Betting Down

have I been living in? Anyone who was paying attention knew there was a huge bubble building here and when it broke, things would go the opposite direction. But to suggest that Paulson has any influence on the press is laughable. He's just another investor who has been watching the situation objectively with the intent of capitalizing on the inevitability of a downturn. This happens with every downturn, some lose and others profit. If anything, the press should have been giving more scrutiny to what was occurring with the subprime mortgage market, SIV's and CDO's before they ballooned to the bubble that allowed Paulson to pocket $28 billion. As the WSJ noted, Paulson did the work and it is paying off:

"This is crazy," Mr. Paulson recalls telling an analyst at his firm. He urged his traders to find a way to protect his investments and profit if problems developed in the overall economy. The question he posed to them: "Where is the bubble we can short?" They found it in housing. Upbeat mortgage specialists kept repeating that home prices never fall on a national basis or that the Fed could save the market by slashing interest rates. One Wall Street specialty during the boom was repackaging mortgage securities into instruments called collateralized debt obligations, or CDOs, then selling slices of these with varying levels of risk. For buyers of the slices who wanted to insure against the debt going bad, Wall Street offered another instrument, called credit-default swaps. Naturally, the riskier the debt that such a swap "insured," the more the swap would cost. And this price would go up if default risk appeared to be increasing. This meant an investor of a bearish bent could buy the swaps as a way to bet on bad news happening. During the boom, however, many were so blind to housing risk that this "default insurance" was priced very cheaply. Analyzing reams of data late at night in his office, Mr. Paulson became convinced investors were far underestimating the risk in the mortgage market. In betting on it to crumble, "I've never been involved in a trade that had such unlimited upside with a very limited downside," he says. Paulo Pelligrini, a portfolio manager at Paulson & Co., began to implement complex debt trades that would pay off if mortgages lost value. One trade was to short risky CDO slices. Another was to buy the credit-default swaps that complacent investors seemed to be pricing too low. "We've got to take as much advantage of this as we can," Mr. Paulson recalls telling a colleague around the middle of 2005, when optimism about the housing market was at its peak. His bets at first were losers. But lenders were getting less and less rigorous about making sure borrowers could pay their mortgages. Mr. Paulson's research told him home prices were flattening. Suspecting that rating agencies were too generous in assessing complex securities built out of mortgages, he had his team begin tracking tens of thousands of mortgages. They concluded it was getting harder for lenders to collect. 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.

Paulson was doing the work of a wise investor and protecting himself by finding a way to continue to make money while everyone else was still chasing hot air. Someone in the press should have been reporting on CDO's a long time ago. The NYT wrote an article on them in Feb.:

Credit default swaps form a large but obscure market that will be put to its first big test as a looming economic downturn strains companies’ finances. Like a homeowner’s policy that insures against a flood or fire, these instruments are intended to cover losses to banks and bondholders when companies fail to pay their debts. The market for these securities is enormous. Since 2000, it has ballooned from $900 billion to more than $45.5 trillion — roughly twice the size of the entire United States stock market. No one knows how troubled the credit swaps market is, because, like the now-distressed market for subprime mortgage securities, it is unregulated. But because swaps have proliferated so rapidly, experts say that a hiccup in this market could set off a chain reaction of losses at financial institutions, making it even harder for borrowers to get loans that grease economic activity. ... But financial history is rife with examples of market breakdowns that followed the creation of complex securities. Financial innovation often gets ahead of the mechanics necessary to track trades or regulators’ ability to monitor the market for safety and soundness. The market for default insurance, like the subprime mortgage securities market, is a product of good economic times and has boomed in recent years. In 2000, $900 billion of credit insurance contracts changed hands. Since then, the face value of the contracts outstanding has doubled every year as new contracts have been written. In the first six months of 2007, the figure rose 75 percent; the market now dwarfs the value of United States Treasuries outstanding.

If anything, the press continued to happily support the rosy scenarios of a booming economy that Wall Street wanted until it reality struck and it could no longer support the excesses that inflated the bubble. They did the same with the dot com bubble, with Enron and will probably be as complicit with the next one. I would feel much better if the press would function properly and help prevent these bubbles in the first place.