Thursday, August 29, 2013

How to Make a Billion Dollars in a Year: Wall Street, Stocks, Mortgages, and Financial Crisis (2010)

How to Make a Billion Dollars in a Year: Wall Street, Stocks, Mortgages, and Financial Crisis (2010)

In 2005, Paulson became concerned about weak credit underwriting standards, excessive leverage among financial institutions and a fundamental mispricing of credit risk. To protect its investors against the risk in the financial markets, Paulson purchased protection through credit default swaps on debt securities they thought would decline in value due to weak credit underwriting.

As credit spreads widened and the value of these securities fell, Paulson realized substantial gains for investors and is reported to have earned $15 billion with $12.5 billion in assets under management in 2007.

In December 2009, the New York Times reported that Paulson had profited during the financial crisis of 2007 by betting against synthetic collateralized debt obligations (CDOs).

On April 19, 2010, the Wall Street Journal reported that Paulson employee Paolo Pellegrini was the point man in Paulson's investment in subprime mortgages.

In 2008, Paulson believed that credit problems would expand beyond subprime mortgages to include areas of consumer, auto, commercial and corporate credit, and that the rising credit costs would continue to stress financial institutions causing spreads to widen and causing certain institutions to fail. This bearish outlook on the credit markets led them to take short positions in some large financial institutions in the US and the UK with high degrees of leverage, high concentrations of assets in deteriorating sectors and rising credit costs. Sectors include mortgage finance companies, specialty finance companies and regional, national, and global banks.

In September 2008, Paulson bet against four of the five biggest British banks including a £350m bet against Barclays; £292m against Royal Bank of Scotland; and £260m against Lloyds TSB. Paulson is reported to have earned a total of £280m after reducing its short position in RBS in January 2009.

To help protect these bets, PCI and others successfully prevented attempts to limit foreclosures and rework mortgage loans.

Following the collapse of Lehman Brothers in the fall of 2008 and the subsequent turmoil in the markets, Paulson launched a fund at the end of 2008 dedicated to restructuring and/or recapitalizing companies such as investment banks and other hedge funds currently feeling the pressure of the more than $345 billion of write downs resulting from under-performing assets linked to the housing market. By providing capital to companies at trough valuations, thus enabling them to survive beyond the crisis, Paulson believed there would be considerable upside potential through a subsequent recovery in the equity of these companies. Companies in the fund that benefited from such recapitalizations were largely concentrated in the financial, insurance and hotel sectors.

Amongst some of the holdings disclosed in Paulson's June 30, 2009 13F filings were 2 million shares of Goldman Sachs as well as 35 million shares in Regions Financial Paulson also purchased shares of Bank of America in the spring of 2009 when the bank was forced to recapitalize its balance sheet following the results of the bank stress tests conducted by the US government, and was reported to have a 1.22% stake in the bank in 2011. According to certain sources, Paulson purchased the shares expecting the stock to double by 2011.

After the 2008 Stock Market crash, Paulson's investment in Citigroup reportedly generated $1 billion from the original investment in 2009 through the end of 2010, called by reporters the "Betting on Citigroup". Mr. Paulson stated that the investment in Citigroup "demonstrates the upside potential of many of the restructuring investments we have added to our porfolio and our ability to generate above-average returns in large positions"

In November 2009 Paulson announced a gold fund focused on gold mining stocks and gold-related investments. Paulson believed that the massive amount of balance sheet expansion through monetary stimulus undertaken by the Federal Reserve and other central banks would eventually lead to inflation in the US dollar and other fiat currencies. In such an environment, gold would become the alternative currency of choice for investors globally, causing the value of gold to increase significantly.

Paulson also has a long track record of investing in distressed debt, bankruptcies and restructurings. The 2008-2009 financial crisis resulted in a record high level of defaults and bankruptcies across numerous industries, and Paulson was a large investor in many of the largest and most prominent ones, including the Lehman Brothers bankruptcy and liquidation.

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