A Closer Look at the Biggest Trade of All Time

The Greatest Trade Ever is the inspirational story of how John Paulson, a mediocre M&A specialist, rose to greatness by betting against the housing bubble – and defying all of Wall Street in the process.

Being an avid observer of markets, financial history and the human psyche, your editor reads a good two dozen books per year on average. There are usually at least two in progress at any given time.

As might be expected, many of these titles fall into the “decent” or “not bad” category. (The disappointments are given very short shrift.) But every once in a while, a book really and truly stands out. That was the case with a recent read: The Greatest Trade Ever by Gregory Zuckerman.

The book tells the story of how John Paulson, a run-of-the-mill M&A (mergers and acquisitions) specialist – seen by his peers as a “nobody” on Wall Street – managed to smash all previous trading records with one masterful play.

As Zuckerman puts it,

Paulson’s winnings were so enormous they seemed unreal, even cartoonish. His firm, Paulson & Co., made $15 billion in 2007, a figure that topped the gross domestic products of Bolivia, Honduras, and Paraguay, South American nations with more than twelve million residents. Paulson’s personal cut was nearly $4 billion, or more than $10 million a day.

Given that Paulson had a personal net worth in the neighborhood of $100 million at the beginning of 2007, he managed to increase his wealth something like 40 times over – a factor of 4,000% – as a result of one trade. Not too shabby.

In a nutshell, Paulson made the killing of a lifetime by figuring out how to bet against the housing bubble. The trade was extremely complex and extremely tough to implement – after all, you can’t just go out and short real estate. The Greatest Trade Ever unfolds like a movie plot, beginning with details of Paulson’s life and background and then slowly building to climax.

Zuckerman, the book’s author, is an award-winning Wall Street Journal columnist. To get the story right, he spent more than 50 hours with Paulson, and nearly as much time with some of the other key players behind the big trade.

One Man Against Wall Street

The book was deeply inspirational on a number of fronts. To begin with, I had no idea going in just how much frustration, ridicule and opposition John Paulson – or “JP” to his friends – had to endure to pull off his legendary score.

The reason Paulson was able to make billions is because all of Wall Street stood on the other side of the trade. When nearly all your friends and colleagues are Wall Streeters, this is not a comfortable arrangement to say the least.

On the one hand, you had all the goliaths of the financial establishment, standing shoulder to muscular shoulder like a row of skyscrapers, mighty and imposing in their unbroken solidarity. And then there was essentially one lone man – Paulson – standing up to them all and saying, “You people are crazy. The emperor has no clothes, and I am going to prove it by betting against you. ALL of you.”

Paulson didn’t act alone, of course. His No. 2 man on the trade, Paolo Pellegrini, played a huge role in confirming the existence of a housing bubble and figuring out how to act on it. There were a handful of others, too, who spotted the insanity of the times and had the courage to act.

But Paulson was unique in that he bet bigger than the others – much, much bigger – and put his reputation and conviction on the line like no one else.

As Zuckerman unfolds the tale, it becomes clear just how much of a stubborn contrarian Paulson had to be to make his billions. Imagine taking the biggest, most aggressive position of your life – by far – and having virtually everyone you know telling you that you’re wrong. Not quietly suggesting that maybe you are wrong, but practically shouting that you are wrong. And then whispering behind your back… making you an object of derision and ridicule.

Defying the Quants

The most remarkable trait Paulson showed, in addition to sheer dogged determination, was an almost superhuman ability to stick with the courage of his convictions.

As the Paulson & Company team shared their views on the housing bubble with other investment banks and research houses on the Street, they were told over and over again that no, they were wrong, that they had to be missing something… again and again it was argued that home prices were justified, and that investor exposure to risky mortgages was thus justified, because all the “quant” models said so.

In other words, very smart people with very powerful supercomputers had crunched all the numbers, and the numbers all said the same thing – everything is fine – so why should one guy who didn’t even have a supercomputer think he should know better?

Paulson looked past the brainpower of the Ph.D.s and the supposed infallibility of the experts. At the end of the day, he was comfortable rejecting the verdict of Wall Street and instead relying on plain old common sense.

Ironically, Paulson didn’t even have a background in real estate or mortgages. He was an “M&A” (mergers and acquisitions) guy by trade. This likely helped him rather than hurt him because, if Paulson been immersed in the industry like everyone else, he would have had more regard for the big names (none of whom saw the bubble) and been more exposed to the temptation of “groupthink.”

The Power of Persistence

The Greatest Trade Ever isn’t exactly a rags-to-riches tale. Paulson wasn’t broke at the beginning of the story. (Although a key man who helped set up the trade, Paolo Pellegrini, really was all but broke – fighting for his career after a long string of disappointments – and went from zero to tens of millions.)

Whether or not the reader can identify with Paulson, though, the man’s tenacity is unquestionable. Hurdle after hurdle, obstacle after obstacle… he plowed through them all.

And once the trade began to work, and huge profits began to roll in, Paulson showed yet more fortitude in refusing to cash out too early. All the same people who were once saying “you’re wrong, you’re stupid, the play will never work” were now saying “take profits, you’re a fool not to take the money and run.” Paulson stuck to his guns, and greatly increased his gains as a result.

For those who are interested in the inner workings of Wall Street, The Greatest Trade Ever is also fascinating in terms of specific details. Without getting too arcane or complex, Zuckerman does a great job of explaining “credit default swaps,” also known as CDS – the new and untested tool Paulson used to bet against pools of risky mortgages. The book also tells the tale of other, smaller-scale winners like Michael Burry, Greg Lippman and Andrew Lahde, all of whom who stood against the tide as lone contrarians.

Guts, persistence, creativity, conviction… as The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History shows, they still count for something. In a free market society (or at least a close approximation of one), they always will.

Original article here.