The Paulson letter

By Felix Salmon
April 21, 2010
WSJ and the FT have got their hands on a letter from John Paulson to his investors, but infuriatingly neither of them have seen fit to share it with their readers. So we're left with a few snippets of direct quotes, and we have to simply guess at the overall tone of the note.

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Both the WSJ and the FT have got their hands on a letter from John Paulson to his investors, but infuriatingly neither of them have seen fit to share it with their readers. So we’re left with a few snippets of direct quotes, and we have to simply guess at the overall tone of the note.

Here’s the WSJ:

Mr. Paulson sent a letter to investors Tuesday night saying that in 2007 his firm wasn’t seen as an experienced mortgage investor, and that “many of the most sophisticated investors in the world” were “more than willing to bet against us.”

And here’s the FT:

“Paulson was transparent and open regarding its concerns about the mortgage market which were driven by analysis of publicly available data,” the letter states…

In his letter, Mr Paulson took pains to cite the SEC complaint that states that while he suggested 123 securities to be included in Abacus, ACA, the firm that acted as collateral manager and chose the mortgage securities to be included, ultimately accepted 55 and rejected 68. “All our dealings were through arm’s length transactions with experienced counterparties who had opposing views,” the letter adds.

Without seeing the actual letter, I’m going to have to conclude that it reads largely as a set of Goldman Sachs talking points, which is interesting: the fact that the SEC has charged Goldman but not Paulson gave Paulson an opportunity to try to distance himself from the alleged fraud. But instead he seems to be lining up with Goldman here — a stance which he might regret, if the SEC makes its fraud charges stick.

Once again, there seems to be a lot of hints and nudges in the direction that ACA knew that Paulson was short and willingly took the opposite side of his trade. Which sophisticated investors is Paulson talking about, who were more than willing to bet against him, if not ACA and IKB? Especially seeing as how the “transparent and open” Paulson had meetings with ACA in the run-up to the Abacus deal.

And once again we see the odd Goldman defense that ACA rejected a chunk of Paulson’s picks, with the unhelpful implication that if it hadn’t done so, then disclosure might have been warranted. At that point the question becomes just how many Paulson picks ACA needs to reject before you don’t need disclosure any more, and I don’t think that Goldman is going to like the answer to that question.

Paulson is now one of the largest hedge-fund managers in the world, largely because of all the people who piled into his funds after he made lots of money shorting mortgages. Those people aren’t particularly loyal to him: they haven’t been with him all that long. And if they think he’s starting to smell a little toxic, they’ll probably start looking for other places to put their money. Once upon a time, investors probably liked the fact that Paulson was so aggressive in his bets that he would do things like hire former SEC chairman Harvey Pitt, who then lobbied against proposed moves which would allow underwriters to modify mortgages and thereby help homeowners. Nowadays, however, that kind of activity is increasingly the kind of thing that investors want to disassociate themselves from.

So while I doubt Paulson will get a massive wave of redemption letters next Friday, I do think that his grip on his AUM is becoming increasingly tenuous. In turn, that might lead him to take a few more risks in an attempt to boost his returns and keep his investors that way.

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