The Greatest Trade Ever


By Tim Hanson and Paul Elliott
April 13, 2010
ShareThisYou've likely heard of John Paulson by now. He's the hedge fund manager from Queens who personally pocketed $3.7 billion by the end of 2007 betting against subprime mortgages, the U.S. housing market, and companies such as AIG. His investments were so lucrative that Michael Lewis wrote a new book about it, and The Wall Street Journal's Gregory Zuckerman called it the "greatest trade ever."

We, however, aren't convinced. In fact, we're not even sure that Paulson's $3.7 billion profit will ultimately be considered his greatest trade ever. That's because he has a new fund, the Paulson Recovery Fund, which is now going long the same financial institutions he shorted to the brink just three years ago.

Seriously?
See, Paulson is no ideologue. In fact, he's the opposite: a pragmatic and savvy investor. And after playing the fall just a few short years ago, he's gone contrary to popular wisdom again. Now he's playing the theory that the world isn't coming to an end -- buying shares within the past year of Bank of America (NYSE: BAC), Citigoup (NYSE: C), Capital One (NYSE: COF), and Goldman Sachs (NYSE: GS).

Those bets are already paying off (the fund was up 17% in the first quarter overall), and we suspect that they will pay off even bigger over the long term. Paulson, after all, bought these financial behemoths when the rest of the world thought they were going under. And while they continue to work through some troubles, all have proved to be far more resilient than that.

Which brings us to Greece ...
We bring this up because we recently traveled to Greece, searching for short ideas not unlike those that made Paulson so much money in 2007.

Greece was in turmoil at the beginning of March. Its new government had disclosed that the country's debt -- at more than twice its GDP -- was higher than previously thought, and that the deficits it was running had put it wildly out of compliance with eurozone requirements. Furthermore, Athens was reportedly paralyzed by strikes of unions protesting proposed austerity cuts.

Not only was the country at risk of losing its currency, but commentators thought it might even default on its debt by the end of May. This is the type of stuff that's only supposed to happen in emerging and frontier markets, not developed economies like Greece.

We change our minds
When we got to Greece, however, we found a situation that didn't match our expectations. In no small part, that's because the smart money on the ground told us a different story. In cross-checking their stories with our own independent research, we came to believe they weren't just paying lip service to optimism.

First, we concluded that Greeks are more accepting of the government's austerity plan than most media outlets are reporting. We saw for ourselves first-hand that the "violent protests" that so spooked foreign investors were actually quite tame by Greek standards.

Second, we learned just how big a problem tax evasion is in Greece, and how the government plans to corral it. If it succeeds, Greece may be able to raise more public revenue than many anticipate.

Third, we heard the prediction weeks ago that despite the rhetoric coming out of Germany, the EU would ultimately step up to rescue Greece. This is precisely what happened over the weekend, with the EU pledging more than $40 billion to Greece should the country need it. No matter what you may read or hear, the political elites in Europe are committed to providing an economic safety net for Greece.

Finally, we got word from a contact on the trading desk at Proton Bank that while big institutions were pulling out of Greece, hedge funds and private-equity investors were calling daily looking for things to buy. These are the profit-obsessed "vultures" of the finance world who -- like Paulson -- are drawn to crisis like moths to a flame. They, like us, see opportunity in the country.

What this means for you
As a result, when it comes to Greece, we're now much more Paulson 2010 at Global Gains than Paulson 2007. In place of economic malfeasance and widespread panic, we found a country quietly committed to a new austerity plan and a financial solution within the European framework.

This doesn't mean Greece has an easy path. Just as Paulson's financials may struggle in a weakened U.S. economy, Greece may struggle to implement its austerity plan, crack down on tax evaders, and refinance its debt. Frankly, it will take years for Greece to get back on track, and its GDP and the value of its currency are both likely to decline in the meantime.

That said, opportunity exists for investors willing to wade into these volatile waters, because the expectations priced into the Greek market are overly pessimistic. The clock, however, is ticking.

The news of the EU's rescue package sent shares of Greek companies such as Coca-Cola Hellenic (NYSE: CCH) up sharply on Monday. However, many Greek stocks remain subdued, as skeptics get caught up on complicated details of fund disbursement. They may also be preoccupied by Fitch's downgrade of Greek bonds and banks such as National Bank of Greece (NYSE: NBG) -- though why anyone is still heeding ratings agencies, given their recent track record, is beyond me.

There may also be opportunity in some of the European banks, such as NBG, Deutsche Bank (NYSE: DB), and Credit Agricole, which have been sold off on the belief that they hold too much Greek debt on their balance sheets.

So we're looking to go long. At Motley Fool Global Gains, we've identified three trades investors can make to profit from the Greek crisis -- and we've written up our thinking on each in our newest Global Gains special report. Get a copy of that report, and read all about our three handpicked trades to profit from the Greek crisis, by joining Global Gains free for 30 days.

Tim Hanson is co-advisor of Motley Fool Global Gains. Neither he nor Paul Elliott own shares of any companies mentioned in this article. The Fool's disclosure policy should not be Greek to anyone.


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