"There's no question we made money in these transactions," said a Paulson spokesman in a statement. "However, all our dealings were through arms-length transactions with experienced counterparties who had opposing views based on all available information at the time. We were straightforward in our dislike of these securities but the vast majority of people in the market thought we were dead wrong and openly and aggressively purchased the securities we were selling."
Some of the people whose mortgages underpinned Paulson's wager were themselves taking a gamble -- that U.S. housing prices would continue to march upward, making it possible for them to eventually pay off loans they couldn't afford.
In early 2007, Paulson's company was identifying different bonds from across the country that it wanted to place bets against. Paolo Pellegrini, Paulson's right-hand man, began working with Goldman trader Fabrice Tourre to choose bonds for the Abacus portfolio, say people familiar with the deal.
Abacus was a "synthetic" CDO, meaning that it didn't contain any actual bonds. Rather, it allowed Paulson's company to buy insurance on bonds it didn't own. If the bonds performed well, Paulson would make a steady stream of small payments -- much like insurance premiums. If they performed poorly, Paulson would receive potentially large payouts.
According to the SEC complaint, Paulson especially wanted to find risky subprime adjustable-rate mortgages that had been given to borrowers with low credit scores who lived in California, Arizona, Florida, and Nevada -- states with big spikes in home prices that he reckoned would crash.
