The Greatest Trade Ever

by Gregory Zuckerman

  But Paulson was becoming gutsier, playing the merger game differently than his peers. He began to short companies set to be acquired when he deduced that their merger agreements might collapse, a step most competitors were uncomfortable taking. And because Paulson had crafted mergers at Bear Stearns, he felt at ease taking big positions in stocks he was most certain would be acquired or receive competing acquisition offers, rather than simply spreading his investments evenly among a number of such companies.

  The steps helped Paulson & Co. gain about 5 percent in 2001 and 2002, even as rivals suffered. Investors took a bit more notice of the firm, pushing it up to $300 million in assets by the end of 2002.

  Paulson felt handcuffed, however, like a performer unable to show off his entire repertoire.

  “I didn’t like being narrowly tagged as merger-arb,” Paulson says. “I had a broad skill set … high yield, bankruptcy, arbitrage … I always felt underutilized.”

  Paulson had done some debt investing at Gruss and he hungrily eyed beaten-down bonds amid the ongoing recession. But the rules of his funds limited his focus to mergers and other situations in which shares were exchanged. He found an opening, though, when some troubled companies sought bankruptcy protection and their debt was traded for new shares, something that Paulson told his investors was just another form of a merger.

  So Paulson bought debt of troubled companies, like Enron, WorldCom, AT&T Canada, and European telecom provider Marconi Corp., all selling for pennies on the dollar. As the economy improved and the debt advanced in price or was exchanged for shares that climbed, Paulson & Co. scooped up profits, gaining 20 percent in 2003.

  Paulson now managed $1.5 billion, a figure that sounded like a lot to friends outside the business. But the firm was dwarfed by its many rivals. With only nine employees, Paulson himself usually attended various meetings with companies, asking respectful questions from the back of the room as younger analysts from competing hedge funds blustered in front of the group. Paulson’s hedge fund was such small potatoes that he worried it might not survive an ongoing consolidation of the business.

  “In order to survive, I needed to be one of the larger players; midtier players would be squeezed out,” he recalls. “I wanted to be a more significant participant in the industry.”

  Paulson was playing catch-up, much like he did during college and when he first was looking for a job on Wall Street. New investors weren’t flocking to merger investing. And larger firms in his business had been in the game longer; some were operated by hallowed names on the Street, such as George Soros, Richard Perry, and Paul Tudor Jones, making it hard to compete.

  “The leaders all came out of large, risk-arb trading desks from places like Goldman Sachs,” Paulson remembers. “Once they had the lead, once they got an allocation [of money] from foundations or funds-of-funds and performed well, the doors to others were closed.”

  Paulson’s outside marketing pro, Peter Novello, insisted to potential clients that Paulson wasn’t like other investors. He might never match the huge scores that some rivals were scoring in adventurous areas, such as emerging markets. And Paulson’s returns might be more unpredictable than those who carefully spread their money around. But Paulson’s results would be impressive, Novello assured them. Just give him a chance.

  “John piles into positions he believes in,” Novello told a group of investors one day. “He has an investment-banking background, not a trading one like everyone else.”

  Finally, Novello succeeded in arranging meetings with some big investors. But Paulson sometimes seemed bored sitting through the barrage of simplistic questions, an impatience that worried Novello.

  Once the conversation was steered to his complex trades, however, Paulson demonstrated a remarkable ability to explain his moves in surprisingly simple terms, as if he were a favorite professor teaching a challenging course. Numbers seemed like a favored language to Paulson, one that he could easily translate for even the uninitiated.

  “In ten seconds their eyes lit up,” Novello says. “It was so easy to understand.”

  One prospective client, Richard Leibovitch, visited Paulson for a one-hour meeting. He sat in an awkward reclining chair in Paulson’s office and struggled to take notes on a coffee table, wondering why Paulson had original Calders on his walls but no formal conference room to host guests.

  “It felt like a doctor’s office,” Leibovitch says.

  Once they got going, though, the one hour turned into four, stretching into the evening. Paulson detailed the twists and turns of his trades with such relish that it captivated Leibovitch.

  “He just didn’t want to leave, so I didn’t either,” Leibovitch remembers.

  Other investors were taken with Paulson’s surprisingly self-deprecating manner, and the way he cited trades that went awry along with his successes. It helped that he was “one of the best-dressed managers we ever met,” Novello says.

  As Paulson’s performance perked up, investors discovered his firm. Assets surged to $3 billion in 2004. Rather than live it up, however, Paulson turned more conservative, sometimes to the derision of friends who remembered his livelier bachelor days. He spoke in a more measured, serious tone and offered fewer glimpses of humor. Viewing the endless parade of dark suits and somber ties from his wardrobe, friends began to call him “the undertaker” behind his back. Paulson asked one old friend to clean up his language when he cussed in front of him. Paulson stopped speaking with Christophe von Hohenberg, a friend from his wilder days.

  Some noticed Paulson becoming more deliberate and gaining more control over his emotions and temper. Paulson also adopted a healthier lifestyle, eating smaller portions of healthier food throughout the day—a piece of fruit for breakfast, salad or fish for lunch. For a snack, he stopped at a produce stand for a bag of grapes or cherries. He encouraged those working for him to follow in his footsteps, handing out copies of books advocating vegan or wholesome diets, such as T. Colin Campbell’s The China Study and Roy L. and Lisa Walford’s The Anti-Aging Plan.

  One day, Paulson saw Keith Hannan, his stock trader, eating pizza at his desk and became incensed, an employee recalls.

  “That stuff’s going to kill you!”

  Some employees started eating less-healthful food on the sly, sometimes out of drawers, though Hannan and others began to embrace Paulson’s healthier diet.

  Some of the Paulson team speculated that the early death of Paulson’s father had sparked his interest in healthful food. But Paulson gave Jim Wong, his head of investor relations, another explanation.

  “He told me, ‘If I can stay alive longer, I can compound my wealth longer,’ ” Wong recalls. “He was joking, and yet he wasn’t.” It was a hint at what was driving Paulson.

  Paulson’s domestic life became his new passion. He hurried straight home after work most evenings to be with Jenny and their two young daughters. Paulson was one of the only investors to take his wife on a ski trip to Utah sponsored by a brokerage firm. And he began a tradition of taking his family on annual summer trips abroad.

  Though the firm raked in tens of millions of dollars per year, Paulson’s offices were understated, even Spartan. He clung to a few pieces of worn furniture, including a black leather couch that he bought in 1994 from a Bloomingdale’s warehouse. That wasn’t out of character. Paulson tended to hold on to things close to him. For years, he was smitten by a black 1986 Jaguar with a doe-skinned interior. It was the first car he ever owned and he refused to give it up, even after the car began having electrical problems. One day on a drive back to New York from Southampton, the Jaguar’s engine caught fire and Paulson had to quickly ditch it on the side of the road before it was engulfed in flames.

  “I get attached to things and I look for good value,” Paulson explains.

  He frequently walked to work or a meeting, sometimes bumping into clients along the way. Some of them were surprised Paulson didn’t take a car service like most other hedge-fund managers.

  On a
business trip to England in 2003, Paulson stayed at Peter Soros’s country home in the English countryside. After dinner, Paulson excused himself and walked into a nearby room to arrange a flight back home. Rather than book a private plane, Paulson spent forty-five minutes on the phone with a representative of American Airlines, haggling for a better business-class fare back to the United States.

  “Can you do better than that?” Paulson asked of the representative.

  Listening from another room, his incredulous host shook his head, smiling.

  “It wasn’t even a first-class seat” he was negotiating for, Soros recalls, by then a close friend.

  Paulson liked to track real estate, and he noticed prices heating up in 2004. He sold his SoHo loft, pocketing more than $1 million in profit. Paulson wasn’t yet wary of the market, however; he just needed more space for his growing family. On the lookout for a new place to live, Paulson heard about a home languishing on the market—a 28,500-square-foot building on the Upper East Side, just off Fifth Avenue, a magnificent six-story limestone mansion with an indoor pool and a tragic past.

  Built in 1916 by legendary architects Delano and Aldrich for the patrician banker and horse breeder William Woodward Sr., the home, one of New York’s largest residences, was the backdrop of lavish parties thrown by William Woodward Jr. and his wife, Ann, a former actress and model. Their giddy days ended when she shot her husband to death at pointblank range in the middle of the night at their Long Island estate after she said she mistook him for a prowler. Life magazine dubbed it “The Shooting of the Century.” Ann was cleared by a grand jury, but the case was full of intrigue. She later committed suicide, shortly after Truman Capote published a thinly veiled account of the case in 1975.1

  After the shooting, the New York home was transformed into the Town Club, where a group of members enjoyed high-stakes games of gin and bridge. The residence became rundown, however, allowing Paulson to purchase it for $15 million, well under the original $27 million asking price.

  DESPITE THE BARGAIN he had found in his own home, Paulson began to sense that real estate was getting out of hand. He heard about homes similar to his own being sold in Southampton for five, seven, and even ten times what he had paid a decade earlier. Developers and buyers seemed on a building-and-buying spree.

  “It was out of control,” Paulson remembers. “The amount of appreciation relative to what people were earning was startling.”

  Paulson sold his Southampton home, figuring that he would find another bargain. When he heard about an attractive home nearby, though, he was astonished at its $13 million asking price. In the end, he decided to rent.

  Others were getting caught up in the frenzy, however. A friend purchased forty-five acres of land from a farmer for $3 million and then flipped it for $9 million. He watched it quickly sell for $25 million. The rapid appreciation stunned Paulson. He warned friends about their real estate investments, but they ignored him, insisting that there were very few lots available; prices were bound to rise further.

  “I kept saying, ‘This isn’t sustainable,’ but no one seemed to listen,” Paulson recalls.

  He hadn’t yet translated his concern about his high-end world to the national market, nor did he have much reason to, given that he still focused on merger investing. That all changed, however, when Paulson received an unexpected phone call from an old friend.

  AS PAOLO PELLEGRINI picked up the phone in the spring of 2004, he debated how to ask John Paulson for a job. A career Web site operated by the Harvard University Business School listed an opening for a chief financial officer at Paulson’s hedge fund.

  Pellegrini didn’t have high hopes. He hadn’t worked with Paulson in years and they hadn’t stayed in close contact. Pellegrini already had sent out hundreds of fruitless letters to prospective employers. Moreover, Pellegrini was sure that he wasn’t nearly qualified enough for the job.

  But Pellegrini had drained his bank account and didn’t have many other options, so he took the chance. He half-expected Paulson to laugh at his boldness. Instead, Paulson sounded happy to hear from him. Then Paulson delivered the bad news: The job already was filled.

  “What about a job as an analyst?” Pellegrini quickly countered.

  Paulson sounded uncomfortable.

  “Well, Paolo, usually those jobs are for young people out of school. There’s a lot of grunt work involved, and you don’t make many decisions.”

  “I’m fine with grunt work,” Pellegrini responded, with as much enthusiasm as he could muster. So Paulson suggested they get together.

  When they met in Paulson’s office, the hedge-fund manager was friendly but exceedingly blunt.

  “It looks like your career is going nowhere,” Paulson said, looking over Pellegrini’s résumé. “You’ve been doing nothing, really, since Bear.”

  He’s more or less accurate, Pellegrini thought.

  “But you’re a smart guy and a hard worker,” Paulson continued. A young associate recently had left the fund to attend business school, creating an opening.

  Paulson set up an interview for Pellegrini with two of his associates. It was a last chance for Pellegrini to make something of a career that began with much promise but had stalled out, quite badly.

  Born in Rome in 1957, Pellegrini moved to Milan at the age of five when his father, Umberto, a physicist, was hired to teach electronics at Politecnico, Milan’s prestigious engineering school. On the side, Umberto ran a company that manufactured electronics for Italy’s military and later built the country’s first minicomputer. The family led a comfortable life in a neighborhood near the university and enjoyed skiing vacations in the Dolomites section of the Alps. But Umberto was a reluctant capitalist, more focused on the technical and intellectual challenges of his work than on his pay. Pellegrini’s mother, Anna, taught high-school biology and pursued her own research, sharing her husband’s distaste of money.

  In many ways, the Pellegrinis’ attitudes reflected a period of economic upheaval and frustration in Italy, as a series of governments clamped down on foreign-currency holdings and took other restrictive measures to try to stem runaway inflation.

  Early signs suggested that Paolo didn’t quite share his parents’ perspective. At the age of six, he used toy Lego pieces to build a huge replica of a bank, startling his parents. From the age of twelve, he worked at his father’s company, writing computer code and showing unusual interest in the business world.

  “I always liked money,” Pellegrini recalls. “My parents were puritanical about it; I think it was a reaction to them.”

  Paolo excelled in school, especially in math and physics, but his grades dropped in high school as he showed little interest in a curriculum featuring Italian literature, philosophy, Latin, and Greek.

  Most summers Pellegrini worked at various international companies operating in Italy, or could be found in front of a computer at his father’s company.

  “Programming computers taught me to break down problems and set up intellectual experiments to verify and demonstrate theories, and to run simulated experiments,” Pellegrini recalls. “My dad indirectly provided certainty that I could handle it all because he had.”

  At the University of Milan, Pellegrini finally could focus on the computer sciences and electrical engineering courses that intrigued him, and he received top grades. He spent one summer working for Hewlett-Packard in France and another in Boston working for Honeywell.

  Most graduates served in the Italian army after school, but after five years of university Pellegrini already was a year behind contemporaries in the United States, and he was in a rush to catch up. So he found an entry-level job at a computer-equipment company in Holland. Pellegrini quickly became bored, though, quitting after just two years to attend Harvard Business School.

  Class work came easily to Pellegrini, even though English was his second language. He received honors in his first year at Harvard and was described by one professor as having one of the “most creative mathema
tical minds” he had ever seen in a student.

  “I remember him very well, he was really special,” says Elon Kohlberg, a professor at the school. Pellegrini was “sort of like those annoying kids who are just too smart for their own good. Whatever comes up they can just poke holes in it.”

  Pellegrini aced a class on regression analysis, a course that Harvard later abolished because students complained it was just too hard, Kohlberg says.

  During his first summer in business school, Pellegrini worked at the investment-banking department at Bear Stearns, sharing an office with John Paulson, impressing him by developing a detailed, proprietary database of merger deals.

  At Harvard, Pellegrini felt uncomfortable socializing with his classmates; he was a bit older than most of them, and was concerned that his English wasn’t up to par. The six-foot-two Pellegrini was more relaxed in one-on-one settings. He soon discovered that his accented English held a special charm for certain women. Pellegrini dated a series of classmates but found himself looking forward to seeing fellow student Claire Goodman, the daughter of legendary New York State Senator Roy Goodman, to whom he gave regular tutoring sessions.

  Their relationship blossomed, as Goodman’s outgoing personality seemed to complement Pellegrini’s more introverted nature. A year later they married; John Paulson was among the attendees. After Pellegrini graduated from Harvard with distinction in 1985, the young couple moved to New York. He landed a job at investment-banking firm Dillon, Read & Co., and Goodman took a job at First Boston.

  Pellegrini seemed on the fast track to success. He quickly received a promotion, joining Dillon Read’s mergers-and-acquisitions department, and then was hired away by the prestigious banking firm Lazard Freres & Co. for its international mergers and acquisitions group. The firm didn’t have an insurance-industry expert and turned to Pellegrini, who enjoyed the challenge of figuring out a new industry.