We know that in one of the most successful trades in financial history, John Paulson's hedge fund firm Paulson & Co., made $15 billion for itself and its investors in 2007, with the firm's two credit funds chalking up a whopping 440% return. We also know that Paulson & Co. followed up with another impressive performance in 2008 by taking short positions in various financial stocks, with its flagship fund, Paulson Advantage Plus (with $7 billion in AUM), racking up a 37.6% return net-of-fees in 2008.
What we do not know about one of the most successful trades in financial history are the behind-the-scenes actors – actors at Paulson & Co., and others who betted against the U.S. subprime housing market – as well as the pains and humiliation that most of these actors suffered at the hands of their peers and investors when the housing market went against them in 2005 and through the end of 2006.
Written by famed WSJ writer Gregory Zuckerman and published in November 2009, “The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street And Made Financial History” is a Tour de Force chronicling the rise of John Paulson from a mediocre merger arbitrage investment manager into a financial titan – one that Congress and even George Soros seeks for advice. Paulson is intelligent and has always had a knack for making money – but an early career detour into consulting quashed his early chances at making it big in Wall Street. Moreover – while it was not explicitly mentioned in the book – Paulson's financial background was all in merger arbitrage. As any investor should know, merger arbitrage is a strategy that typically promises slow and steady returns. Any extreme move in a merger arbitrage strategy is usually to the downside. Paulson & Co. simply cannot “make it big” without venturing away from its core strategy (e.g. shifting from merger arbitrage into global macro) – and in the institutional investment world – any “style drift” usually lends to investor redemptions. Paulson & Co. simply cannot take such a risk unless it was very sure that it would work (and only lead to minimal losses in the event that it does not). To that end, the bet against the U.S. subprime housing market was the perfect bet – as one can glean from reading Zuckerman's book.
At its core, this book is about biases in investor psychology, human relationships when significant money is at stake, and a history about how the financial world and the U.S. housing market have progressed in the last 30 years. It has something for everyone that is interested in financial history. It provides the backdrop behind the financial crisis, the financial instruments but it does not detail the mathematics or the models behind the trades. It discusses Paulson's relationships and conflicts with his friend Jeffrey Greene and his right-hand-man Paolo Pellegrini – both of whom had a falling out with Paulson despite (or in spite) of their collective successes. Perhaps the best discussions about human relationships – especially in this context – were the ones Paulson (and other managers involved in the same trades) had with his investors. As John Maynard Keynes would say: “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.” The road to successfully constructing and implementing one of the greatest trades in financial history is a very long, treacherous, and difficult road, indeed.
Whether this book will end up being a must-read for global macro investors – such as Edwin Lefevre's “Reminiscences of a Stock Operator” or Jack Schwager's “Market Wizards” series will depend on Paulson's future success, but the elements are mostly in place. Should Paulson continue with his streak of successes in the global macro world, a revised and updated edition of the book – a book that will be much more timeless – will be sorely needed.