Greed is a funny thing. Usually, in the world of high finance, it leads people to jump off cliffs together, all chasing the same shiny object until the ground comes up to meet them. But in 2007, John Paulson did the opposite. He didn’t just avoid the cliff; he figured out how to get paid for every single person who fell off it.
Most people think they know the story of the subprime mortgage crisis. You’ve probably seen The Big Short. You know about the strippers in Florida with five houses and the bankers who didn't care. But the actual mechanics of the greatest trade ever—the one that turned a mid-tier hedge fund manager into a billionaire overnight—are way weirder and more calculated than the movies suggest. Paulson didn’t just get lucky. He found a specific, structural glitch in how the world’s biggest banks valued "crap."
He bet against the American dream. And he won $15 billion.
The Man Who Saw the Crack in the Foundation
Before 2006, John Paulson was a merger arbitrage guy. Honestly, he wasn't a superstar. He was a solid, low-profile manager who focused on the boring stuff—like what happens to stock prices when two companies get married. But then his analyst, Paolo Pellegrini, started looking at the housing data.
The numbers didn't make sense.
Home prices had basically doubled in a few years, but wages were flat. It's a simple math problem that everyone ignored because everyone was getting rich. Paulson and Pellegrini realized that if housing prices just stopped going up—not even crashed, just stayed flat—the whole system would melt. They realized that the "triple-A" ratings on mortgage-backed securities were essentially a lie. These were boxes of toxic waste wrapped in gold foil.
How the Greatest Trade Ever Actually Worked
You can’t just go to a bank and say, "I bet housing will fail." You need a vehicle. Paulson used Credit Default Swaps (CDS). Think of a CDS as an insurance policy on a bond. If the bond stays healthy, you pay a small premium. If the bond goes into default, the insurance company pays you the full value.
At the time, the market thought housing was indestructible. This meant the "insurance" was incredibly cheap. Paulson was essentially buying fire insurance on a house that was already soaked in gasoline, and the insurance company was charging him like it was a brick fortress.
He didn't just buy a little bit. He went all in.
He started the Credit Opportunities Fund. He convinced investors to give him billions to bet against the very thing every other person in America thought was the safest investment on earth. It was lonely. People thought he was crazy. For months, he sat there paying those insurance premiums, watching his fund bleed money while the housing bubble grew even larger. That’s the thing about the greatest trade ever—it looks like the dumbest trade ever until the exact second the music stops.
The CDO Machine
To understand the scale here, you have to understand the Synthetic CDO. Banks were taking subprime mortgages, bundling them, and then creating "synthetic" versions of those bundles so more people could bet on them. Paulson actually worked with banks like Goldman Sachs to help "select" the specific mortgages that went into these bundles.
He was picking the ones he thought were most likely to fail.
Then, he’d buy the CDS to bet against them. It’s controversial. It led to massive lawsuits later—like the one involving the "Abacus 2007-AC1" deal. But from a purely clinical, profit-seeking perspective, it was the ultimate chess move. He was the architect of his own payout.
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Why 2007 Was the Breaking Point
By early 2007, the cracks became canyons. New Century Financial, a huge subprime lender, went bust. Suddenly, those "gold-wrapped" bonds started looking like the garbage they actually were.
Paulson’s premiums started paying off.
In a single year, his firm made $15 billion. Paulson personally took home about $4 billion. To put that in perspective: if you earned $100,000 a year, it would take you 40,000 years to make what John Paulson made in twelve months. It remains the largest one-year payout in the history of Wall Street. It’s a number so large it almost loses its meaning.
The Myth of the "Easy" Short
We love to look back and say, "It was so obvious!" It wasn't.
If you were a trader in 2006 and you tried to short housing, you were fighting the Fed, the big banks, the government, and your own neighbors. The psychological pressure to "capitulate"—to give up and join the crowd—is immense. Paulson had to watch as his peers made millions in the bubble while he looked like a doomsday prepper.
That’s the nuance people miss. The greatest trade ever wasn't just about being right; it was about being right and being able to stay solvent long enough to see the finish line. Most people who saw the crash coming went broke trying to time it. Paulson timed it to the minute.
What Most People Get Wrong About the Aftermath
There’s this idea that Paulson is a genius who can see the future. But if you look at his record after 2009, it’s... complicated. He made a huge bet on gold that didn't pan out the same way. He bet on a recovery in Puerto Rico.
It turns out that catching lightning in a bottle once doesn't mean you own the storm.
The subprime short was a specific alignment of massive systemic fraud, cheap insurance, and a total lack of oversight. Those conditions don't happen every decade. Today, the "Big Short" trade is much harder to pull off because the "insurance" (CDS) is priced much more efficiently. The "alpha"—the extra profit—has been squeezed out by algorithms and better data.
Can It Happen Again?
Probably not in housing. Not like that.
Regulations like Dodd-Frank changed how banks hold these risks. But the lesson of the greatest trade ever is that there is always a "crowded trade" somewhere. Whether it's tech stocks, crypto, or government debt, whenever everyone is convinced that a specific asset class "can only go up," the ghost of John Paulson is somewhere in a basement looking for a way to buy cheap insurance against it.
Actionable Insights from the Paulson Playbook
If you want to apply the logic of the greatest trade to your own world, you don't need $15 billion. You need a specific mindset.
- Look for Asymmetry: Paulson’s risk was limited to the premiums he paid, but his upside was virtually infinite. Never take a bet where the risk is huge and the reward is small. Only play when the math is skewed in your favor.
- Question the "Risk-Free" Label: Whenever the consensus says an investment is "safe" or "guaranteed," that’s exactly where the highest risk is hiding. Safety creates complacency, and complacency creates bubbles.
- Data Over Narrative: Everyone had a story about why housing was great (immigrants, limited land, "they aren't making more of it"). Paulson had the data on how many people were actually missing their first three payments. The data eventually killed the narrative.
- The Power of Staying Power: You can be right and still lose everything if you don't have the capital to wait. Ensure your "short" or your contrarian bet doesn't have a "margin call" that kills you before the win.
The 2007 crash was a tragedy for millions of families who lost their homes. It’s a dark chapter in economic history. But strictly through the lens of game theory and market mechanics, Paulson’s maneuver remains the gold standard for how to spot a lie and bank the difference. It was the moment the world realized that the biggest players in the room didn't know what they were doing, and one man in a midtown office was more than happy to take their money for it.