I just finished reading Gregory Zuckerman’s new book The Greatest Trade Ever: The behind the scenes story of how John Paulson defied Wall Street and made financial history. The story is about how JP, a relatively staid merger expert, became intensely bearish on the housing market in 2004. He took a $2 billion in assets firm and, using credit default swaps and derivatives trades against an index of subprime housing markets, began trading against the mortgage market. When the meltdown occurred, Paulson & Co. made money – lots and lots of money. In 2007, they made $15 billion. In 2008 through early 2009, they made another $5 billion. Zuckerman estimates Paulson’s personal share at about $6 billion over two and a half years.
The book itself follows a fairly standard formula. Tell the story, punctuated with the main characters and tidbits from their upbringing, add drama, repeat. His access to Paulson appears pretty extensive, and his quite fawning, often uncritical stance towards Paulson is consistent with that. It sort of helps readers understand credit default swaps, but doesn’t give enough information to be helpful for rank beginners. I am not sure I would recommend it if it is the only thing you’re reading on the financial crisis, but as I haven’t yet read the final word on it, this may be an interesting addition to your store of knowledge.
I’d like to focus on two elements of the book that I think are wildly problematic. The first is the attitude taken towards Paulson. Zuckerman chose the one investor (or actually the 3-4 investors) who were bearish on the housing market, and spent the entire book explaining how they were so incredibly wise and persistent in the face of an industry and even a whole country’s zeitgeist pushing in the opposite direction. This is selection on the dependent variable in the worst and most glaring sense. That is, choose people who succeed and then explain why they succeeded.
Here’s the thing: imagine 10,000 people go over Niagara Falls in a barrel, and 100 survive. Then those 100 people go over the falls, and 1 survives. That person will then write a book about how to survive going over Niagara Falls in a barrel. But without knowing what these barrel-goers are doing before they all go over, there is no way to know if the survivor made it because of what they did, chance, or whatever. Likewise, despite his sideline stories of the 3-4 others who also tried shorting the housing market (and most of whom failed doing so, despite doing much the same thing as Paulson!), Paulson was the only one who made tons of dough. As they say on the webular intertubes, causality FAIL.
But let’s say you buy that Paulson & Co. were geniuses. The problem, then, is that they decided to make decisions that benefited them at the massive expense of harming society.
Now, I’m not going to talk about how Paulson & Co. worked with banks to create even more toxic collateralized debt obligations (CDOs) than even existed at the time, so that they could bet against the housing market more directly (though from the hemming and hawing on pp 179-181 it is obvious to all that it was indeed ethically dubious and that both author and Paulson are trying to explain it without shouldering too much of the blame for it).
Instead, I’d like to focus on the fact that Paulson knew that things were going to crap, and often his willingness to speak out about it was highly subordinated to his desire to keep his trades quiet enough to make a boatload of money off of the housing collapse. Of course, the environment at the time was completely over-the-top rah rah bullish. And yet. And yet. Some examples:
1.
In November 2006, Pelligrini went to a presentation to investors by Robert Cole, the CEO of New Century. There the chief executive played up the low levels of defaults in subprime. “Pelligrini was convinced that his rivals were missing it. Wait till rates reset, he thought. He resisted speaking up, though, lest they figure how bearish his firm was, and perhaps warm to the CDS protection that Paulson was becoming enamored with, pushing prices higher” (98).
2.
In early August 2007, Paulson had been purchasing billions of dollars of CDS, betting against the housing markets:
…Paulson let his friend in on a secret. A few months earlier, he had reflected on how easy it was for him to buy billions of dollars of protection on all those toxic mortgages…Paulson began to wonder, if his fund found it so easy to buy billions of dollars of protection, who was selling it all to them? And what would happen to them as housing came crashing down?
…Banks were selling subprime protection to investors like Paulson and often keeping the positions for themselves…Paulson knew that as long as [housing prices kept falling] the banks and others holding these investments would have to record deep losses because they held so much of it themselves. It was just a matter of time before the pain began.
It was no secret that banks and investment banks like Merrill Lynch, Morgan Stanley, Countrywide, and Bank of America had pushed into subprime lending. They hadn’t acknowledged any huge losses just yet, though, reassuring some investors. But as the ratings companies lowered their grades on various pools of subprime home loans, it would have to happen” [235-237]
3.
On February 20, 2008, Paulson was invited with a number of investors to a lunch with Samuel Molinaro, Jr. of Bear Stearns. At that lunch, meant to bolster confidence in Bear, Paulson finally revealed his doubts, of course after “bulking up its bets against a range of financial giants, from Lehman Brothers and Washington Mutual to Wachovia and Fannie Mae. He had deep concerns about Bear Stearns, too” (256). The meeting, apparently spearheaded by Paulson’s accurate and massively negative assessment of Bear, “was a dagger in the staggering investment bank’s heart” (257).
On March 14th, the NY Fed tried to bail out Bear Stearns with a loan, then turning to securing their debt as they were acquired by JP Morgan Chase. Oh, and providing $29 billion in financing to help a 3rd party entity eat the BS crap assets.
In each of these cases, Paulson or his adviser turned their knowledge about the dysfunctional workings of the world’s financial system into their own private advantage, at the expense of the public welfare.
I was struggling with how to make what they were doing clear, and I remembered a maddening MassMutual advertisement that irked me to no end whenever I saw it. And then it clicked:
Exactly! There’s the rub. A responsible person would not just step back from the curb and let everyone else get wet. A responsible person would say to the other people, “Hey! There’s a bus coming! You may want to step back from the puddle!” This woman makes me want to shout. She may be making a good decision, but she’s a horrible citizen.
And that’s how I feel about Paulson. He stepped back from the brink, and was highly rewarded for it. Meanwhile the rest of Wall Street got massively splashed. But the thing is, it’s the rest of us that are getting screwed over by the damages caused.
It seems a very likeable and loveable stance you are making here.
But …
The problem is not really that Paulson did shut up about what he did. That he `secretly` build up positions in order to profit from a downturn. The problem was much, and much more, that many people knew they were blowing a bubble, and did not stop helping to blow the bubble because they were profiting from it. They did not know when to stop and they were the ones blowing up the bubble and leaving the mess to the rest of the world.
It is way to easy to blame the person smart enough to go against the current, and risking his own money to follow his conviction. Why is taking a positive position and profiting from a boom allowed, and when people are stupid en mass, being an opposite is suddenly being a fraud? Whatever Paulson wrote CDSses on was just a drop in the bucket. And he could only do it because people, greedy people, tried to squeeze as much out of the orange as they could, even though they knew, or at least had all the tools to could have known, that things were about to blow up.
These were not senior citizens tricked into giving up their last savings like with Madoff. These were not homeowners given dreams as if things can only go up and each homeowner has the right to get rich in no time. Paulson`s counterparties were sophisticated investors, people who had whole organisations, investigation firms, computer software etc etc behind them to tell them what the world looked like and where things were heading. But they choose to ignore, going for the short term profit. They are malicious, they created the bubble and they should suffer for it.
There were people speaking up (remember the Peter Schiff video`s, he was being laughed at). Paulson would not have been heard in case he would have chosen to do so, at the expense of himself and his investors. He has the right to make investment decisions just like anybody else, and to profit from them. There were a lot of investment firms before the crash profiting billions from helping blow the bubble, they should be the one you should attack.
Just like in the video, come on. These are 10 adults standing on the curb or very close. They have been through life, have been standing there often enough to know when there is water you can get wet. Are you serious that if you were standing there, you would stand graciously in front of these people and start to explain that if and when a bus comes by, they might get wet? Most likely they will push you in front of the bus, because they are just to eager to get to the other side. They are not in an unknown spot, they are in known territory.
It is to easy to judge the smart for being smart, or the wise for being wise, because they don`t share. To often people who try to share are not being listened to, are being laughed at, or are being blamed for something they saw coming after wards.
M – first, thank you for your thoughts! I would say that I am not blaming Paulson et al for the crisis. Not at all. Nor do I hate on short sellers. Nor on people who bet the ‘don’t pass’ line!
I said two things, which I think are pretty fair: 1) after the fact, it’s easy to see contrarians as ‘smart’ rather than lucky, despite the fact that even in this book others who were smart were not lucky; and 2) that rather than extolling his smartness, there’s a large element of moral selfishness in turning a massive social problem into personal profit.
As far as the puddle goes, I would try to say something, and have! In fact, a similar situation happened to me, shortly after I first complained about the ad to my wife. Which meant it was top of mind. When I spoke up, the pissy-looking woman ignored me (which is completely common – it is NYC after all). Now, that’s not graciously standing in the way, it’s taking minimal effort to try to warn other people. Does this make me a saint? No. Do I do it all the time? No. But I am a better person when I am trying to warn people than I am when I’m not.
All I’m saying is that Paulson may be smart, and didn’t cause the crash, AND his actions make him not a very good person.
Peter,
I don`t dispute your Niagara Falls example, although he was not the only one. Goldman Sachs also started to see the problem rising and starting hedging their positions.
But somewhere in your post you change from “he was just kind of lucky, and not an example to follow” to “The problem, then, is that they decided to make decisions that benefited them at the massive expense of harming society.”
Or, as in your reply above: “there’s a large element of moral selfishness in turning a massive social problem into personal profit”.
I think you are on very thin ice there in your argument. First of all, he tried to profit from a turn in the housing market. I don`t think even he knew at that time that it would become such a massive financial problem and turn into a large scale recession. Secondly he did not create the problem, and also had no means to really stop it. Thirdly, reasoning in this way there is hardly any business in the world you can be acting in without hurting anyone else s interest. Weapon industry comes easily to mind, but what about car industry (how many people die a year using a car), shops (how many successful shops forces other shops to close), banks (how many people go bankrupt or get into trouble because they cannot afford paying interest on debt) and I can go on forever.
Coming back to the example in the film, of course you can say as you argue that the girl should warn the others. But by being mad at her you forget the more essential and important issues at hand: she did not create the puddle of water, she was not driving the bus, and she was not standing on the edge of a puddle of water to cross the streets as soon as possible. She was just being sensible. As Paulson was.
Someone should teach bus drivers to avoid water near pedestrians, it is common sense. Someone should check out the sewage system to make sure the water does not stand still on the street. And then there is own common sense of the waiting people. But rather than point to the responsible people, the poor girl gets the blame. Of course, it would have been nicer if she would have tried, and you were very nice to try in your case (but I assume the lesson you learned is that it does not help in a lot of cases), but I object against calling her not responsible or Paulson only acting in selfishness at the harm of society. By doing that you let the real, actual harm doers go free.
Again I agree, Paulson is not a good person because he made money out of the situation, but it also does not make him a bad person being morally responsible for a situation that was created by others.
Peter & M — The commercial provides a bad analogy. M is correct that she did not create and therefore was not responsible for the puddle that led to the “disaster.” However, I agree with Peter that her silent avoidance of the problem and lack of courtesy and concern for her fellow pedestrians is rather reprehensible, especially given her apparent smugness after the fact.
Paulson did not create the conditions that led to the real estate meltdown, either. It is not clear how much effect he would have had if he had widely and loudly advertised his concerns. For one thing, the concerns were widely known and discussed for some time prior to the meltdown, so he would not have added much new information to the discussion. For another, as a hedge fund manager massively short housing, many people would have dismissed Paulson as simply “talking his book,” and therefore less than objective or credible.
However, Paulson did likely benefit directly from not speaking up, if only in the way he and his minions seemed to suggest: his silence made it easier and cheaper for him to establish and add to his positions. He wanted more people to get long in housing, since that made it easier and cheaper for him to get short. It is as if, for example, the woman in the ad was not merely a pedestrian, but rather a seller of towels or drycleaning services who set up a booth on the corner right by the biggest puddle available. Such a person wants more people to get wet, and as a commercial matter will do nothing to prevent that, even if she does not directly encourage more people to use that dangerous crossing site.
There is a word for such behavior in markets: profiteering. It is not illegal, but it is arguably morally reprehensible and undeniably antisocial. Whether that makes Paulson a “bad person” in your book or not is a personal judgment.
As far as I am concerned, all I will say is that I would consider it poetic justice if Paulson married the imaginary woman in the ad. They richly deserve each other.
M – yes, let’s call this structural problems. And the systemic bases for problems on Wall Street are deep. But there is a difference between saying, ‘housing in unsustainable!’ (I mean, Shiller and other had been doing just that, to little effect) and saying ‘my firm is betting $2 on a coming downturn in the housing market.’ I mean, let’s not let structural problems preclude us from pointing to individuals. It’s not either/or, it’s both/and.
Epicurian – Thanks for the comments! profiteering does have the ugliness that I’m happy to capture.
To be clear, what bugs me is that individual selfishness gets magically transformed into smartness or wisdom or good decision-making. That we have a system that allows this (and there’s a broader irony w/r/t Adam Smith-type magic-of-the-market arguments that individual selfishness gets transformed via markets into collective welfare – does not mean that it’s not morally problematic.
Profiteering is exactly right: taking individual profit at public expense is (and should stay) legal, but it should also come with some moral criticism.