Billionaire Big-Shorter John Paulson Says The Housing Downturn May Be Different This Time Around

Zinger Key Points
  • John Paulson's return surged to 66% by February 2007, just before the credit crisis truly began.
  • Paulson says "the underlying quality of the mortgages today is far superior."
Billionaire Big-Shorter John Paulson Says The Housing Downturn May Be Different This Time Around

John Paulson, the billionaire hedge fund investor who made around $15 billion shorting $25 billion worth of subprime mortgages back in the "no credit, no money, no cash, no problem" underwriting debacle back in 2007-2008, says another downturn in the current "frothy" housing market may be in the cards.

Still, it could be different this time as the banking system is in a much better position to handle it, says Paulson.

First, some history for the uninitiated:

Paulson noticed there was a problem with the mortgage business around 2005. With low limits and credit standards, banks were giving mortgages (often at adjustable rates). When the rates rose and borrowers were unable to make their payments, they had two options: refinance or default.

Read also: Housing Prices Jumped Just 0.1% Last Month, But It Could Be A Sign For The Next Big Price Hike: Here's Why

The loans were predicated on the assumption that home prices would rise further. In 2010, Paulson testified before the Financial Crisis Committee that he started purchasing securities against low-graded loans that were likely to default as soon as he noticed that home values had stopped rising.

Mortgage brokers assured Paulson that the loans were secure because there had never been a nationwide decrease in home values since the Great Depression. “Our opinion was [homes] were overvalued, and they were going to correct and that the quality of mortgages was very poor, and the losses would likely be substantial,” Paulson said.

In order to profit from the consequences, by June 2006, he had established a fund for credit default swaps, a type of insurance that would pay him if borrowers were unable to repay their loans.

His return surged to 66% by February 2007, just before the credit crisis truly began. His fund generated $15 billion in revenue by the end of 2007. Paulson, incidentally, was not featured in the Michael Burry-focused film “The Big Short.”

“Well, the financial market, the banking system and the housing market are much different today than in ‘06 and ‘07,” Paulson said to Bloomberg. “The underlying quality of the mortgages today is far superior. You don’t even have any subprime mortgages in the market … And the FICO scores are very, very high.”

The banks during the 2008 financial crisis were also heavily leveraged, with average capital in large institutions like Credit Suisse and Morgan Stanley hovering around 3% and significant off-balance sheet exposure.

“So, you know, it doesn’t take a lot to fail if you have, let’s say, a hundred dollars in assets, and then on the liability side you only have $3 in equity and $97 in various types of borrowing,” Paulson explained. “If you’re not really careful on the asset side, all the assets have to do is fall 3% and your equity is wiped out. You go into default.”

The investor noted that because banks held a sizable proportion of subprime, high-yield, leveraged loans, their equity was put under pressure when the market started to collapse because banks were very speculative about the investments they were making.

Looking ahead, Paulson says another collapse in the U.S. housing market wouldn't resemble 2008 since underwriting standards have gotten considerably more sober since the Great Financial Crisis, the banking system is much more protected, there are greater capital requirements, and there are many more regulations in place.

“Today, the average bank is probably 9% equity, the systemically important banks are 11%-12% equity,” Paulson said. “Almost between three and four times as much equity as before. So we’re not at risk of a collapse today in the financial system like we were before. Yeah, it’s true, housing may be a little frothy. So housing prices may come down, or they may plateau, but not to the extent it happened.”

For the prospective buyer who can’t wait for a downturn to purchase their dream home, mortgage lender NASB Financial Inc. NASB is offering a variety of banking products including checking, savings, and certificate of deposit accounts. It is also offering mortgage and refinancing options, including self-employed mortgage options for the handyman or self-incorporated day trader.

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