<a href="http://online.wsj.com/public/article/SB120036645057290423.html">Trader makes billions on subprime</a>.
<p><em>On Wall Street, the losers in the collapse of the housing market are legion. The biggest winner looks to be John Paulson, a little-known hedge fund manager who smelled trouble two years ago.</em></p>
<p><em>Funds he runs were up $15 billion in 2007 on a spectacularly successful bet against the housing market. Mr. Paulson has reaped an estimated $3 billion to $4 billion for himself -- believed to be the largest one-year payday in Wall Street history.</em></p>
<p><em>"Most people told us house prices never go down on a national level, and that there had never been a default of an investment-grade-rated mortgage bond," Mr. Paulson says. "Mortgage experts were too caught up" in the housing boom.</em></p>
<p><a href="http://www.traderdaily.com/">Trader Daily's trader of the year goes to</a>...</p>
<p><em> The place to be in 2007 was short subprime, and no one executed this position with more gusto than John Paulson. His immense, insightfully crafted bet against pools of perilous home loans produced unprecedented profits for his various credit funds, while helping to generate at least $3 billion in management- and performance-fee revenue — although the final figure (neither confirmed nor denied by Paulson & Co.’s external publicity representative) will end up, by our reckoning, much higher. </em></p>
<p><em> Paulson’s subprime play wasn’t just the trade of the year — it might well have been the greatest trade of all time. How massively did the 51-year-old Manhattan-based portfolio manager’s short subprime play pay off? Consider that Paulson & Co.’s four “Credit Opportunities” funds (the largest, for offshore clients, is Paulson Credit Opportunities Ltd.; the others are Paulson Credit Opportunities II Ltd., Paulson Credit Opportunities LP and Paulson Credit Opportunities II LP) started the year with a combined $1 billion. </em></p>
<p><em> The standout Credit Opportunities LP fund returned 590 percent in 2007. At year’s end, the entire quartet totaled roughly $9 billion. Paulson’s firm, which runs 12 funds altogether — including a series of merger-arbitrage and event-driven strategies — started the year with a combined $7 billion in assets under management; it was expected to finish the year having quadrupled that. The trade-of-the-year debate is over: All hail John Paulson. In the four years Trader Monthly has been tracking trades — the four most lucrative in history — Paulson’s haul ranks as the largest profit ever logged. </em></p>
<p><em> Paulson and Paolo Pellegrini, co–portfolio manager for the firm’s credit strategies, determined in 2006 that the U.S. housing bubble was ready to pop, a projection based on meticulous proprietary research. Paulson and Pellegrini then skinned the subprime cat two ways, via an ABX index position and by shorting individual CDO names. Their real score came through the second approach, which involved a huge purchase of credit default swaps tied to certain handpicked CDOs; Paulson homed in on the most troubled mortgage pools, regardless of rating-agency or Wall Street assurances. The value of the CDS instruments he amassed went through the roof when the CDOs’ value plummeted as subprime borrowers, many with adjustable-rate hikes kicking in, began to default. </em></p>
<p><em>How, exactly, did Paulson envision this? One trader familiar with his activities says that in 2006, Paulson began to notice that premiums on the protection of CDOs were out of sync. “He shorted CDOs packed with residential mortgage-backeds by buying credit default swaps when the premiums were only a few basis points,” this trader says. “As homeowners [became unable to] pay their ARMs, the performance on the ‘insured’ credit deteriorated.” </em></p>
<p><em>In time, Paulson’s CDO insurance — the CDSs, that is — became far more valuable than the CDOs it was designed to protect. “The market for CDSs is actually quite liquid,” the trader points out. “With lots of traders trying to cover their asses and stopgap their losses, they were willing to pay more for credit protection.” </em></p>
<p><em> Those double-digit basis-point premiums jumped to triple digits. And while a few forward-thinking traders were playing well in the CDS sandbox, Paulson was in one all by himself, buying swaps featuring covenants requiring the seller to post collateral — in the form of cold, hard cash — when the protection premiums reached a certain threshold. </em></p>
<p><em>Two sources close to the action describe how, at one point last summer, Paulson put the touch on a major bulge-bracket brokerage for $500 million — a reverse margin call, as it were. A 24-hour tension-filled tussle ensued over whether the brokerage would pony up. Paulson prevailed. The lesson here for traders: When you really believe in a trade, go hard or go home.</em></p>
<p><em>It could well go down as one of the most treacherous years in trading history. Credit markets imploded. Equity markets shuddered. Commodities ran wild. Now we settle up on 2007 with a robust recap of the year’s top subprime plunderings, commodities killings and other money-making marvels, and our inaugural survey of sell-side excellence. Prepare to close the books on a year many might prefer to forget.</em> </p>
