John Paulson / 2007 / Credit
Buying insurance on a boom.
John Paulson and the trade against the machinery of housing credit.
Before the outcome was obvious.
The housing boom depended on more than rising house prices. It depended on loans being refinanced, defaults staying manageable and investors continuing to trust mortgage securities. Paulson’s case in the workbook puts credit default swaps at the centre of the response. Buying protection allowed a bearish view on housing credit to be expressed without borrowing and selling every underlying bond. When the assumptions supporting the securities broke down, that protection became valuable. The architecture of the trade mattered as much as the forecast.
What could have gone wrong
Protection costs money while the clock runs. Counterparty exposure and the exact bonds covered by a contract matter; a broad housing thesis does not make every credit hedge profitable.
Translate the insight into the right contract. Being right about an economy and owning the instrument that pays are separate achievements.
Put the thesis to the test.
Change the assumptions and watch the arithmetic update. These are simplified scenarios; they do not recreate the instrument’s pricing or the path of the trade.
How this model works
Profit ratio = profit ÷ stated position. Exposure ratio = stated position ÷ fund assets. Neither is a measure of maximum loss or a net investor return.
The workbook’s simple annualisation is profit ratio × 365 ÷ duration = 30%. It is linear, not compounded, and is not a repeatable annual return. Fees, financing, collateral, premium carry and changing exposures are not modelled.
What these figures mean.
Source: Legendary Trades Models, Master Comparison!A5:L5; Trade P&L Models, case 2. The following are original workbook inputs, preserved for transparency. They are estimates, not independently audited results.
- Workbook position
- $25bn
- Workbook “gross profit”
- $15bn
- Workbook duration
- 730 days
- Workbook fund assets
- $12bn
- Workbook fund return
- 590%
- Workbook position ROI
- 60%
The fund-return field is a separate source claim, not a calculated result of this trade. Its reporting period and gross/net basis are not independently established here. Model ratios are recalculated from inputs rather than copied from rounded source ROI values.
Historical context: Financial Crisis Inquiry Commission · The madness, chapter 10 ↗. This source supports the context discussed above; it does not validate every workbook input.