Recently, I finished a book called The Greatest Trade Ever, written by Wall Street Journal columnist Greg Zuckerman. The book records some real stories of investors like John Paulson, who made billions of money during the sub- prime mortgage crisis in 2007 by betting against mortgage backed securities. By using tools like CDS (credit default swap), Paulson received large amounts of payments from the banks since the issuer of the CDS defaulted. Even the legendary investor George Soros asked John Paulson for a tutorial after the young man made 20 billion for his firm out of the worst financial downturn since the Great Depression. The book spends a lot of words on how Paulson decided to bet against the mortgage security which was thought to be very safe by the majority. It also describes the pressure that Paulson received from his clients and investors who were dubious about the CDS transaction.
I believe the transaction itself is, undoubtedly, the “greatest”. However, this does not mean that Paulson was the greatest or the smartest guy at that time. In fact, many people, though not the majority, had perceived the bubbles in the mortgage securities in the late 2006, including those who were lending money to the unqualified borrower. I know you are not convinced since nobody will dump their money if they know they are going to lose them all. An ordinary explanation would be that “people are greedy”. That is true, but not complete. The fact that people were conservative is the explanation for all these things happened! These financial pros, even successfully foresaw the crisis, would unlikely to bet against the market. The reason is that they had a job which would stop them from making the rational decisions. There were many traders and investors in the market, who were constantly competing for customers. Suppose you were trader who was selling mortgage securities to your clients in 2005, you would unlikely to do something that is going to lose your clients by stop selling the securities that were going up every day. Again, suppose you were a fund manager in 2005, you would unlikely to choose to risk your client’s money by betting against the real estate when it was going up. So no matter on the buy side or the sell side, you were doomed to fail. Even you were among the few who chose to take the risk, any gain in the housing prices would put you in a difficult situation. Frequent calls from your clients asking you to clean you positions, blame from your boss and laughter from your competitors. As someone who has used up all the savings to finish your business school and works like a dog for years, you do not want to lose your job on Wall Street. Besides, the tools used in the Paulson’s trade were brand new and only a few people had heard of them at that time. No one would like to try tools that they are not familiar with. This is why hardly any person could successfully make a fortune in the crisis. It was not just because people wanted to make money, but also because people wanted to survive by protecting themselves from any bad outcomes possible. Conservativeness is the ultimate human nature.
I believe the transaction itself is, undoubtedly, the “greatest”. However, this does not mean that Paulson was the greatest or the smartest guy at that time. In fact, many people, though not the majority, had perceived the bubbles in the mortgage securities in the late 2006, including those who were lending money to the unqualified borrower. I know you are not convinced since nobody will dump their money if they know they are going to lose them all. An ordinary explanation would be that “people are greedy”. That is true, but not complete. The fact that people were conservative is the explanation for all these things happened! These financial pros, even successfully foresaw the crisis, would unlikely to bet against the market. The reason is that they had a job which would stop them from making the rational decisions. There were many traders and investors in the market, who were constantly competing for customers. Suppose you were trader who was selling mortgage securities to your clients in 2005, you would unlikely to do something that is going to lose your clients by stop selling the securities that were going up every day. Again, suppose you were a fund manager in 2005, you would unlikely to choose to risk your client’s money by betting against the real estate when it was going up. So no matter on the buy side or the sell side, you were doomed to fail. Even you were among the few who chose to take the risk, any gain in the housing prices would put you in a difficult situation. Frequent calls from your clients asking you to clean you positions, blame from your boss and laughter from your competitors. As someone who has used up all the savings to finish your business school and works like a dog for years, you do not want to lose your job on Wall Street. Besides, the tools used in the Paulson’s trade were brand new and only a few people had heard of them at that time. No one would like to try tools that they are not familiar with. This is why hardly any person could successfully make a fortune in the crisis. It was not just because people wanted to make money, but also because people wanted to survive by protecting themselves from any bad outcomes possible. Conservativeness is the ultimate human nature.
The entire book can be considered as a good biography of what happened in the crisis, however, it lacks the author’s own insight and analysis of the crisis. But still, it is a book worthy to read for those who are interested in what happened during the financial downturn.
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