The Greatest Trade Ever

by Gregory Zuckerman

  “Al didn’t care about winning,” says Finn. “He never made a lot or cared about making a lot. He was brilliant, very sensitive and friendly, but he was happy where he was in life.”

  A natural peacemaker, he sometimes approached colleagues involved in a dispute and gave each an encouraging smile, instantly healing the office rift.

  Jacqueline, now a practicing child psychologist, was more opinionated than her husband, weighing in on politics and business at social gatherings as Alfred looked on. She believed in giving her children a lot of love and even more leeway. Jacqueline brought the Paulson children up Jewish, and their eldest daughter later moved to Israel. Alfred was an atheist, but he attended synagogue with his family. Until he turned twelve, John had no idea that his father wasn’t Jewish.

  John attended a series of local public schools, where he entered a program for gifted students. By eighth grade, Paulson was studying calculus, Shakespeare, and other high-school-level subjects. Every summer, Alfred took his family on an extensive vacation, in the United States or abroad. By his sophomore year, John was going cross-country with friends, visiting Europe a year later.

  John showed signs of unusual independence in other areas as well. Though the Paulsons were members of a local synagogue, the Whitestone Hebrew Centre, Paulson listed in his yearbook at Bayside High the “Jesus club” and the “divine light club” among his interests.

  By the time Paulson entered New York University in the fall of 1973, the economy was floundering, the stock market was out of vogue, and Paulson’s early interest in money had faded. As a freshman, he studied creative writing and worked in film production. He took philosophy courses, thrilling his mother, who loved the arts. But the young man soon lost his interest in his studies, slipping behind his classmates. Vietnam, President Nixon, and the antiwar and civil rights protests dominated the news.

  “I felt directionless,” says Paulson, who wore his hair to his shoulders, looking like a young Robert Downey Jr. “I wasn’t very interested in college.”

  After John’s freshman year, Alfred sensed he needed a change and proposed that his son take a summer trip, the Paulson family remedy. He bought him an airplane ticket to South America, and that summer John traveled throughout Panama and Colombia. Soon he made his way to Ecuador, where he stayed with an uncle, a dashing bachelor who developed condominium projects in the coastal city of Salinas. His uncle appointed Paulson his hombre de confianza, or trusted right-hand man. He kept an eye out for thieves trying to steal materials from his uncle, supervised deliveries at various construction sites, and kept track of his uncle’s inventories.

  For a young man from Queens, Salinas was a little piece of heaven. Paulson lived in the penthouse apartment of one of his uncle’s buildings, the tallest in Ecuador, with a cook, a gardener, and a housekeeper. He found the women beautiful, the weather warm, and the beach close by. He grew to admire his uncle, a charismatic bon vivant who thoroughly enjoyed himself and his money. It was as if Paulson had been reborn into an affluent side of the family; he put off his return to NYU to extend his time in Ecuador.

  “It brought me back to liking money again,” Paulson remembers.

  There was only one drawback: His family was conservative and proved too confining for a young man just beginning to enjoy his independence. Paulson wasn’t allowed to date without a chaperone and could choose only young women from the right families, as designated and approved by his uncle.

  One day, Paulson met a pretty sixteen-year-old at one of his job sites, a young woman who turned out to be the daughter of the chief of police of Salinas. He invited her back to his apartment for dinner, asking his cook to whip up something special. The cook quietly called Paulson’s uncle to tip him off. Soon an associate of Paulson’s uncle came to the door. “What’s going on in there?! What’s going on?!” he demanded. He pulled aside Paulson and said, “We can’t have that type of person here.”

  The young woman fled the apartment, running into the night.

  Eager to be on his own, Paulson moved to the capital city of Quito, before traveling elsewhere in Ecuador. When he soon ran out of money and needed to drum up some cash, he discovered a man who manufactured attractive and inexpensive children’s clothing; Paulson commissioned some samples to send to his father back home in New York. Alfred took the samples to upscale stores such as Bloomingdale’s, which ordered six dozen shirts, thrilling the Paulsons. The shirts continued to sell and Paulson hired a team in Ecuador to produce more of them, spending evenings packing and shipping boxes of the clothing, learning to operate a business on the fly.

  Later, though, as orders piled up, Paulson missed a key delivery date with Bloomingdale’s and the store canceled its order. He was stuck with one thousand unwanted children’s shirts, which he had to store in his parents’ basement. Years later, whenever Paulson needed a little extra spending money, he would return to Queens, grab some shirts out of a box, and sell them at various New York retailers.

  Another time during his two years in Ecuador, Paulson noticed attractive wood parquet flooring in a store in Quito. He tracked down the local factory that produced it and asked the owner if he could act as his U.S. sales representative, in exchange for a commission of 10 percent of any sales. The man agreed, and Paulson sent his father a package of floor samples, which Alfred showed to people in the flooring business in New Jersey. They confirmed that the quality and pricing compared favorably with that available in the United States. By then, Alfred had left Ruder Finn, Inc. to start his own firm, but he made time to help his son. Working together, the Paulsons sold $250,000 of the flooring; his father gave John their entire $25,000 commission. The two spoke by phone or wrote daily while John was in Ecuador, bringing them closer together. It was John Paulson’s first big trade, and it excited him to do more.

  “I found it a lot of fun, and I loved having cash in my pocket,” Paulson recalls.

  Paulson realized that a college education was the best way to ensure ample cash flow, so he returned to NYU in 1976, newly focused and energized. By then, his friends were entering their senior year, two years ahead of Paulson, and he felt pressure to catch up. His competitive juices flowing, Paulson spent the next nineteen months accumulating the necessary credits to graduate, taking extra courses and attending summer school, receiving all As.

  Among his classmates, Paulson developed a reputation for having a unique ability to boil down complex ideas into simple terms. After lectures on difficult subjects like statistics or upper-level finance, some approached Paulson asking for help.

  “John was clearly the brightest guy in the class,” recalls Bruce Goodman, a classmate.

  Paulson was particularly inspired by an investment banking seminar taught by John Whitehead, then the chairman of investment banking firm Goldman Sachs. To give guest lectures, Whitehead brought in various Goldman stars, such as Robert Rubin, later secretary of the Treasury under Bill Clinton, and Stephen Friedman, Goldman’s future chairman. Paulson was transfixed as Rubin discussed making bets on mergers, a style of investing known as risk-arbitrage, and Friedman dissected the world of mergers and acquisitions deal making.

  An avid tennis player, like his father, Paulson sometimes invited friends to the Westside Tennis Club in Forest Hills, New York, where his father was a member, to play on the grass courts that served as home to the U.S. Open. But he rarely invited friends back home, and some never even knew he was a native of Queens. For years, Paulson would simply say that he was from New York City.

  It was his classmate, Bruce Goodman, who began calling Paulson “J.P.,” a reflection of Paulson’s initials as well as a sly allusion to J.P. Morgan, the legendary turn-of-the-century banker. The nickname, which stuck for the rest of his life, spoke to Paulson’s obvious abilities, his growing ambition, and his blue-blood aspirations. Paulson smiled when he heard the new nickname, appreciating the compliment and the double entendre.

  Paulson graduated first in his class from NYU with a degree in finance. As the
valedictorian of the College of Business and Public Administration, he delivered a speech about corporate responsibility. A dean suggested that he apply to Harvard Business School. Although Paulson was only twenty-two and didn’t have much business experience, he cited the lessons of his business in Ecuador in his application; he not only gained acceptance but won the Sidney J. Weinberg/Goldman Sachs scholarship.

  One day at Harvard Business School, a classmate, on the way to a meeting of Harvard’s investment club, approached Paulson, telling him, “You’ve got to hear this guy Kohlberg speak.” Paulson had never heard of Jerry Kohlberg, founder of investment powerhouse Kohlberg Kravis Roberts & Co., but he tagged along, one of only a dozen students to show up. Kohlberg, an early pioneer of so-called leveraged buyouts, brought two bankers with him, and they walked through the details of how to buy a company using little cash and a lot of borrowed money. Then Kohlberg detailed how KKR put up $500,000 and borrowed $36 million to buy an obscure company that they sold six months later, walking away with $17 million in profit.

  For Paulson, it was a life-changing experience, like seeing the Beatles for the first time, one that opened his eyes to the huge paydays possible from big investments. Paulson calculated that partners at Goldman Sachs like Whitehead and Rubin made just $500,000 that year, a figure that seemed puny next to what could be made by Kohlberg Kravis Roberts & Co.

  Jerry Kohlberg can make $17 million on just one deal, thought an astounded Paulson.

  In his developing worldview, the acquisition of massive wealth deserved unabashed admiration. John Whitehead and Jerry Kohlberg played the game fairly, with intelligence and diligence. To Paulson, they seemed deserving of the rewards they commanded. During his second year in business school, Paulson undertook a research project to identify the key players in the leveraged-buyout industry. Upon graduation, Paulson assumed that he, too, would head to Wall Street.

  Paulson graduated as a George F. Baker Scholar in 1980, in the top 5 percent of his class. But when firms came to recruit on campus, it was the consulting firms that offered the largest starting salaries, grabbing Paulson’s attention. Wall Street was still battling a bear market. So Paulson accepted a job at Boston Consulting Group, a prestigious local firm that recruited only at upper-echelon schools.

  Early on in his new job, Paulson was asked to help Jeffrey Libert, a senior consultant, advise the Washington Post Co. on whether to invest in real estate. Paulson initially was bullish on the idea—the Paulson home in Beechhurst had increased in value over the previous two decades and housing seemed like a good investment.

  Libert, the same age as Paulson and also a native New Yorker who had graduated from Harvard Business School, showed Paulson a chart mapping the impressive growth of housing prices over the previous few decades. But when Libert factored in the rise of inflation over that period, the annual gains for housing turned out to be just 1.5 percent. Unless you can find an inexpensive home or building that can be purchased for less than its replacement cost, Libert argued, real estate isn’t a very attractive investment.

  “I was amazed to see that,” Paulson says. “I wasn’t an investor, so it didn’t have meaning at the time, but the low rate of growth always stuck in my mind.”

  The work Paulson did at Boston Consulting Group was research intensive, and he excelled at it. An upbeat presence in the office, he flirted with the secretaries and other women in the office, most of whom liked Paulson much more than his less-approachable colleagues. But Paulson quickly realized he had made a mistake joining the firm. He wasn’t investing money, he was just giving advice to companies, and at an hourly rate no less. To other executives at the firm, Paulson seemed out of place and uncomfortable.

  “John would say, ‘How can I make money off this’ while others were giving advice,” Libert remembers. “BCG was really about a bunch of geeks sitting around seeing who’s smarter than the next guy, and that made him impatient. He seemed to have an instinctual sense of how to make money.”

  Paulson, for example, was taken with the story of Charlie Allen Jr., a high-school dropout who built an investment firm, Allen & Co., into a powerhouse in the first half of the twentieth century. “The shy Midas of Wall Street,” Allen took taxis while members of his family enjoyed chauffeured Rolls-Royces. In 1973 Allen’s firm took control of Columbia Pictures after an accounting scandal left it weakened, then sold it to Coca-Cola nine years later in exchange for Coke stock. Later Coke shares soared and Allen pocketed a billion-dollar profit. (Years later, Paulson would recall details of the transaction by memory, as if reciting the batting average of a favorite baseball player.)

  Paulson wanted to move to Wall Street. But when he applied for various jobs, he found that his consulting experience accounted for very little. He didn’t want to start at the bottom of the ladder with recent grads, placing him in a quandary. At a local tennis tournament, Paulson saw Kohlberg in the stands and approached him, telling the LBO doyen how much he had enjoyed his lecture at Harvard. Kohlberg invited the young man to drop by his New York office.

  At their meeting a few days later, Paulson confided to Kohlberg, “I went into the wrong career.” He asked for Kohlberg’s help in finding a position on Wall Street.

  Kohlberg didn’t have any openings at KKR. When Paulson asked if Kohlberg might introduce him to other heavy hitters in the buyout world like Leon Levy at Oppenheimer & Co., Kohlberg picked up the phone and got him an appointment.

  A few weeks later, Paulson went to Levy’s Park Avenue apartment for an interview. He had never seen anything like it before—everywhere he looked he saw antiquities, collectibles, and objets d’art. Paulson couldn’t help but gawk, unsure if the busts around the home were Roman, Greek, or of some other origin he knew even less about. Paulson worried that if he moved too quickly in any direction, he would knock over one of Levy’s priceless pieces, a move unlikely to further his career. Sitting down, carefully, he began to talk with Levy, sipping coffee from delicate fine porcelain. It turned out that Levy was looking to expand his firm and needed a smart associate. By the end of the day, Paulson had landed a job.

  Paulson was so eager to leave the world of consulting that he hadn’t thought to ask many details about the firm he had joined. It turned out that Paulson had been hired by Oppenheimer, a partnership that owned a larger brokerage firm as well as an investment operation run by Levy and Jack Nash. When Paulson opened the door to his new office, he found another young executive, Peter Soros, sitting in his seat.

  “What are you doing in my office?” Paulson snapped.

  “What are you doing in my office?” Soros replied.

  A stare-down ensued, as neither Paulson nor Soros would vacate the room.

  “It wasn’t the friendliest meeting,” recalls Soros, a nephew of George Soros, who had been hired by another Oppenheimer executive, unbeknownst to Paulson.

  Days later, Oppenheimer split up, with Levy and Nash leaving to start their own firm, Odyssey Partners. They convinced Paulson to join them. The move gave Paulson an enviable opportunity for hands-on experience working with Levy and Nash, who already were Wall Street legends with a string of successful investments. They later raised $40 million for John DeLorean, the auto executive famous for a sports car with gull-winged doors, among a string of high-profile transactions.

  At Odyssey, Levy pushed Paulson to search for leveraged buyouts with the potential for huge, long-term upsides, Levy’s specialty. He and his partners once paid less than $50 million to purchase the Big Bear Stores Co., a regional grocery chain, and immediately recouped their investment by claiming a fee that was almost as much as their entire investment. They gave management incentives to improve operations, and eventually walked away with a $160 million profit.

  Paulson focused on underappreciated conglomerates selling at inexpensive prices. The firm bought a position in TransWorld Corp., a company weighed down by the struggling operations of its TWA Airlines. But TransWorld also owned Hilton Hotels, Century 21, and other profitable b
usinesses. Levy and Paulson figured that if they broke up the company, investors would focus on the value of the other businesses and the stock would soar. So Odyssey bought a big position in the stock. But TransWorld resisted a breakup and fought back, resulting in a nasty public squabble. The Odyssey team eventually profited from the venture, but it taught Paulson a lesson in how difficult the buyout business could be.

  After a couple of years, Levy and Paulson realized that Paulson didn’t have the experience to excel at his job. Nash agreed a change needed to be made. Paulson was smart and presented his ideas well, but he hadn’t learned the financial skills necessary to lead buyout transactions, nor did he have a thick Rolodex of contacts in the corporate world to pull them off on his own.

  “As much as Leon and I liked each other, they needed someone more senior,” Paulson says.

  Looking for a new job, once again, Paulson now was more than four years behind his classmates from business school. Several investment banks offered him entry-level positions, where he would join the most recent business school graduates, but it was something he resisted. An opportunity at Bear Stearns suited him much better. The firm was just below the upper echelon of the investment banking business, and it didn’t have extensive databases or other resources to help bankers compete. Banking wasn’t even a focus at Bear; Dick Harriton’s clearing operation was minting money loaning out customers’ stock, Bobby Steinberg ran a top risk-arbitrage operation, and Alan “Ace” Greenberg was working magic on the trading floor.

  What Bear did have in spades was a group of smart, hungry bankers who shared Paulson’s lust for money. The firm was hoping to win business from the same financial entrepreneurs that Paulson was so enamored with and saw him as an obvious match.