisis.
This is how Paulson became the biggest earner during the 2008 crisis. If you want to learn more about the 2008 crisis and The Big Short movie then check out these articles or Subscribe to our YouTube channel.
FAQs
How did John Paulson make money in 2008?
John Paulson made money in 2008 by shorting the housing market with credit default swaps. His hedge fund, Paulson & Company, capitalised on the subprime mortgage crisis, leading to substantial profits as the housing market collapsed.
Who made the most money from the 2008 crash?
John Paulson made the most money from the 2008 crash. His hedge fund profited over $20 billion, and he personally made $6 billion, surpassing the combined profits of other prominent investors like Michael Burry.
What is John Paulson famous for?
John Paulson is famous for making highest profits during the 2008 financial crisis. He made such a huge profit by betting against the housing market. He made billions and became one of the most successful hedge fund managers of all time.
Who shorted the market in 2008?
John Paulson, along with other investors like Michael Burry, shorted the market in 2008. They predicted the housing market collapse and profited immensely by betting against mortgage-backed securities.
Who is John Paulson in The Big Short?
John Paulson is not in “The Big Short” movie. The movie focuses on other investors like Michael Burry and their roles in the crisis.
Who was The Big Short guy in 2008?
“The Big Short guy” typically refers to Michael Burry. He was the main figure in both the book and movie “The Big Short” for his early bet against the housing market. John Paulson, although he made the most profit, was not featured in the movie.
What companies does John Paulson own?
The top 5 holdings are Madrigal Pharmaceuticals Inc (MDGL), Bausch Health Companies Inc (BHC), BrightSphere Investment Group Inc (BSIG), Perpetua Resources Corp (PPTA), Novagold Resources Inc (NG), companies owned by John Paulson.
How much gold does John Paulson have?
Paulson bought lots of gold. His firm, Paulson & Company, owns gold equivalent of 96 metric tons.
Why John Paulson is not in The Big Short?
The Big Short movie is based on the Michael Lewis’s book. Michael Lewis did not include John Paulson in “The Big Short” because he chose to focus on a specific group of characters whose stories he found particularly compelling and illustrative of the broader themes he wanted to explore about the financial crisis.
What is the book about John Paulson named?
His story is covered extensively in the book, “The Greatest Trade Ever” by Gregory Zuckerman.
