“‘It got to the point where I literally got sick to my stomach,’ she recalls. ‘Every day I got home and would think to myself, I helped set someone up for failure.’”
The Greatest Trade Ever
Karen Waheed, who worked at New Century Financial, was becoming increasingly worried about the firm’s lax lending. Her bosses, on the other hand, didn’t seem to have a care in the world.
Trouble in Paradise
New Century Financial was based in a gleaming glass tower in Orange County, California, just a few miles from the beach. In a little over a decade, it had grown to become the largest independent subprime lender in the United States.
But by early 2007, New Century was in trouble. It disclosed issues with loans early in the year and suddenly collapsed into bankruptcy less than 2 months later.
Paulson’s trade was finally beginning to pay off.
Cashing In
The day New Century filed for Chapter 11, Paulson made $1.25 billion. This surpassed even the $1 billion George Soros made in a day betting against the British pound in 1992.
As one lender after another ran into trouble in 2007, Paulson began to trim his positions. He exited about 30% of his bets that year, locking in huge gains.
In all, Paulson’s funds made over $12 billion betting against the housing market. In 2007 alone, Paulson personally made $4 billion — the largest payout in the history of financial markets.
Other bearish hedge fund managers like Michael Burry and Andrew Lahde emerged from obscurity to make tens of millions as well. Meanwhile, the nation’s largest banks imploded on an almost daily basis.
How Did They Do It?
Paulson’s trade was the best in the history of financial markets. But it didn’t take a miracle to pull it off.
Paulson and Pellegrini clearly saw a huge bubble. It wasn’t all that hard to spot — does the price of a house jumping 50% in a year seem normal to you?
One thing Paulson, Pellegrini, Burry and Lahde all had in common was that none was an expert in mortgages.
They viewed the market with fresh eyes. Handing hundreds of thousands of dollars to borrowers with no documentation wasn’t normal to them — even if it had become the norm in the mortgage industry.
While mortgages and derivatives may have been new to these traders, they studied hard to learn these new markets. A fresh pair of eyes and a keen desire to learn are powerful weapons.
But most importantly of all, they had conviction. Even as their trades lost money, they held on, sure they’d be vindicated.
“…sitting and waiting his how we made money from the subprime debacle…”
Andrew Lahde
Wrap-Up
As an angel investor, my investments are very different from Paulson’s. But I’m still learning a lot from him.
Paulson made a nonconsensus bet. He stuck to it even when it was hard. And he was right.
Angels and VC’s do pretty much the same thing. And we do have one advantage: even if we wanted to dump our positions, we can’t!
Reading about Paulson and Pellegrini’s incredible trade, I’m even more excited to double down on my most successful investments.
The great opportunities are rare. When I find one, I’m all in.
What do you think of Paulson and Pellegrini’s trade? Leave a comment and let us know!
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More on markets:
The Greatest Trade Ever (Part One)
The #1 Thing Investors Get Wrong
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