WASHINGTON - New York hedge fund manager John Paulson was one of the first to predict the collapse of the subprime mortgage market - and to cash in on his knowledge.
By late 2005, he already had concluded that the subprime loans underlying high-yield bonds being sold worldwide would become worthless, even as some Wall Street firms were still ramping up their sale of related securities.
"We determined ...that there was a complete mispricing of risk of mortgage securities," Paulson testified at a congressional hearing in November 2008.
As a result, his firm, Paulson & Co., made a $3.7 billion profit by betting against the housing market as it nose dived in 2006 and 2007. On Friday, the Securities and Exchange Commission disclosed that $1 billion of those profits came in an insider deal in which Goldman Sachs allegedly let the company select subprime securities for a complicated offshore deal and then bet on their failure.
Paulson & Co., which was founded in 1994, manages funds that are open only to "qualified purchasers" - individual investors with $5 million in assets to invest or institutions with at least $25 million to invest. In 2004, the company registered with the SEC as an investment adviser.
The company was able to anticipate the losses because Paulson's researchers looked at the underlying home loans, Paulson told Congress. Paulson realized they were comprised of risky mortgages - some of which were made with 100 percent financing.
Even worse, he testified, mortgages were given to borrowers who had a history of poor credit, had no verified income or whose appraisal that was typically inflated.
"It was that analysis that allowed us to buy protection on these securities, which resulted in large gains for our funds," he said.
SEC officials said Friday that Paulson was not charged in the Goldman case because the company did not mislead investors.
In a statement, the company pointed to the SEC's statements, saying, "Paulson is not the subject of this complaint, made no misrepresentations and is not the subject of any charges."
The company declined to respond to questions.
Several media outlets reported Friday that former Paulson co-manager Paolo Pellegrini was cooperating with the investigation and provided the SEC with crucial information that led to the Goldman charges.
A spokeswoman for Pellegrini, who left to start his own fund, didn't immediately comment.