John Paulson
Event-driven investment master who used credit default swaps to short the subprime mortgage bubble
John Paulson (born 1955) is an American hedge fund manager and founder of Paulson & Co. He holds an MBA from Harvard Business School and previously worked at Bear Stearns. He founded Paulson & Co. in 1994, specializing in event-driven investing and risk arbitrage strategies. In 2007-2008, he purchased massive amounts of credit default swaps (CDS) to short subprime mortgage securities, earning approximately $20 billion for his fund during the financial crisis with personal gains of about $4 billion. New York Times journalist Gregory Zuckerman called it The Greatest Trade Ever. This trade made Paulson famous overnight and also sparked widespread controversy about Wall Street short-selling. Subsequently, his investments in gold, healthcare, and other areas had mixed results, and in 2020 he converted Paulson & Co. into a family office.
Methodologies
- Event-Driven Investment Analysis Framework - Systematically analyze the impact of specific events on security pricing, establishing asymmetric positions before event outcomes become clear
- Credit Default Swap Short Strategy - Use CDS as an asymmetric short instrument to gain massive leveraged exposure to credit events at limited annual cost
Key decisions and timeline
- Earned Harvard Business School MBA - Systematic theoretical training and elite networks are important tickets to entering the elite finance world
- Founded Paulson & Co., Focused on Event-Driven Investing - Building deep expertise in a specific strategy is the core competency of a hedge fund
- Began Deep Research on Subprime Market, Discovered Systematic Mispricing - When there is a huge gap between fundamental analysis and market pricing, that is the greatest investment opportunity
Beliefs and mental models
- Belief 1 - Specific events such as mergers, restructurings, bankruptcies, and regulatory changes cause systematic mispricings in related securities. Through deep research into these events, one can discover risks or opportunities not fully reflected by the market, achieving predictable excess returns.
- Belief 2 - The best investment opportunities have limited downside risk (lose at most the full investment) but enormous upside potential (potentially multiple times or even dozens of times return). The subprime short perfectly embodied this principle: the cost of buying CDS was limited, but if subprime collapsed, the return would be astronomical.
- Belief 3 - In the subprime trade, Paulson's team spent over a year deeply analyzing the underlying asset quality of subprime mortgage securities, discovering risks severely underpriced by the market. This deep research capability is the core competency behind Paulson's consistent excess returns.
- Model 1
- Model 2
- Model 3