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Bets against mortgages paid off

Fri., April 18, 2008

The subprime mortgage mess that caused massive losses for homeowners and banks was a little kinder to hedge fund manager John Paulson. Betting subprime mortgage securities would sour, Paulson personally earned $3.7 billion last year.

Yes, you read that correctly. That’s billion with a “b.”

He wasn’t the only one with Titanic-size profits. Two other fund managers, George Soros and James Simons, who are notoriously secretive about their investments, earned $2.9 billion and $2.8 billion, respectively, according to Alpha Magazine’s annual list of top hedge fund earners.

The numbers left jaws agape across Wall Street and Washington. With his windfall from last year alone, Paulson could have bought troubled Wall Street giant Bear Stearns three times over. Or he could have matched the price Delta agreed this week to pay to merge with Northwest Airlines and still have $600 million left over.

A few years ago, individual income reaching into the billions of dollars was unfathomable. In 2002, the first year the magazine tracked hedge fund compensation, the top 25 managers earned $2.8 billion combined.

Paulson amassed his winnings by “shorting” securities linked to subprime mortgages. In a short sale, the investor borrows securities – in this case, subprime mortgages that were widely held by banks, brokerages and other investors – and sells them to another buyer. Later, the investor must buy those securities back and return them to the original lender. As the subprime market collapsed, the value of the securities fell, and Paulson was able to pocket the difference. The lenders were stuck with the losses.

Hedge funds are pools of private money, largely generated from wealthy individuals, pension funds and endowments, used for a wide range of investments. Usually 80 percent of any gains are given to such investors, while fund managers take 20 percent, plus an annual fee for their services. Alpha’s list tracks the income that managers receive after paying their staff members and other expenses.


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