Hedge fund billionaire John Paulson made mad money betting against the housing market. (Photo Credit: CC BY-ND/Global Astrology Blog)

Hedge fund manager John Paulson bet against the health of the U.S. housing market by funneling money into credit default swaps against subprime mortgages, which effectively ensured that as homeowners defaulted he would receive a massive cash advance on his investment in failure. Thanks to the bursting of the U.S. housing bubble and some shrewd choices with U.S. financials, John Paulson is a billionaire.

John Paulson and the Citigroup venture

To some, hedge fund manager John Paulson represents all of what’s wrong with Wall Street. After earning approximately $15 billion betting against the U.S. housing market in 2007 – and being labeled a “guru” for doing so – John Paulson moved to the other side of the investment speculation fence. He bet that the U.S. economy would soon rebound. This involved a series of investments in various indexes, as well as an “after the fall” outlay in favor of rebounding house prices and a bet on high gold prices. Paulson’s stake in Citigroup earned his hedge fund investors utilizing Paulson & Co. about $1 billion in 2010. Over the past year, Citigroup’s share price shot up 50 percent.

Paulson & Co. is currently responsible for $35 billion in investments. Where most hedge funds eschewed the more volatile elements of the market last year, Reuters reports that John Paulson and company took small financial lumps early in 2010, yet managed to swing things around into double-digit gains. The Paulson Advantage Plus Fund rose 17 percent for the year, while Paulson’s gold investments jumped 35 percent in 2010.

Is 17 percent all that special?

The Globe and Mail might have a reasonable point regarding the scope of John Paulson’s success when it claims that the Paulson Advantage Plus Fund’s 17 percent gain isn’t all that different than the 15 percent gain experienced by the S&P 500. But the Canadian newspaper’s viewpoint could just as easily be considered sour grapes. While it may be true that John Paulson’s “against-the-bubble” investing strategy undermined the economy at the expense of millions, the investments were made in a Wild West-style climate where federal regulators were about as effective at cleaning up the town as the milk-and-cookies sheriff who hesitates before firing. Yet few except the excuse.

Sources

The Guardian

The Globe and Mail

Reuters

Wikipedia

John Paulson and Joe Stiglitz on the mispricing of risk

A former IBM executive was one of Danielle Chiesi's targets. Image from Flickr.

In the high-power, high-risk game of information trading, Danielle Chiesi has become  “a confirmation of all (people have) suspected is wrong with Wall Street and the hedge fund industry,” according to Fortune. Former IBM executive Bob Moffat and Danielle Chiesi have both been arrested and charged with securities fraud and conspiracy.

The story of Danielle Chiesi

Danielle Chiesi was an employee of the Galleon hedge fund, employed directly by Raj Rajaratnam, the founder of the fund. Danielle Chiesi traded mostly and primarily in information. As an information gatherer for Galleon, Danielle Chiesi maintained a “stable” of sources at companies that she was targeting for inside information. By targeting older men, wearing short skirts and low-cut shirts, and telling them all that “I love the three S’s, sex, stocks and sports” she was able to get inside stock information for her employer, says Fortune. A former beauty queen and sorority girl, Chiesi was well-known as a powerful seductress.

The crimes of Danielle Chiesi

While targeting and sleeping with lots of high-profile executives is not technically illegal, what she did with some of the information was. By gathering and passing on inside information about tech stocks, Chiesi was allegedly participating in insider trading. She has pleaded not guilty to charges of insider trading, and the trial is currently under way.

The effects of insider trading

Insider trading can be a very difficult crime to both prove and understand. The idea of the stock market and stock trading is that everyone is “betting” on stocks with the same information. When people get inside information from people who work at the company, they are able to buy or sell stocks before the information is public knowledge. In other words, people like Danielle Chiesi cheat the system. This is the same crime that Martha Stewart was convicted of. The story of Danielle Chiesi is most compelling because it proves that even the most quiet of tech execs can, under the right circumstances, give up information they know they are not supposed to. Is a financial system that can be gamed this easily one that we should be putting our money into?

It’s been a good year for scammers — or a bad year, depending on how you look at it. From Bernie Madoff to Sky Capital, people who bilk others out of their money are getting caught. You can add Raj Rajaratnam to that list now, as he was arrested yesterday and charged with four counts of conspiracy and eight counts of securities fraud.

Of course, Raj Rajaratnam couldn’t do it alone; it takes more than one person to conspire. Six people, including ex-directors at a Bear Stearns Cos. hedge fund were charged in the scheme, which federal prosecutors said involved insider trading. While regular Americans are just trying to scrape by with installment loans for bad credit, Raj Rajaratnam and his alleged partners in crime are accused of conducting a $20 million scheme.

Who is Raj Rajaratnam?

Raj Rajaratnam is a billionaire and the founder of the Galleon Group hedge fund. He was born in Sri Lanka, but moved to the U.S. in 1981. He is now the 236th richest American, though I doubt that will be true anymore after his trial Bloomberg.com says:

Prosecutors said they used wiretaps on the billionaire’s phone. “A number of the calls intercepted over the wiretap consist of Rajaratnam either providing, receiving, or seeking material nonpublic information about various publicly traded companies,” a complaint says.

Federal prosecutors say Raj Rajaratnam and his co-conspirators conducted the biggest ever hedge fund insider trading scheme.

Raj Rajaratnam and friends

The  other people accused in the insider trading scheme are Rajiv Goel, of Intel Capital, Anil Kumar, who was a director at McKinsey & Co., IBM Corp. executive Robert Moffat, Bear Stearns Asset Management official Danielle Chiesi and Mark Kurland, also from Bear Stearns. Bloomoberg.com says:

It’s the first time wiretaps were used to target insider trading, and the arrests show a new level of prosecutorial aggressiveness towards Wall Street. Tips came from insiders and others at hedge funds, investor relations firms, and companies including Intel, IBM, McKinsey, and companies whose shares were traded in the scheme.

In closing, I’ll leave you with the words of U.S. Attorney Preet Bharara, who wins the award for most obvious quote of the decade:

“Greed, sometimes, is not good.”