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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come on felix, you can do better than that. ZH has the letter here: vestor-paulson-letter

and i don’t understand the point of this post – surely you know that Paulson has none of the disclosure requirements that GS has. Paulson isn’t trying to defend GS – they’re trying to defend themselves – against populist ignorati who write articles about how they are the bad guy.

Posted by KidDynamite | Report as abusive

I have found a few sources, namely, Janet Tavakoli on Zero Hedge, Macroeconomic Resilience, and SEC Tea Party™, that have given some legal grounds for my problems with GS in this deal, although this is totally my take. Also, Bear Stearns seems to have had a similar take. Now, Paulson’s letter also makes my point.

I have no problem with what Paulson did. He saw what was going on. But what he saw strikes me as evidence of misrepresentation of the financial products he was betting against. So that when other investors scanned these products, they were looking at cooked data.

My problem is with GS role as middleman. If they had their own analysis affirming Paulson’s view, did they need to disclose that to prospective buyers? Ethically, I think they do. That means they would have to tell prospective buyers something like: Here are some investments with possibly cooked books. Enjoy!

In other words, it’s not simply as if Paulson were betting against a toy company marketing a bad toy, but against the veracity of the products being offered. I’m not sure this is illegal, or that other people find this iffy, or that GS didn’t do what I just asked. But I am worried that people are saying he was just betting against the housing market, because it lends credence to the view that this bubble was just poor investing, as opposed to fraud, negligence, collusion, and fiduciary mismanagement.

Posted by DonthelibertDem | Report as abusive

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.

I think you are misreading this implication. The rejection is evidence (at least in GS’s mind) that ACA expressed their own free will on portfolio selection. If they hadn’t rejected any, it would simply be an absence of evidence rather than evidence of absence.

Posted by Ledbury22 | Report as abusive

I think the Wall Street journal was using past unethical practice rather then literal points of law. The misleading is not a water pistol, but the very essence of what constitutes fraud. Their take on it sounds as though they have some wall Street bankers in their pocket…

I feel the point of this article is very valid. If paulson were already deemed innocent, why are they making 6 page pleas to their investors that they did nothing wrong? Note that the letter nowhere discusses how the AAA list was actually toxic and they knew it.

There are many unanswered questions and they lend to speculation. Why is Goldman Sachs protecting the VP? Why was Paulson suggesting the list for the Abacus prospectus of junk in the first place? Was ACA advised the list was made by an independent manager or by Poulson?

Why is a bank holding company making a prospectus of junk? How is it possible Moody’s was coerced to give AAA rating to such volatile bonds (subprime mortgages likely to be defaulted are AAA? ) in the first place? Are there kickbacks on this path?

In this case is the bonus to the VP a kickback after the fact? Did Poulson give kickbacks to anyone at Goldman for helping make them that fortune? How much money was involved in the short bet? Did the supposed financial loss to Goldman mean a loss for Goldman or just shareholders? Was there insider trading as they knew the bonds were junk?

Why is Paulson talking about the very points that Goldman will use in their defense when Paulson has not been found at fault? (yet… sounds like a preparation of statements)

let’s not veer too far from the beaten path and remember that Goldman’s number one priority in building its reputation was that the client comes first. Was that done here? How often has that NOT been the case? Besides fraud is Goldman guilty of being a smoke and mirrors bookie and not representing clients but entirely its own interests?

Subpoenaing the ex-employee who left shortly after the deal was made and the VP in London who designed Abacus will hopefully tell the story eventually.

(No I am not a conspiracy theorist, but I do have these questions and lots of curiosity and the answers so far look to be deflection rather then fact)

Posted by hsvkitty | Report as abusive

The fact that Paulson had a role in picking the mortgage packages and payed GS ( I believe $14M to set up the CDO) doesn’t pass the “smell” test. If the standards in place can’t arrive at the simple conclusion that this behavior is unethical, then there is a problem with the standards. Outlaw all these crazy financial weapons of mass destruction. At a minimum, a regulatory agency should be reviewing these products and have all the details about who is involved BEFORE they are marketed and have veto power. Including Repo 105, which simply needs to be removed as an accounting option period. The innocent public is paying for the unscrupulous ways these vultures try and make big bucks. The only thing missing from Fuld’s action on the hill was fake crying. Sarbanes Oxley says that guy should be in jail.

Posted by justanotherjoe | Report as abusive

Folks the lame Democrats are stinking up the place and the Republicans are furiously trying to kill any meaningful regulation of these vultures. Where the Hell are the politicians that are supposed to work for and protect the masses. Vote all incumbents, left or right, out of office. Because they are all responsible and have failed us miserably. Start with the biggest loud mouthed, self serving jerk of them all. John McCain.

Posted by justanotherjoe | Report as abusive

Here’s what happened, in layman’s terms: A guy named Goldman went to Scottie and said, “Ace, who knows his stuff, has put together a fantasy baseball team. Pauley over there is betting a billion bucks they’ll lose. Wanna take his bet, and get a billion if they win?” Scottie said OK and took the bet, not knowing that it was actually Pauley who picked the team and loaded it with dogs. Scottie lost his shirt and had to be bailed out by his Mom. Now that they know what happened, they’re really ticked off. Never mind the fact they shouldn’t be betting a billion dollars on a fantasy baseball team — which is about as legitimate an investment vehicle as a synthetic CDO.

Posted by DKNY999 | Report as abusive

A detailed quibble of the letter to investors is in my opinion unnecessary at present time for sound reasons. The crucial question is what value this ABACUS-deal create for the economy? Is there any benefit to society? Do we have now an increased productivity for the economy ? It’s mainly a greedy bet between highly leveraged speculators. The banks do not provide the economy with money, thereafter they only apperar to have achieved a return on equity of at least 25%. So what ! Credit derivatives are destructive. Why is this market still unregulated?

Posted by CEZMI-DISPINAR | Report as abusive

There are two parts to the defense:

1) ACA had final say on the portfolio.

2) If ACA had final say on the portfolio, then Goldman did not have to disclose Paulson’s involvement.

The fact that ACA did in fact reject some of Paulson’s suggestions is evidence of 1, not 2. If they had not rejected any of Paulson’s suggestions, it would be easier to argue that 2) was not true, but would have no impact on whether 2) is justification for not disclosing Paulson’s involvement.

It seems to me perfectly valid for them to argue that the fact that ACA rejected some of Paulson’s suggestions strengthens 1) and therefore the whole proof. I am not qualified to opine on whether 2) is a true statement, but it seems reasonable to me.

It seems to me that ACA, like a lot of these companies, got used to relying on ratings and not doing their own analysis, and got themselves and their investors burned.

Posted by MattJ | Report as abusive

In last, I meant to write “If they had not rejected any of Paulson’s suggestions, it would be easier to argue that 1) was not true”.

Posted by MattJ | Report as abusive

DonthelibertDem makes are really interesting point. Was Paulson betting against housing, or better against the house of cards of packaging toxic mortgages into AAA products? I guess if it was the latter, then he should have shorted all the bank stocks and then gone long when he knew they’d be bailed out. Did he short banks in the collapse? That’d be interesting. Is he now long GS? That’d be interesting too…

Posted by nicfulton | Report as abusive

A broker to any transaction, has responsibilities to BOTH parties, not just the ‘client’. Paulson spins that this is somehow ‘legal’ because fees were paid and someone else did the selling.

The essential crime is in designing an investment to fail in the first place. Defacto, if it sells, the party that is long has not been adequately informed.

In another world it is as if an insurance company discovers that one need not merely place bets against certain aircraft designs, but rather designs something that clearly will never fly in the first place. That’s easy. What’s needed is an unstoppable sales agent to sell it. (GS).

Posted by firstbridge | Report as abusive