Book Review: The Greatest Trade Ever

The Greatest Trade Ever - The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History by Gregory Zuckerman

John Paulson was one of the traders who researched the US subprime mortgage loans and believed that those loans will default one day. He bet on fall of the ABX subprime mortgage loan index. The symptoms that pointed to a bubble were
- low interest rates
- shady practices where income documents were neither required nor verified; even your dog can buy a house
- property prices rising much faster than income
- optimism that the government will never make millions of citizens become homeless
- risky (high risk of default) derivative securities bundled with safe securities, and passed off as safe securities rated AA when they shouldn't be
- subprime mortgage lenders issuing more loans than mainstream banks

The bankruptcy of New Century Financial Corporation, a subprime mortgage lender in Apr 2007 was the start of the financial crisis. After making his money from the ABX index fall, he shifted his bets to buying securities that bet against bank collapses because the the cost was a lot lower that shorting bank stocks directly, and banks were insufficiently insured with capital to withstand any sudden drop in valuation of their riskier asset loans. The symptoms were:
- banks holding lower rated mortgage bonds
- banks selling insurance that they had no means to payout
- banks not having sufficient cash to withstand a bank run

In Sep 2008, a mass exodus of clients led Lehman Brothers into bankruptcy. That was the drop of water that broke the vase. They had been suffering losses from their subprime mortgage loans but apparently there were cover-ups to shield these numbers.

This book is a good reminder to watch where complacency is the greatest.