Mr Paulson’s move marks the latest example of a famously bearish investor shifting gears to profit from depressed prices in the global credit markets.
US residential mortgage securities fell in value last week after Hank Paulson, Treasury secretary, said that the federal government had decided against buying toxic assets as part of its $700bn troubled asset relief programme (Tarp).
John Paulson, who is not related to the Treasury secretary (obviously!), has told his investors that he started buying troubled mortgage-backed securities at the end of last week, hoping to capitalise on price falls that followed the Treasury announcement.
Mr Paulson, who has $36bn under management, was scheduled to hold a dinner and wine-tasting at New York’s Metropolitan Club on Monday night so that he could brief his investors on his plans.
According to Alpha Magazine, Mr Paulson made $3.7bn in 2007, reflecting the success of his strategy – begun in 2006 – of betting on a collapse of the subprime mortgage market. At the end of the third quarter of this year, his funds were up 15-25 per cent. His funds also made profits in October, his investors say.
For several months Mr Paulson has been considering investing in distressed subprime mortgage securities, financial firms and debt used to back private equity deals.
He estimated there are $10,000bn in total in such assets.
He signalled a potential new direction on October 1 by launching his Paulson Recovery Fund, which will take equity stakes in financial institutions. He also has moved to start a real estate fund.
However, Mr Paulson has been careful to avoid moving into distressed markets too early. For example, he refused in April when approached to invest alongside TPG in Washington Mutual. The debt and equity of WaMu was wiped out when it was taken over by JPMorgan in September.
In a letter to investors at the end of the third quarter, Mr. Paulson said his strategy was “to reduce leverage, maintain market exposure and maintain short credit bias”. He said: “The majority of our gains came from short positions in the equities of declining financials and CDS [credit default swaps] on financials. Generally our short exposure has been reduced as many of the companies we were short have failed.”
Mr. Paulson’s plans come at a time when other leading investors, including Jeff Aronson at Centerbridge Partners and Bruce Karsh at Oaktree Capital, are wading into the market for discounted leveraged buyout loans.