Bloomberg Wealth with David Rubenstein: John Paulson
I would say that cryptocurrencies are a bubble. If you invest in areas that you don't know, ultimately you're not going to do well. You know, I always say you should do what you're passionate about. I happen to always found investing from a very young age to be fun. John Paulson made Wall Street's most lucrative trade of all time.
One of our investors called me and he said, uh John, I just got the monthly results. I think there was a mistake. It was no mistake. Paulson's bet on the collapse of subprime mortgages in 2007 earned his firm $15 billion, the largest one year payout in the history of financial markets. It's kind of like. Finding a needle in a haystack?
Paul since 2007 performance rocketed him to the ranks of superstar managers at its peak. His firm manage $38 billion, making it one of the largest hedge funds in the world. It opened up a lot of doors and became very interested in terms of the people that I meant. Paulson has yet to repeat the success that made his fortune. Recently. He joined the list of industry legends to quit
the hedge fund business, converting his fund into a family office. Personally, I never really liked the the business side of the business. I did like the investing side. He's also enjoyed giving away his fortune.
He pledged $400 million to Harvard University and donated $100 million to the Central Park Conservancy. I wanted to give back to the institutions generally that were important to me. John, you made one of the most famous investments in Wall Street history over a period of time, you put a short on effect to make it simple on the mortgage market around 2007 or so, and that trade, it is reported made roughly $20 billion or so for you and your investors. Nobody has reported anything more profitable than that, and that in the Wall Street, I'd say last couple decades or so in one trade.
Did you have any doubt that that trade was going to work? Well, we were. We were pretty convinced that the mortgage market segments of the mortgage market were overvalued and were likely to implode. So we took a very concentrated position in these securities and what we expected to happen happened.
Can't be that easy 'cause nobody else quite did what you did. So at the time that you were doing it, did you have any sleepless nights saying hey, I might be wrong and maybe I'll lose a lot of money or you didn't really worry about that so much. Well, again, you know it was structured where the downside was very limited. I think the reason why other people didn't hadn't done it is because there had never been according to Moody's and S&P, a default of an investment grade mortgage backed securities. Mortgage backed securities were viewed as the safest securities next to Treasurys, and that was essentially true up until that point.
What they missed was the the underwriting quality had never been as poor. Of securities that had been in that period. So the fact that they hadn't defaulted in the past had had nothing to do with whether or not the securities that would be issued would default in the future. The idea for doing this was something that came to you one day when just reading the newspapers or watching Bloomberg on TV, or or did somebody who worked for you coming with this idea. Where did the idea come from? I developed a specialty which very few people do in shorting credit. The difficulty in shorting credits.
You have to get a borrow. They generally a liquid. You can never get size, but I never gave up on looking and finally we found it in the mortgage backed securities market, which at the time was larger than the treasury market. So there was literally unlimited liquidity and because of the development of the credit default swap market, you didn't have to get to borrow. So there was synthetic securities. Just people trading synthetically on actual bonds and.
You can do 100 million. We were doing 100 million at a clip 500 million it did with banks. In some cases a billion dollars a day with banks lose massive liquidity to set up these positions. So when you did your famous trade you became world famous before you were relatively unknown to the public.
How did that change your life all of a sudden people are calling you all the time. High school friends are saying they always knew you were going to be successful and they're calling you for contributions or whatever else. How did your life change? What was very funny? I remember the the time that it happened, David, one of our investors called me. He said, uh John, I just got the monthly results.
I think there was a mistake said 66% you meant 6.6% and I said no it was 66% he goes for that. That's that's impossible I I've invested with Soros with Tutor Jones with with everyone. No one's been up to 66% in a year. How can you be up to 66 in a month? I said, well that's what happened shortly after that all our investors got these.
Results and it leaked out to the press and then became. You know, the cover story in the Wall Street Journal, which was picked up globally that we had this incredible performance in February. Up 66% net and that performance continued throughout the year. The funds wound up being up close to 800% net for the year and you know it was became a, you know. Opened up a lot of doors and became very interested in terms of the people that I meant. It was reported in the press that you had to write a check at one point to the federal government, IRS. Of over a billion dollars is it feel nice
to write a check over a billion dollars is a little bit painful to the IRS. Well, we were big supporters of not only EU S Treasury but also New York State in New York City. So we you know we paid you know a fair amount of taxes so you'll have in your office anywhere. I'll check that says a billion plus EU S government. You don't keep that check. I don't keep the check but I do keep the tax returns.
Both the state tax returns and the federal returns. So I've asked you from time to time outside of this setting. When I've seen you, do you have any other good ideas like that when you've always said to me, pretty much what you just said. If you have something good you would let me know, perhaps, but you have anything as good as that. Is that right? You haven't anything as good as that yet I would say not as good, but I would say the the area that's most mispriced today is credit and the and the the potential you know.
Really, I think the 10 year Treasury is it's about 1.3% and the 30 year Treasury bond. Is 2%. And we're coming into an inflationary period. I think that PP came out today and it was over 7%. The CPI came out yesterday was over five and a half percent. So you have inflation, current inflation, well in excess of long term yields.
Now there's a perception in the market that this inflation is transitory. I think they bought the Fed line that is just temporary due to the restart of the economy and it's eventually going to subside. However, if it doesn't subside, or if suicides at a level that's above the 2% that the Fed is targeting or stays in the four 4%, three to 5% range, then I think ultimately interest rates will catch up and bonds will fall in that scenario. So you know there are various options strategies related to bonds and interest rates that you know could offer very high returns. If interest rates do move up to those higher levels. But when you've had a kind of a life changing event or an unbelievable success as you did with that trade, is there a temptation to say I don't want to tempt fate and try it again? Or is this you want to prove that you can do it again and you're looking for another deal just as good as that one? You know we do look, but you have to be realistic.
You know we have put on some trades that you know on smaller scale that have potential returns. So 25 to 50 to 1. Related to both interest rates and gold prices so you know our viewpoint is that the markets are currently too complacent regarding inflation and that if inflation does prove to be higher than expectations that will result in both higher gold prices and higher interest rates. And if you get those two happening at the same time. In a period of time, we can set up positions that could, you know, return from 25 to 50 to one.
Now, after you've made your famous trade that we talked about, yeah, I think you put on our trade where you bought a lot of gold or gold futures and you were what was called by some a goldbug your big believer in gold gold. Now about $1700 an ounce or so. Are you believing that gold is now a good investment? That this price? Yeah we do and and thank you for bringing that up. We you know we do believe that gold. It does very well in times of inflation, So what happens is if you own long term treasury bonds that are yielding 2% and interest rates move up to 5%. Those bonds fall materially in value A.
Likewise, if you have cash sitting in a bank that you're earning 0% on, inflation is 4%, you're gradually eroding the value of your money, so its inflation picks up. People try and get out of fixed income. They try and get out of cash, and the logical place. To go with gold, especially if it starts to rise in inflationary times. But because the amount of money trying to move out of cash and fixed income dwarfs the amount of investable gold that the supply and demand imbalance causes gold to rise, and the more it dries, it sort of feeds on itself and has the potential to go. What I call parabolic. So today you are a big
believer in gold as a good investment now, yes, so we. We thought in 2009. That would the Fed doing quantitative easing, which is essentially printing money that that would lead to inflation. But what happened was that the effect while the Fed printed money they at the same time raised the capital and reserve requirements and banks. So the money sort of recycled what the Fed bought Treasurys created money wound up in the banks and then was redeposited at the Fed. So the amount of excess reserves at the Fed almost grows by the same amount they were printed.
And the money never really entered the money supply, so was not inflationary this time around. The money has entered the money supply, so the money supply was up something like 25% last year and the the best indicator of inflation is is money supply. So I do think we have inflation coming well in excess of what the current expectations are. I'm not a believer in cryptocurrencies and I would say that cryptocurrencies are a bubble.
So let's talk about for a moment where you think the economy is going. You've mentioned inflation. I should say, when I worked in the White House under President Carter, I was responsible. I'd like to say for the double digit inflation.
Obviously others were involved as well, but I don't know if we're getting back to there, but are you worried about inflation? Is that your principal concern right now in terms of the economy? I wouldn't say I'm worried about it because. If we don't have any, we have zero fixed income, so inflation wouldn't hurt. Our fixed income company, but we are. We do believe we will get more inflation than the market is currently expecting. So we positioned our portfolio to benefit.
If we do get more inflation. So if inflation does become more embedded at higher levels than anticipated, that will benefit. You know a good portion of our portfolio. What about interest rates? So you think the Fed has kept interest rates artificially low for too long? Have they kept artificially low? Yes, have they kept artificially low too long? I don't think so. I mean, we, we went through probably the worst financial crisis imaginable with COVID, in which the entire economy shut down. And if it wasn't for the very aggressive policies of the Fed and the Treasury, we could have. We could have delved into a deep
recession, but provided by providing all the monetary and fiscal stimulus that they did, they really minimized the downturn, resulting in a very rapid recovery, allowing the economy to, you know, have a minimal you know, minimal GDP contraction and a very sharp GDP correction. And today are you worried about the size of the debt and the deficit in the United States? Absolutely so. We did borrow a lot of money in order to stabilize the economy, but at some point that money either has to be paid back or monetized via higher rates of inflation. So paying back is very confiscatory and would likely result in slower growth and long period of slow growth. So the easier alternative is to monetize the debt via inflation.
In the way that works with inflation, GDP grows more rapidly and a nominal basis, and since debts. Expressed in nominal terms, the debt to GDP ratio could come down with with inflation, so ultimately I think you'll have a choice and inflation will be the more desirable outcome. People always looking for bubbles that are going to burst, and one of the most significant ones that burst you picked up, which is the mortgage backed security market. A couple years ago. What about the spec market you think that's a bubble rating waiting to burst? I don't think it's quite a bubble, but it's clearly a elements.
Shows elements of a frothy market. There's just too much liquidity so I would say these spec market is overvalued. That people that invest in specs in general on average will be losing proposition. OK, what about crypto currencies? Are you a believer in crypto currencies? No, I'm not a believer in crypto currencies and I would say that cryptocurrencies are a bubble and I would describe crypto currencies as a limited supply of nothing. So to the extent. There's more demand than the limited supply the price would go up, but to the extent that demand falls and the price would go down, there's no intrinsic value to any of the crypto currencies, except that there's a limited amount.
Or based on what you've just said, why would you not put a big short of some type on crypto currencies? Or maybe you have, but you think that's a good short? Well, you know when we look for these subprime, the the reason why we shorted the subprime in size. Because it was asymmetrical, he's shorting a bond at par. That has a limited duration that trades in one percent spread of treasury, so he can't lose more than the spread in the duration. Yet if it defaults, you can make the poor amount in crypto, there's there's unlimited downside. So even though I I could be right over the long term in the short term is the case of Bitcoin, you know, went from 5000 to 45,000. You know I would be wiped out on the short side, so it's just too volatile.
So short. While John Paulson is shining the crypto craze, many of his peers in the industry are wading deeper into it. Earlier this summer, Steve Cones .72 was hiring a head of crypto currencies. The fund told investors it would be remiss to ignore a $2 trillion market.
Meanwhile, the family office of billionaire George Soros has started trading Bitcoin macro trader Paul Tudor. Jones has begun investing in crypto, and Dan Loeb says he was doing a quote deep dive. Now the big financial. Institutions such as Goldman Sachs and
Citigroup are getting in on the game. The result. Hundreds of job openings by ***** the world's largest crypto exchange, is advertising for 370 jobs. Still is the talent pool deep enough to fill everyone's needs? A single job posting may attract hundreds of applicants, but finding candidates with the right experience can be difficult, so some firms are lowering their expectations or changing job criteria. I always say the best investment for an individual. An average individual is to buy their own home.
So your firm was a hedge fund in the hedge fund format. Hedge funds have different types of investment approach as yours was. Is it fair to say you were more of a macro investor or is that not fair? We were. We were sort of risk arbitrage or specialty
was two specialties, merger arbitrage, and bankruptcy reorganizations for people who don't know what risk arbitrage is what? Actually, is risk arbitrage. Well, it's it's primarily investing in in mergers when a deal is announced, let's say IT stocks trading for $30 and someone's offering to buy it for $50, and after the mergers announced, the stock goes to $48. So there's a $2.00 spread and it doesn't seem like a lot of money, but $2.00, let's say over 50 is 4%,
so if the deal closes in. In four months, to do that three times a year, so 3 * 4 would be a 12% rate of return, so the so if you could have a portfolio of these deals and they all learn about the same thing, you can make a steady return. The beauty of it is if the market goes down. As long as the deal closes, you still make the same 12% annualized returns, so the returns are uncorrelated with the market direction but correlated to the risk in the transaction. So it's called risk arbitrage because you have $2 on the upside. But if for whatever reason the deal breaks and it falls to where the deal was before was announced, $30 is a lot of downside $18.00,
so play for $2.00 on the UP, 18 on the downside. So that's why it's an arbitrage. It's risky if you don't. If you you don't know what you're doing, you're viewed to be a good investor. What are the qualities of hard work, some luck, good contacts? What are the qualities that make a good investor and the kind of investor you have been doing well? You definitely need a lot of training so you know there's a lot of issues to understand from illegal investing business standpoint, so you know before you start investing, you really need a lot of experience. And depending on the type of investing depends on the type of experience.
So someone like in in risk arbitrage or private equity probably the best place to start, as mergers and acquisitions would become familiar with valuations and merger agreements and takeover laws, and then you could apply that later on to purchasing companies on your own behalf or trading in the securities of companies undergoing mergers. So when you're at cocktail parties, do people come up to you all the time and say you got any good ideas for me or? That doesn't happen all the time sometimes, but you know the worst thing is to give someone an idea you know casually and then it turns out the wrong way. You feel terrible, so it's you know I'd prefer not to give investment advice. So what's the best investment advice you've ever received? I think the best thing is to invest in areas that you know well that you know you can be lucky. Anyone could be locking in particularly investment, but that's not a long term strategy.
If you invest in areas that you don't know. Ultimately, you're not going to do well, so the most important thing is to invest in areas to concentrate on particular areas that you know better than other people in that area, and that's what gives you an advantage to succeed in investing. And what is the most common mistake that you think investors make? I think that they look for get rich quick schemes and they buy based on stories and then they chase investments that are going up and ultimately those investments deflate and then they lose money.
So if somebody came to you and said John, I just got $100,000. What should I do with 100,000? What would you tell them? I always say the best investment for an individual. An average individual is to buy their own home. So if you took that 100,000, put 10% down. Get a 900,000 mortgage or whatever. You can buy a home for $1,000,000 and yeah, it's just reported that home prices were up 20% in the last month. So if you bought a home for $1,000,000 with 100,000 down, the home was up 20%.
That's 200,000 on 100,000 investment you'd be up to 100% and overtime asexually. That's what's going to happen. The longer you wait, the more the house is going to appreciate and the greater return. You'll have on your equity investments, so I think the single best investment investment for anyone with that type of money would be to buy their own house or apartment.
And what do you think? For example, you would tell people not to invest in or something you'd say. Do not ever invest in XY or Z. Well, now I'll have a lot of people that disagree with this, but I I would think you know you shouldn't invest in cryptocurrencies. Ultimately, I think cryptocurrencies, regardless of where they're training today. Whether they go up from here or down Will eventually proved to be worthless, so there is no value to them. It's just a question of supply and demand and what's the exuberance.
Whereas offer liquidity dries out, these will go to zero, so I wouldn't recommend anyone invest in the future occurrence of all the things you've said in this interview. I think that's probably going to get the most attention from people. Probably possibly. Yeah, and you hope your children will get
into the investing world at some point. Well, you know, I always say you should do what you're passionate about. I happen to always found investing. From a very young age to be fun.
So I like buying things, selling things. I like, making money and the independence that earning money gives me and allows me to have a lifestyle. So that's what I'd like. But you can't force that upon someone.
So the most important thing is to pursue your passion 'cause you can be successful in anything you can be successful in music, dance, medicine, physics, math. The important thing is that you you know you pursue a career in what you're naturally passionate about. And that will that will improve your odds of achieving success.