Posted: 07 Oct 2010 10:38 PM PDTI got a very interesting report from a contact who is reasonably well plugged in with some of the government authorities that are taking a hard look at the foreclosure crisis.
Readers have no doubt heard of hedge fund manager John Paulson, whose famed subprime short bet is reportedly the most profitable single trade in history, netting him over $4 billion personally. Paulson famously reversed his stance in early 2009 and started buying distressed debt, including distressed mortgage securities.
Apparently he still has a substantial long position, because today a Paulson operative was making the rounds in DC, throwing temper tantrums about the impact various investigations might have on the residential mortgage backed securities market. He was particularly upset about the fact that the theory that we have discussed on this blog, that the problems facing deals where the notes were not properly conveyed (which we think are pervasive) are not easily remedied. As we have discussed, the “fixes” for the note conflict both with the provisions of the pooling and servicing agreement and New York Trust law.
Although Paulson’s minion reportedly got very angry, he did not offer a substantive critique or counterevidence to the thesis that these failings are very serious.
The party on the receiving end of this tantrum basically told the Paulson proxy that they were not changing course, but there is no way of telling whether his show of pique was more effective elsewhere.
This isn’t the first time Paulson has thrown his weight around to try to impede efforts that would help borrowers. Greg Zuckerman’s book The Greatest Trade Ever recounted at some length how Paulson first made threats and then lobbied to block swapping mortgages out of securitizations to facilitate mortgage modifications.
Per Zuckerman, In January 2007, Paulson employees heard that Bear Stearns traders had told investors on a couple of occasions that ” ‘It’s not so simple to short mortgages. A servicer can just buy mortgages out of a pool, so you guys will never be able to collect’ ” on the credit default swaps used to make the short wager.
Bear owned a mortgage servicer called EMC Mortgage Co., and Paulson staffer Paolo Pellegrini became worried that EMC would exchange poorly performing loans in a pool with refinanced healthier ones, or exchange them for different loans, or add cash to the pool, with the intent of avoiding a payout on the CDS. Pellegrini started making inquiries, and Bear sent him a fax showing him that in the documents, Bear had “reserv[ed] the right to work with EMC to adjust mortgages.” Furthermore, “a senior trader said Bear Stearns was proposing the new language to ISDA (the industry group responsible, among other things, for standard form documentation for credit default swaps). Adjusting loans that borrowers were hvaing difficulty paying could be effective public relations for Bear Stearns – the firm already had created what it called the EMC Mod Squad, a team working with local community groups to modify the home loans of delinquent borrowers.”
The lawyer at Paulson & Co. tasked to this effort was Michael Waldorf. After reading the document, Waldorf “stormed out of Paulson’s office, his pink hue turning a beet red as he shook with anger. ‘They’re going to manipulate the market!’ he bellowed. ‘They could take away’ all the firm’s winnings.”
Waldorf called others shorting subprime, including Greg Lippmann at Deutsche Bank and Kyle Bass, and then hired former SEC chair Harvey Pitt to lobby on their behalf. Pitt and Waldorf argued that “EMC could modify all the mortgages it wished – slicing a home owner’s mortgage payments actually might help Paulson because it would reduce the cash coming into mortgage pools. But, they argued, EMC couldn’t discuss its moves with Bear Stearns or switch mortgages just to keep a pool of subprime loans from running into problems.” After sufficient complaining, Bear Stearns withdrew its proposal.
So it appears this time that Paulson made a simple contrarian bet, based on insufficient due diligence, and again is relying on his financial firepower to make sure his trade works out as planned, no matter how many people get hurt in the process of maximizing his bottom line.