Of pricks and bubbles

Chairman Greenspan introduced us to the central bank dilemma of whether to prick a bubble or pick up the pieces. His assessment was that bankers weren't such good pricks and much better at cleaning up after the fall.

Tell that to Humpty Dumpty.

But, it seems, maybe he's right, at least on a personal level. He's about to clean up, himself, by joining the winning side that bet on the subprime bubble (which Guambat prefers to describe as a more generic credit melt-up engineered by the Chairman's easy credit policies, and which are now visiting us as a wider credit crunch melt-down than mere subprime bust).

The WSJ reports that Mr. Greenspan "is signing on as an adviser to hedge-fund firm Paulson & Co., which has profited handsomely from the collapse of that bubble."

The story tells us he now has three consulting contracts: "all three of his clients have profited from a bearish view on housing and mortgages."

That story is one of a trifecta that the Journal put together on the people who gained from the pained subprime borrowers, but probably more from the funny money that thought they were the ones making the money off the subprimes, the banks and brokers who packaged, sold and distributed that toxic waste.

Now that the big banks are finally fessing up to gigantic losses on those bets, these stories show us where at least some of those losses are showing up on the other side of someone else's balance sheet. The Journal, following other stories in Bloomberg and, perhaps elsewhere, began to lift the cover on this story over a year and a half ago.

One of the biggest players to profit from the mortgage bubble burst, as reported in today's WSJ, was John Paulson. Although his hedge funds did well enough, "Mr. Paulson has reaped an estimated $3 billion to $4 billion for himself -- believed to be the largest one-year payday in Wall Street history." More:

Merely holding a different opinion from the blundering herd wasn't enough to produce huge profits. He also had to think up a technical way to bet against the housing and mortgage markets, given that, as he notes, "you can't short houses."

Also key: Mr. Paulson didn't turn bearish too early. Some close students of the housing market did just that, investing for a downturn years ago -- only to suffer such painful losses waiting for a collapse that they finally unwound their bearish bets.

He began selling short the bonds of companies such as auto suppliers, that is, betting on them to fall in value. Instead, they kept rising, even bonds of companies in bankruptcy proceedings.

"Where is the bubble we can short?"

One Wall Street specialty during the boom was repackaging mortgage securities into instruments called collateralized debt obligations, or CDOs, then selling slices of these with varying levels of risk.

For buyers of the slices who wanted to insure against the debt going bad, Wall Street offered another instrument, called credit-default swaps.

Naturally, the riskier the debt that such a swap "insured," the more the swap would cost. And this price would go up if default risk appeared to be increasing. This meant an investor of a bearish bent could buy the swaps as a way to bet on bad news happening.

During the boom, however, many were so blind to housing risk that this "default insurance" was priced very cheaply. Analyzing reams of data late at night in his office, Mr. Paulson became convinced investors were far underestimating the risk in the mortgage market. In betting on it to crumble, "I've never been involved in a trade that had such unlimited upside with a very limited downside," he says.

"We've got to take as much advantage of this as we can," Mr. Paulson recalls telling a colleague around the middle of 2005, when optimism about the housing market was at its peak.

His bets at first were losers.

He decided to launch a hedge fund solely to bet against risky mortgages.

Housing remained strong, and the fund lost money.

Investors had recently gained a new way to bet for or against subprime mortgages. It was the ABX, an index that reflects the value of a basket of subprime mortgages made over six months. An index of those made in the first half of 2006 appeared in July 2006. The Paulson funds sold it short.

Mr. Paulson, who was already worth over $100 million before his windfall, isn't changing his routine much.

One thing is different: It's easy to attract investors now. The firm began 2007 managing $7 billion. Investors have poured in $6 billion more in just the past year. That plus the 2007 investment gains have boosted the total his fund firm manages to $28 billion, making it one of the world's largest.

Mr. Paulson has taken profits on some, but not most, of his bets. He remains a bear on housing, predicting it will take years for home prices to recover. He's also betting against other parts of the economy, such as credit-card and auto loans. He tells investors "it's still not too late" to bet on economic troubles.

But as often happens to spoil a perfectly good trade, many others started jumping in to do it, too. Guambat's chemistry teacher in a dingy South San Antonio Junior High School lab almost 50 years ago demonstrated to him the fallacy of "if a little is good a whole lot is better".

So it was that Mr. Paulson found big fish, like George Soros, inviting him around to share his lunch. But it seems what really cheezed him off was when an associate of his struck out on his own using the same idea.

Actually, "struck out" is not the most accurate description. Struck oil would be more like it.

The third tale in the WSJ trifecta is about that guy, Jeff Green.

If Mr. Paulson is the pensive, low-key mastermind of the lucrative bearish bet, 53-year-old Mr. Greene is the strategy's most flamboyant exemplar. A Los Angeles real-estate investor who made and lost a bundle 15 years ago, bounced back, bought himself three airplanes and a yacht, and entertains celebrities in his multiple homes, Mr. Greene has hired a P.R. firm to raise his profile and help him move into new business spheres.

"He never told me: 'Don't do it,'" Mr. Greene says. Mr. Paulson won't discuss the matter.

For the artwork in Mr. Greene's new Beverly Hills mansion, money is one motif. A dark metal rendering of a dollar bill hangs over the bar.

Eroticism is another. In the east wing are two huge erotic paintings that Mr. Greene waited to hang until after his September wedding there.

After a 2½-year run through Johns Hopkins University, he saved up $100,000 in three years managing telemarketing centers, which he used to make his first property investment: a three-family house in the Boston area. He lived in it while getting a Harvard M.B.A., acquiring 17 more homes while at the business school.

He bought and developed low-slung apartment buildings in the Los Angeles area, using loads of borrowed money. "My early windfall was a result of the excesses of the S&L era," Mr. Greene says. He says he had pushed his net worth to $35 million before the savings-and-loan crisis all but wiped him out in the early 1990s.

"I went through a very tough time. I didn't know how I would get out of it," he says. But by the late 1990s, as the California economy recovered, he was on his way to an even bigger fortune, eventually including 7,000 apartments.

He bought three jets, most recently a Gulfstream. Though he paid just $2 million for an older model, "I certainly could afford" a $50 million one, he says. He adds, in a telephone interview from his 145-foot yacht: "I tend to be pretty conservative in the way I spend money."

His wine will bear a label using the name that he and his 32-year-old bride, Mei Sze Chan, chose for their sprawling nest. "Palazzo di Amore," Mr. Greene says -- "it's a bit cheesy, but that's what it means to us."