The Greatest Trade Ever By James Sanders
One man's refusal to believe in the health of the housing boom tells us a great deal about the financial crisis and why the crowd can often be very, very wrong…
The mania that gripped investors in the wild bubble years of the 00s is widely portrayed as a universal disease, but a few stubborn souls refused to succumb. At the time, they were derided and mocked for not realising that ‘things are different this time’. They simply didn’t believe the hype. One such refusenik, hedge fund manager John Paulson, was not only sceptical about the health of the over-inflated US housing market, but bet against it – and won in some style.
$15bn in 12 months The scale of Paulson's bet earned it the title of "the greatest trade ever“ in Greg Zuckerman’s book. In any context, it was a truly extraordinary example of backing your own judgement against the noise of the crowd. By hoovering up complex "credit default swaps" against mortgages – in effect, insurance policies that would pay out if homeowners defaulted on their loans. His fund made a cool $15bn in a year, $4bn of which he took home himself.
$1.25bn in a single morning On a single morning in 2007, when sub-prime lender New Century announced it was ‘in difficulty’, Paulson's fund clocked up gains of just over $1.25bn – more than his idol George Soros made in his notorious gamble against sterling in 1992 when Britain was forced out of the European exchange rate mechanism. Others placed similar (much smaller) trades, such as west coast property developer Jeffrey Greene, a friend of Paulson's before they fell out over his refusal to invest in his hedge fund. These investors were considered mavericks or outsiders and had to fight to be taken seriously at the time by the banks they wished to trade with.
Is it different this time? The financial engineering that blighted these years left bank bosses with only the vaguest understanding of their own balance sheets, and the trail that leads from bafflingly complex securities such as "collateralised debt obligations" to cash-strapped homeowners across the US. You would hope that Banks and Investors would learn from such an experience wouldn’t you? You would assume that rules would be in place to ensure that people are not able to borrow more than they can ever afford to repay? You might hope that would be the case. Remember, this was a time when a school cleaner was able to secure an $800,000 mortgage on a new build house.
Auto loans – the next disaster? The US consumer is being lured into some very suspect loans when they buy their new wheels. Recently, Wells Fargo admitted it was facing litigation over its ‘sales practices’, you can read more here. Many consumers are now taking loans over 6 years, a timescale that enables the lender to keep the monthly payments as low as possible. Around 42% of all auto loans are over this timescale, compared to 26% of loans in 2009. For a breakdown of how the maths works, take a look at this scenario: If a borrower gets a five-year loan to finance a $20,000 car purchase with a 5.0 percent interest rate, after three years the borrower will have paid $2190.27 in interest and still have a remaining balance of $8602.98. That same loan financed over six years would cost the same borrower $152 more in interest and still have a remaining balance of $10,747, more than $2000 higher.
Sound familiar? The CFPB is a consumer watchdog and advocacy agency created by the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, said the longer loans have higher default rates, have been used more often by consumers with lower credit, and have on average financed larger amounts of money. Sound familiar? “The move to longer-term auto loans is opening up more risk for consumers,” CFPB director Richard Cordray said in a recent release. “These loans are more expensive and can result in consumers continuing to owe even after they are no longer driving their car.”
Worrying data
Who I Am‌ •
James Sanders is a property Investor and entrepreneur who provides the help in business development and property trading in London.
Conclusion Most Americans go into debt for a car or truck rather than pay cash, CFPB figures say consumers get financing to purchase 86 percent of new vehicles and 53 percent of used ones. In the United States, more than 90 percent of American households have a vehicle, and auto loans are third only to mortgages and student loans for household debt. Vehicles rarely appreciate and they can’t readily be rented out to provide an income. Mainstream models get less desirable and less reliable as they get older. This will end badly. This time it isn’t different.