1 Man, 1 Year: $3.7 Billion Payout

By David Cho
Washington Post Staff Writer
Thursday, April 17, 2008

The subprime mortgage mess that caused massive losses for homeowners and banks was a little kinder to hedge fund manager John Paulson. Betting subprime mortgage securities would sour, Paulson personally earned $3.7 billion last year.

Yes, you read that correctly. That's billion with a "b."

He wasn't the only one with Titanic-size profits. Two other fund managers, George Soros and James Simons, who are notoriously secretive about their investments, earned $2.9 billion and $2.8 billion, respectively, according to Alpha Magazine's annual list of top hedge fund earners.

The numbers left jaws agape across Wall Street and Washington. With his windfall from last year alone, Paulson could have bought troubled Wall Street giant Bear Stearns three times over. Or he could have matched the price Delta agreed this week to pay to merge with Northwest Airlines and still have $600 million left over.

A few years ago, individual income reaching into the billions of dollars was unfathomable. In 2002, the first year the magazine tracked hedge fund compensation, the top 25 managers earned $2.8 billion combined.

Paulson's feat was even more astonishing because he started 2007 managing $6 billion, not a massive pool of money by hedge fund standards. Over the course of the year, one of his funds earned a whopping 590 percent return, and another soared 353 percent, according to Alpha. By the end of December, his funds' assets were worth $28 billion.

He amassed his winnings by "shorting" securities linked to subprime mortgages. In a short sale, the investor borrows securities -- in this case, subprime mortgages that were widely held by banks, brokerages and other investors -- and sells them to another buyer. Later, the investor must buy those securities back and return them to the original lender. As the subprime market collapsed, the value of the securities fell, and Paulson was able to pocket the difference. The lenders were stuck with the losses.

Several hedge fund managers, including Philip Falcone, who has been challenging the board of the New York Times Co., also profited from the mortgage crisis by betting that subprime debt securities would plunge in price. Falcone earned $1.7 billion last year. Others made fortunes by betting that the prices of commodities such as oil, sugar and corn would rise.

Hedge funds are pools of private money, largely generated from wealthy individuals, pension funds and endowments, used for a wide range of investments. Usually 80 percent of any gains are given to such investors, while fund managers take 20 percent, plus an annual fee for their services. Alpha's list tracks the income that managers receive after paying their staff members and other expenses.

Some Wall Street analysts who follow the industry said the gigantic compensation figures may prompt Congress to consider raising taxes on the business. Last year, several lawmakers introduced bills aimed at raising the tax rate, usually 15 percent, that fund managers pay on their gains. None of these efforts became law.

"Washington is clearly aware of the numbers and has been following the billions of dollars that are being generated," said Michael Peltz, editor of Alpha.

Daniel Strachman, a former hedge fund consultant and author of several books including "The Fundamentals of Hedge Fund Management," was skeptical of raising taxes on hedge fund managers, saying they should be rewarded for taking huge risks. Most managers have their own money in their funds and suffer massive losses when their investments go bad.

"It's clear somebody has to win and somebody has to lose," he said. "It's not pretty at all because people say, 'Oh my God. Look how much money these guys are making while people are losing their homes and are complaining about the cost of eggs and sugar.' But so what? We don't live in a society that is pretty all the time. That's why it's capitalism."

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