The Greatest Trade in History
On November 30, 2022, NYU Stern and Dean Raghu Sundaram welcomed John Paulson, president and portfolio manager of Paulson & Co., a private investment company, to a Fireside Chat before an audience of Stern students, staff, and faculty.
Before forming Paulson & Co. in 1994, Paulson was a general partner of Gruss Partners and a managing director in mergers and acquisitions at Bear Stearns. Paulson & Co. received numerous awards and accolades over its 25-year history, including the Absolute Return's awards for Management Firm of the Year, Best Arbitrage Fund, and Best Event Driven Fund. The Paulson Family Foundation supports education, science, health, culture, and the arts.
A dedicated Stern champion, Paulson has been closely involved with the School over the years, as a member of the Stern Executive Board and a generous donor. The Paulson Auditorium—the School’s largest classroom and event space—is named in his honor.
Professor Charlie Murphy (MBA '74) moderated the discussion and following below are highlights from their conversation.
Charlie Murphy: You grew up in New York City and stayed here for college at NYU. Did you have any inkling of what you wanted to be?
John Paulson: I was entrepreneurial as a kid, and after freshman year I took off two years to start a business, a clothing manufacturer, because that’s what all my friends’ parents did. I went into children’s clothing, but after a couple of years I was missing production targets to Bloomingdale’s and the quality wasn’t there. I returned to NYU’s College of Business and Public Administration. An investment banking seminar taught by Wall Street legend Gustave Levy got me interested in finance. When future Treasury Secretary Bob Rubin guest-lectured about arbitrage at Goldman Sachs, I saw he was producing more money than anyone else, so I became enamored with risk arbitrage. I attended graduate business school with that as a goal, then worked eight years for other firms before starting my own in 1994.
CM: When you started Paulson, where did you go for the money? And who did you hire?
JP: Hedge funds were somewhat new then, so the capital available was limited. I didn’t know any investors and had no record. With some small savings and office resources that my first employer, Bear Stearns, made available, I sent out 500 announcements and got zero calls back. But then I made an amazing hire with a young, MBA-degreed salesperson from IBM, and thanks to her marketing expertise, we very quickly reached $20 million. Another marketing organization signed on, and within a year we raised $100 million. At that number, you can start making money. Ultimately we managed $35 billion, with returns over 20%. Our fees at their peak were well over several billion dollars a year. The two key things to be successful in this business are to produce the returns while avoiding drawdowns. If you have performance and capital, it’s a real money machine.
CM: Before the subprime crisis and the recession, your firm took a big bet. How did you get into the real estate business and make what some have called the greatest trade in history?
JP: I had developed an expertise in shorting the bonds of finance companies, because they have a very levered capital structure. The downside is small, and the upside tremendous, so it’s a very asymmetric trade, but it’s like finding a needle in a haystack. When we came into the subprime crisis, there were an unlimited number of bonds, and the mortgage market was the largest credit market in the world, bigger than the US Treasury market. Like the crypto bubble today, everyone was just buying these bonds and not looking at the downside. As the market for these bonds deteriorated, we progressively shorted them, and I grew more confident they would default. At the peak, we shorted $25 billion worth—to banks like Goldman, UBS, etc., not end users—but it was costing me about $300 million in negative interest. The street thought I was out of my mind. By the end of the year, we were up 1,000% in the fund, 800% net. It was one of the most amazing experiences.
CM: Who does the research and how is it done?
JP: You have to have a team. Analyzing a mortgage-backed security is very technical; you have to have programming skills, download pools, write programs to analyze the pool. I was able to design the format of the information I wanted, but I didn’t know how to actually do that work. Without a team, I wouldn’t have been able to achieve what I achieved.
CM: What do you do when you have losses?
JP: You have to be realistic about losses. I subsequently became a little overconfident and made some risky bets that were more symmetric, that is, you could win 20% but sooner or later lose the same amount—rather than risking a little to make a lot. You want to win over the long term, not every day.
CM: What do you think about the state of regulation in the finance industry?
JP: It’s well balanced. I don’t feel like I’m over-regulated. We have plenty of freedom to do what we do, but I think you need regulation for investor protection. Look at cryptocurrencies: with no regulation, retail investors lost trillions.
CM: What’s the next big thing?
JP: As for bubbles, treasury bonds globally are already down. Crypto is currently probably down 75%, and I think over the next few years it will go the last 25%. As for growth areas, the models for private equity and hedge funds are very strong and will produce wealth over the long term. Matching technology innovation with business is going to be the biggest area for wealth creation in the next generations.
Is the crypto market finished?
It’s in the process of becoming finished. It was a fad. In the end, crypto is an empty box, there’s no tangible value in any crypto assets. The value is that there’s a limited number of shares in that empty box.
How have the markets changed over your career?
More volatile, certainly, but the principles haven’t changed very much on the credit and equity sides. The credit markets have gotten much bigger, research is easier to access, and it’s easier to get the ability to do analysis.
How do you relax?
I have a lot of interests besides work. For instance, I had my own Steinway company, which opened the world of music to me. I love art, and recently traveled with the Metropolitan Museum of Art to see museums and private collections in Mexico. I’ve served on many boards, but I’ve narrowed it down. I particularly enjoy the Princess Grace Foundation. I used to work probably 60 to 80 hours a week, probably 80 to 100 when I was young. I’d like to get it down to 20 to 30 hours. I’ve returned all outside capital now, we just manage basically my own and my foundation’s money, and I’ve shrunk the firm from 160 to 25 people. We only have core investments now, steadier, safer, more muted returns, and I’m looking to work less and enjoy life more.