Tale of a Winning Bet Against Predators

WSJ scores with great subprime story

The Audit congratulates The Wall Street Journal for a riveting read this morning on the big winner in the subprime collapse, John Paulson, a hedge-fund manager who made big and timely bets against the junk subprime-backed securities Wall Street was cranking out.

The piece, by Greg Zuckerman, is compelling enough simply in explaining how Paulson did it, how he came to his negative conclusions about the U.S. housing market and how he figured out ways to bet against it. Credit-default swaps will probably never be more understandable or interesting.

Add to the mix great, random detail: lunch with a curious George Soros, a companion scoop with Greg Ip on Paulson’s (slightly odd) hiring of Alan Greenspan as an adviser, and another great companion piece on how a pal ripped off Paulson’s ideas and made his own fortune on the West Coast.

All for $1.50 a copy. Not bad.

As the story explains, the Paulson score ranks among the big ones, comparable to the late twentieth century deals that made Warren Buffet and Soros himself rich.

But what caught our eye was how Paulson’s bet was predicated not just on a hunch that lenders had gone too far, but on solid evidence of widespread predatory—not overly generous, but predatory—lending in the mortgage industry.

His confidence rose in January 2006. Ameriquest Mortgage Co., then the largest maker of “subprime” loans to buyers with spotty credit, settled a probe of improper lending practices by agreeing to a $325 million payment. The deal convinced Mr. Paulson that aggressive lending was widespread.

He decided to launch a hedge fund solely to bet against risky mortgages.

We’re heartened that the Street’s biggest winner shares The Audit’s view of the housing crisis.

“While we never made a subprime loan and are not predatory lenders, we think a lot of homeowners have been victimized,” Mr. Paulson says.

The guy who got the crisis right is also right about its root causes. The blame-the-borrowers school is for the losers.

A fine New York Times story this morning on how women in Baltimore are more affected than men by the mortgage crisis provides a useful companion to the Journal stories, reminding readers how this crisis started.

Four years ago, Miss Booker (a Baltimore beauty salon owner) bought a brick row house for $130,000, taking a subprime mortgage because she had a low credit score. Her initial payments were $841 a month.

“He said the rate was adjustable but in six months you can refinance,” she said. “But I never did. I didn’t ask why I didn’t get a fixed rate from the beginning.”

After two years, her mortgage payments shot up to $1,769. She has borrowed money from her former husband and two friends, but says it is hard to ask for money “because most people are going through what you’re going through.”

Understanding how hard shady mortgage-industry practices have hit homeowners like these, Paulson gave $15 million to the Center for Responsible Lending. For years it has been blowing the whistle on the predatory nature of the subprime industry and, for those who bothered to look, provided ample evidence of the mortgage market’s corrupt foundation. The center is lobbying for a bill that would give bankruptcy judges power to restructure mortgages.

“Bankruptcy is the best way to keep homeowners in the home without costing the government any money.”

We agree with that, too.

But we can only shake our head at the Greenspan hiring.

Mr. Paulson defended Mr. Greenspan’s record, saying he isn’t to blame for the housing crisis that the hedge-fund investor has profited from. “It’s easy to look back and do Monday-morning quarterbacking,” Mr. Paulson said. “The decisions he made at the time were right.”

Hey, nobody’s perfect.

Congrats, Greg et al.

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Dean Starkman Dean Starkman runs The Audit, CJR's business section, and is the author of The Watchdog That Didn't Bark: The Financial Crisis and the Disappearance of Investigative Journalism (Columbia University Press, January 2014). Follow Dean on Twitter: @deanstarkman.