The Greatest Trade Ever (3 page)

The impressive gains and huge fees helped usher in a Gilded Age 2.0 as funds racked up outsized profits, even by the standards of the investment business. Edward Lampert, a hedge-fund investor who gained control of retailer Kmart and then gobbled up even larger Sears, Roebuck, made $1 billion in 2004, dwarfing the combined $43 million that chief executives of Goldman Sachs, Microsoft, and General Electric made that year.
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The most successful hedge-fund managers enjoyed celebrity-billionaire status, shaking up the worlds of art, politics, and philanthropy. Kenneth Griffin married another hedge-fund trader, Anne Dias, at the Palace of Versailles and held a postceremony party at the Louvre, following a rehearsal dinner at the Musée d’Orsay. Steven Cohen spent $8 million for a preserved shark by Damien Hirst, part of a $1 billion art collection assembled in four years that included work from Keith Haring, Jackson Pollock, van Gogh, Gauguin, Andy Warhol, and Roy Lichtenstein. Whiz kid Eric Mindich, a thirty-something hotshot, raised millions for Democratic politicians and was a member of presidential candidate John Kerry’s inner circle.

Hedge-fund pros, a particularly philanthropic group that wasn’t shy about sharing that fact, established innovative charities, including the Robin Hood Foundation, notable for black-tie fund-raisers attracting celebrities like Gwyneth Paltrow and Harvey Weinstein, and for creative efforts to revamp inner-city schools.

The hedge-fund ascension was part of a historic expansion in the financial sector. Markets became bigger and more vibrant, and companies found it more inexpensive to raise capital, resulting in a burst of growth around the globe, surging home ownership, and an improved quality of life.

But by 2005, a financial industry based on creating, trading, and managing shares and debts of businesses was growing at a faster pace than the economy itself, as if a kind of financial alchemy was at work. Finance companies earned about 15 percent of all U.S. profits in the
1970s and 1980s, a figure that surged past 25 percent by 2005. By the mid-2000s, more than 20 percent of Harvard University undergraduates entered the finance business, up from less than 5 percent in the 1960s.

One of the hottest businesses for financial firms: trading with hedge funds, lending them money, and helping even young, inexperienced investors like Michael Burry get into the game.

M
ICHAEL BURRY
had graduated medical school and was almost finished with his residency at Stanford University Medical School in 2000 when he got the hedge-fund bug. Though he had no formal financial education and started his firm in the living room of his boyhood home in suburban San Jose, investment banks eagerly courted him.

Alison Sanger, a broker at Bank of America, flew to meet Burry and sat with him on a living-room couch, near an imposing drum set, as she described what her bank could offer his new firm. Red shag carpeting served as Burry’s trading floor. A worn, yellowing chart on a nearby closet door tracked the progressive heights of Burry and his brothers in their youth, rather than any commodity or stock price. Burry, wearing jeans and a T-shirt, asked Sanger if she could recommend a good book about how to run a hedge fund, betraying his obvious ignorance. Despite that, Sanger signed him up as a client.

“Our model at the time was to embrace start-up funds, and it was clear he was a really smart guy,” she explains.

Hedge funds became part of the public consciousness. In an episode of the soap opera
All My Children
, Ryan told Kendall, “Love isn’t like a hedge fund, you know … you can’t have all your money in one investment, and if it looks a little shaky, you can’t just buy something that looks a little safer.” (Perhaps it was another sign of the times that the show’s hedge-fund reference was the only snippet of the overwrought dialogue that made much sense.) Designer Kenneth Cole even offered a leather loafer called the Hedge Fund, available in black or brown at $119.98.
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Things soon turned a bit giddy, as investors threw money at traders
with impressive credentials. When Eric Mindich left Goldman Sachs to start a hedge fund in late 2004, he shared few details of how he would operate, acknowledged that he hadn’t actually managed money for several years, and said investors would have to fork over a minimum of $5 million and tie up their cash for as long as four and a half years to gain access to his fund. He raised more than $3 billion in a matter of months, leaving a trail of investors frustrated that they couldn’t get in.
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Both Mindich and Burry scored results that topped the market, and the industry powered ahead. But traders with more questionable abilities soon got into the game, and they seemed to enjoy the lifestyle as much as the inherent investment possibilities of operating a hedge fund. In 2004, Bret Grebow, a twenty-eight-year-old fund manager, bought a new $160,000 Lamborghini Gallardo as a treat and regularly traveled with his girlfriend between his New York office and a home in Highland Beach, Florida, on a private jet, paying as much as $10,000 for the three-hour flight.

“It’s fantastic,” Mr. Grebow said at the time, on the heels of a year of 40 percent gains. “They’ve got my favorite cereal, Cookie Crisp, waiting for me, and Jack Daniel’s on ice.”
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(Grebow eventually pled guilty to defrauding investors of more than $7 million while helping to operate a Ponzi scheme that bilked clients without actually trading on their behalf.)

A 2006 survey of almost three hundred hedge-fund professionals found they on average had spent $376,000 on jewelry, $271,000 on watches, and $124,000 on “traditional” spa services over the previous twelve months. The term
traditional
was used to distinguish between full-body massages, mud baths, seaweed wraps and the like, and more exotic treatments. The survey reported anecdotal evidence that some hedge-fund managers were shelling out tens of thousands of dollars to professionals to guide them through the Play of Seven Knives, an elaborate exercise starting with a long, luxuriant bath, graduating to a full massage with a variety of rare oils, and escalating to a series of cuts inflicted by a sharp, specialized knife aimed at eliciting extraordinary sexual and painful sensations.
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Not only could hedge funds charge their clients more than most
businesses, but their claim of 20 percent of trading gains was treated as capital gains income by the U.S. government and taxed at a rate of 15 percent, the same rate paid on wage income by Americans earning less than $31,850.

For the hedge-fund honchos, it really wasn’t about the money and the resulting delights. Well, not entirely. For the men running hedge funds and private-equity firms—and they almost always were men—the money became something of a measuring stick. All day and into the night, computer screens an arms-length away provided minute-by-minute accounts of their performance, a referendum on their value as investors, and affirmation of their very self-worth.

A
S THE HEDGE-FUND
celebrations grew more intense in 2005, the revelers hardly noticed forty-nine-year-old John Paulson, alone in the corner, amused and a bit befuddled by the festivities. Paulson had a respectable track record and a blue-chip pedigree. But it was little wonder that he found himself an afterthought in this overcharged world.

Born in December 1955, Paulson was the offspring of a group of risk-takers, some of whom had met their share of disappointment.

Paulson’s great-grandfather Percy Thorn Paulsen was a Norwegian captain of a Dutch merchant ship in the late 1890s that ran aground one summer off Guayaquil, Ecuador, on its way up the coast of South America. Reaching land, Paulsen and his crew waited several weeks for the ship to be repaired, using the time to explore the growing expatriate community in the port city. There, he met the daughter of the French ambassador to Ecuador, fell in love, and decided to settle. In 1924, a grandson was born named Alfred. Three years later, Alfred’s mother died while giving birth to another boy. The Paulsen boys were sent to a German boarding school in Quito. Alfred’s father soon suffered a massive heart attack, after a game of tennis, and passed away.

The boys, now orphans, moved in with their stepmother, but she had her own children to care for, so an aunt took them in. At sixteen, Alfred and his younger brother, Albert, fifteen, were ready to move on, traveling 3,500 miles northwest to Los Angeles. Alfred spent two years
doing odd jobs before enlisting in the U.S. Army. Wounded while serving in Italy during World War II, he remained in Europe during the Allied occupation.

After the war, Alfred, by now using the surname of Paulson, returned to Los Angeles to attend UCLA. One day, in the school’s cafeteria, he noticed an attractive young woman, Jacqueline Boklan, a psychology major, and introduced himself. He was immediately taken with her.

Boklan’s grandparents had come to New York’s Lower East Side at the turn of the century, part of a wave of Jewish immigrants fleeing Lithuania and Romania in search of opportunity. Jacqueline was born in 1926, and after her father, Arthur, was hired to manage fixed-income sales for a bank, the Boklan family moved to Manhattan’s Upper West Side. They rented an apartment in the Turin, a stately building on 93rd Street and Central Park West, across from Central Park, and enjoyed a well-to-do lifestyle for several years, with servants and a nanny to care for Jacqueline.
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But Boklan lost his job during the Great Depression and spent the rest of his life unable to return the family to its former stature. In the early 1940s, searching for business opportunities, they moved to Los Angeles, where Jacqueline attended UCLA.

After Alfred Paulson wed Jacqueline, he was hired by the accounting firm Arthur Andersen to work in the firm’s New York office, and the family moved to Whitestone, a residential neighborhood in the borough of Queens, near the East River. John was the third of four children born to the couple. He grew up in the Le Havre apartment complex, a thirty-two-building, 1,021-apartment, twenty-seven-acre development featuring two pools, a clubhouse, a gym, and three tennis courts, built by Alfred Levitt, the younger brother of William Levitt, the real estate developer who created Levittown. The family later bought a modest home in nearby Beechhurst, while Jacqueline’s parents moved into a one-bedroom apartment in nearby Jackson Heights.

Visiting his grandson one day in 1961, Arthur Boklan brought him a pack of Charms candies. The next day, John decided to sell the candies to his kindergarten classmates, racing home to tell his grandfather about his first brush with capitalism. After they counted the proceeds,
Arthur took his grandson to a local supermarket to show the six-year-old where to buy a pack of Charms for eight cents, trying to instill an appreciation of math and numbers in him. John broke up the pack and sold the candies individually for five cents each, a tactic that investor Warren Buffett employed in his own youth with packs of chewing gum. Paulson continued to build his savings with a variety of after-school jobs.

“I got a piggy bank and the goal was to fill it up, and that appealed to me,” John Paulson recalls. “I had an interest in working and having money in my pocket.”

One of Alfred Paulson’s clients, public-relations maven David Finn, who represented celebrities including Perry Como and Jack Lemmon, liked Alfred’s work and asked him to become the chief financial officer of his firm, Ruder Finn, Inc. The two became fast friends, playing tennis and socializing with their families. Alfred was affable, upbeat, and exceedingly modest, content to enjoy his family rather than claim a spotlight at the growing firm, Finn recalls. On the court, Alfred had an impressive tennis game but seemed to lack a true competitive spirit, preferring to play for enjoyment.

“Al didn’t care about winning,” says Finn. “He never made a lot or cared about making a lot. He was brilliant, very sensitive and friendly, but he was happy where he was in life.”

A natural peacemaker, he sometimes approached colleagues involved in a dispute and gave each an encouraging smile, instantly healing the office rift.

Jacqueline, now a practicing child psychologist, was more opinionated than her husband, weighing in on politics and business at social gatherings as Alfred looked on. She believed in giving her children a lot of love and even more leeway. Jacqueline brought the Paulson children up Jewish, and their eldest daughter later moved to Israel. Alfred was an atheist, but he attended synagogue with his family. Until he turned twelve, John had no idea that his father wasn’t Jewish.

John attended a series of local public schools, where he entered a program for gifted students. By eighth grade, Paulson was studying calculus,
Shakespeare, and other high-school-level subjects. Every summer, Alfred took his family on an extensive vacation, in the United States or abroad. By his sophomore year, John was going cross-country with friends, visiting Europe a year later.

John showed signs of unusual independence in other areas as well. Though the Paulsons were members of a local synagogue, the Whitestone Hebrew Centre, Paulson listed in his yearbook at Bayside High the “Jesus club” and the “divine light club” among his interests.

By the time Paulson entered New York University in the fall of 1973, the economy was floundering, the stock market was out of vogue, and Paulson’s early interest in money had faded. As a freshman, he studied creative writing and worked in film production. He took philosophy courses, thrilling his mother, who loved the arts. But the young man soon lost his interest in his studies, slipping behind his classmates. Vietnam, President Nixon, and the antiwar and civil rights protests dominated the news.

“I felt directionless,” says Paulson, who wore his hair to his shoulders, looking like a young Robert Downey Jr. “I wasn’t very interested in college.”

After John’s freshman year, Alfred sensed he needed a change and proposed that his son take a summer trip, the Paulson family remedy. He bought him an airplane ticket to South America, and that summer John traveled throughout Panama and Colombia. Soon he made his way to Ecuador, where he stayed with an uncle, a dashing bachelor who developed condominium projects in the coastal city of Salinas. His uncle appointed Paulson his
hombre de confianza
, or trusted right-hand man. He kept an eye out for thieves trying to steal materials from his uncle, supervised deliveries at various construction sites, and kept track of his uncle’s inventories.