John Paulson: The Subprime Slayer

The Quiet Man Who Saw the Apocalypse

In 2005, while America was throwing a never-ending house party, John Paulson wasn't drinking the Kool-Aid. He was reading the fine print on mortgage documents — and what he found made his blood run cold.

Born in Queens, New York in 1955, Paulson was never the flashy Wall Street type. No yacht parties. No Ferraris. Just a quiet guy with a Harvard MBA who ran a modest merger-arbitrage hedge fund.

By 2005, his fund managed about $2 billion — respectable, but nowhere near the big leagues. He was a nobody on Wall Street. That was about to change in the most spectacular way imaginable.

"I've never been on the cover of a magazine. I've never been in a Page Six story. I'm a pretty private person."

— John Paulson, before becoming a legend

What made Paulson different wasn't his intelligence — Wall Street is full of smart people. It was his willingness to look at data everyone else ignored, and then have the conviction to bet everything on what he saw.

The American Dream Turned Nightmare

To understand Paulson's trade, you need to understand the insanity of the mid-2000s housing market.

Banks were handing out mortgages like candy on Halloween. No income? No problem. No job? Here's $500,000 anyway. They called them NINJA loans — No Income, No Job, No Assets.

Here's the scam: Banks would give mortgages to anyone with a pulse, bundle thousands of these shaky loans together into securities called Collateralized Debt Obligations (CDOs), and sell them to investors worldwide.

The rating agencies — Moody's, S&P, Fitch — stamped these garbage piles with AAA ratings, the same rating as U.S. Treasury bonds. Because, as everyone knew: housing prices never go down.

"It was the greatest mass delusion in history. Everyone believed housing prices would go up forever. Everyone."

— Financial analyst on the 2000s housing bubble

Everyone except John Paulson.

Down the Rabbit Hole

In 2005, Paulson and his analyst Paolo Pellegrini started doing something radical: actually reading the mortgage documents.

What they found was horrifying. They analyzed thousands of individual mortgages inside these CDOs. The data told a story of impending doom:

Pellegrini built a model showing housing prices were 40% overvalued relative to historical trends and rents. Worse, the subprime loans being issued in 2005-2006 were the most toxic ever — borrowers with credit scores under 620 were getting adjustable-rate mortgages they could never afford once rates reset.

The math was simple: When these teaser rates reset in 2007 and 2008, millions of borrowers would default. Housing prices would crash. And everyone holding these "AAA-rated" securities would be holding worthless paper.

Building the Death Star

Paulson had the thesis. Now he needed the weapon.

The problem: You can't just "short" housing like you short a stock. There's no housing stock ticker. Paulson needed a financial instrument that would let him profit when mortgages failed.

He found it: Credit Default Swaps (CDS) on subprime mortgage bonds.

Think of CDS like insurance. You pay a small premium, and if the mortgage bonds default, you get a massive payout. The beautiful part? Wall Street was selling this "insurance" for pennies because nobody believed housing would ever crash.

In 2006, Paulson created a new fund specifically for this trade: Paulson Credit Opportunities Fund. He raised $147 million. Most investors thought he was insane.

"People said I was crazy. Banks laughed at us. They were happy to sell us all the CDS we wanted — they thought it was free money for them."

— John Paulson

Goldman Sachs, Deutsche Bank, and other Wall Street giants were on the other side of Paulson's trades. They were betting that housing would be fine. They were betting wrong.

The Waiting Game

2006 was torture. Paulson had made his bet, but the bomb hadn't exploded yet. Housing prices were still rising. His investors were nervous.

Every month, he paid premiums on his CDS positions. Every month, people asked if he was wrong. Every month, he held firm.

Paulson kept buying more CDS. He targeted the absolute worst mortgage bonds — the ones stuffed with NINJA loans, the ones with the highest risk of default. He called it "picking the weakest gazelles in the herd."

Then, in early 2007, the first cracks appeared. Subprime lenders started failing. New Century Financial, the second-largest subprime lender, filed for bankruptcy. Default rates were climbing.

The gazelles were starting to fall. And Paulson's trap was about to spring.

The World Burns

2007 was the year the music stopped. And when it did, John Paulson was the only one left standing with a golden parachute.

In the first quarter alone, his Credit Opportunities Fund was up 66%. By June, it was up over 200%. The fund's phones were ringing off the hook — suddenly everyone wanted in.

By year-end 2007, Paulson's flagship fund had returned 590%. His other fund, which used more leverage, returned 890%.

But 2008 was when the real carnage hit. Lehman Brothers collapsed. AIG was bailed out. The entire global financial system teetered on the edge of oblivion.

And John Paulson? His funds were up another 37.6% in 2008 while the S&P 500 crashed 38%. Total profit from the trade: $15 billion.

"I've never felt more alive than during the crisis. Every day we'd come in and make $100 million. It was surreal."

— Paulson team member, 2008

The $4 Billion Man

In 2007 alone, John Paulson personally earned $4 billion in compensation. Not his fund. Him personally.

That's not a typo. Four billion dollars. In one year. It remains the largest single-year payday in Wall Street history.

To put that in perspective:

The quiet guy from Queens who nobody knew suddenly became one of the richest people in America. His fund grew from $2 billion to over $36 billion at its peak.

But Paulson didn't gloat. While banks collapsed and executives were dragged before Congress, he stayed quiet. He had made the greatest trade in history, and he knew it.

The Aftermath: Hero or Villain?

Paulson's trade made him rich beyond imagination. It also made him controversial.

Some called him a vulture who profited from other people's misery — the families who lost homes, the workers who lost jobs, the retirees whose savings evaporated.

But others saw it differently. Paulson didn't cause the housing bubble — banks, regulators, and ratings agencies did. He just saw the truth that everyone else refused to see.

In a world full of people looking the other way, Paulson looked directly at the data and acted on what it told him.

After the crisis, Paulson made big bets on the recovery — buying banks, gold, and real estate. Some of these worked spectacularly. Others failed badly. His gold bet in 2011 cost investors billions when gold prices crashed.

By 2020, his fund had shrunk from $36 billion to under $10 billion. Many investors had left. In 2020, he converted his hedge fund into a family office, managing only his own fortune — estimated at $4.4 billion.

"No one's right forever. I had my moment. What matters is I saw it clearly and had the conviction to act."

— John Paulson