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By GREGORY ZUCKERMAN And LIAM PLEVEN

Mr. Ward’s Armajaro Holdings Ltd. shook up the commodities market in July by buying a $1 billion cache of cocoa, enough to make 15 billion Hershey’s milk-chocolate bars. But since Mr. Ward made his audacious bet, cocoa prices have dropped 26%.

Two hedge funds run by Armajaro, including its CC+ Fund, which focuses on cocoa and coffee, lost about 6% of their value during the first two weeks of August, according to investors who have viewed the returns. And since then, prices have continued to decline, suggesting Mr. Ward could be coming under more pressure.

It isn’t certain the drop in cocoa is to blame for the recent losses. And some analysts say the recent decline in prices may be short-lived. An Armajaro spokesman declined to comment.

The funds remained up about 12% on the year through the middle of August, the investors say.

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A Wager by Fairfax Financial Risks $174 Million. If Deflation Arrives, It Could Be Worth Billions.

By GREGORY ZUCKERMAN

A Canadian insurer is turning to a seldom-used strategy to make a big wager on falling prices over the next decade.

Greg Zuckerman discusses a Canadian insurer that has wagered on derivatives that profit from a decline in consumer prices.
As more investors worry about the possibility of deflation—or a sustained period of falling prices that could cripple stocks—Fairfax Financial Holdings Ltd. has spent nearly $200 million to buy derivative contracts wagering on a decline in the consumer-price index, an inflation indicator. The trade could lead to huge profits if deflation occurs.

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Paolo Pellegrini, the investor who helped hedge-fund manager John Paulson score more than $15 billion of profits betting against risky mortgages, is returning money to clients of his own hedge fund after suffering losses this year.

Mr. Pellegrini’s PSQR Capital has lost about 11% so far in 2010, according to a person close to the matter. The decline included a drop of about 8% in July, after bets against U.S. Treasurys and other moves went awry. The loss has made it more difficult for him to raise cash from investors.

Mr. Pellegrini’s fund gained more than 61% last year, and he had hopes of growing the firm, which he launched after leaving Paulson & Co. But investors have proved reluctant to place money with midsize hedge funds over the past year. The decision was reported by AR Magazine.

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Ever wonder how someone could earn four billion dollars in one year? Find out at Wellesley Booksmith on June 10 at 7 p.m. and hear what Wall Street Journal Senior Writer Gregory Zuckerman, author of “The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History,” has to say.

Zuckerman’s book depicts the evolution of hedge fund megastar John Paulson’s massive payday resulting from his timely bet against sub-prime mortgages when housing prices appeared to have a one-way ticket to the moon . Zuckerman’s portrait of the colorful gallery of individuals who won and lost as a result of the housing meltdown makes the book a compelling read even for financial novices.

“The Greatest Trade Ever” has recently received renewed attention amidst the SEC’s allegations regarding Goldman Sachs role in Paulson’s trades. Who thought a book about the hedge fund industry could be a page- turner?

Space is limited, so reservations requested. Call 781-431-1160; events@wellesleybooksmith.com. The event will be downstairs at Wellesley Booksmith, 82 Central St.

By Gregory Zuckerman and Jenny Strasburg

John Paulson hasn’t been accused of any wrongdoing. But the hedge-fund billionaire has gone on the offensive to reassure investors that his huge firm will emerge unscathed from a case that has drawn him into a political and legal vortex.

The steps, including a conference call with about 100 investors late Monday, come amid indications from some clients that they might withdraw money from his firm after a lawsuit brought by the government against Goldman Sachs Group Inc. related to an investment created at his firm’s request.

Investors have indicated they are concerned that scrutiny over the firm’s deals may spread, including to overseas regulators. They said they wanted to protect themselves in case new information emerges that could damage the hedge fund, they say. Another issue, they say: The legal case could simply prove a distraction for Mr. Paulson.

“Some of the callers asked pointed questions, almost like a court inquisition, but most people were supportive,” said Brad Alford, who runs Alpha Capital Management. “I felt reassured that he did nothing wrong.”

“It’s not a rush for the doors,” said another investor in Paulson & Co. who has communicated with larger Paulson investors since Friday, when the government unveiled its Goldman case.

Mr. Paulson sent a letter to investors Tuesday night saying that in 2007 his firm wasn’t seen as an experienced mortgage investor, and that “many of the most sophisticated investors in the world” were “more than willing to bet against us.”

Mr. Paulson’s firm focuses on largely liquid investments, those relatively easy to sell without pushing prices much lower. Even if a number of investors ask out, the firm likely will be able to sell investments without crippling their holdings, investors say.

Some traders have been examining Mr. Paulson’s top holdings and positions in which filings indicate he has been a substantial holder since the news, they say. When the news of the lawsuit broke on Friday, some of these stocks, including Conseco Inc., Cheniere Energy Inc. and AngloGold Ashanti Ltd., fell sharply.

The case has delayed the initial public offering of a Canadian investment fund, Propel Multi-Strategy Fund, formed to give investors exposure to two funds advised by Paulson, according to people familiar with the offering. Propel didn’t respond to requests for comment.

On the Monday night conference call, some investors asked if Mr. Paulson or anyone at the firm had received a government notice of potential civil charges, called a Wells notice, according to people familiar with the call.

Mr. Paulson said no. Mr. Paulson said the case wasn’t a distraction that was affecting the firm’s investments, and that he was confident the public glare would abate.

On the conference call, Mr. Paulson calmly explained the trade with Goldman, which involved a “short” bet on mortgage bonds. He said that the very nature of the transaction required both a “long” and “short” investor, suggesting that investors knew that a bearish investor had bet against the deal.

Mr. Paulson suggested to clients that the large investors who purchased the Goldman deal and others relied on rating firms, and didn’t do enough of their homework, investors say.

The hedge-fund firm has a deadline next Friday for investors who want to withdraw money on June 30. Paulson allows most investors to pull out four times a year, but they need to give at least 60 days notice. Investors can cancel redemptions before the end of June.

Magnetar Capital LLC, another hedge-fund firm that, like Paulson, was heavily invested in collateralized debt obligations in 2007 also has been working to reassure investors that it believes its mortgage-linked investment strategy was sound and can withstand regulatory scrutiny.

Investors in Magnetar, which oversees some $7 billion in assets, also have a deadline next week to request June withdrawals of money. The Evanston, Ill.-based firm sent an 11-page letter to investors Monday saying that it didn’t control which individual assets went into CDO deals in which it invested.

It isn’t clear whether scrutiny of Magnetar will rattle its investors, who have known some details of the firm’s strategy for several years. An article this month in news outlet ProPublica was the latest to assert that Magnetar designed deals built to fail that caused cascading losses for investors on the other side of the trades. The hedge fund’s strategy was the subject of a Jan. 2008 Wall Street Journal article. Magnetar told investors this week that it based its mortgage-CDO strategy on statistical models, not a fundamental belief that the housing market would slide.

A Magnetar spokesman said, “Our communications with investors have been very positive and supportive.”

—

Stephen Grocer and Ben Dummett contributed to this article.

By Gregory Zuckerman and Serena Ng
Of THE WALL STREET JOURNAL

Paolo Pellegrini, a former top executive at hedge-fund Paulson & Co., told investigators at the Securities and Exchange Commission that he had informed ACA Management LLC that his firm was betting against the transaction at the center of a lawsuit the SEC brought against Goldman Sachs Group Inc. (GS), according to a person familiar with the matter.

The testimony, in late 2008, could undermine the government’s case against Goldman, which is accused of misleading ACA, the deal manager, about Paulson’s bearish position on the deal.

Pellegrini and the Paulson team worked with both Goldman Sachs and ACA to structure the deal.

(This story and related background material will be available on The Wall Street Journal Web site, WSJ.com.)

SEC spokesman John Nester said, “Our case is built on a thorough evidentiary record that includes testimony, documents, handwritten notes and emails that will be presented in court at the appropriate time.”

Details of Pellegrini’s testimony were reported earlier by CNBC.

The SEC in its complaint alleges that Goldman “misled ACA into believing” the Paulson firm “shared a long interest with CDO investors.” Goldman has denied wrongdoing and is fighting the charges.

ACA Management, an asset-management company set up under the umbrella of bond insurer ACA Financial Guaranty Corp., earned fees for overseeing investment portfolios of mortgage securities, corporate loans and other credit assets. Goldman engaged the firm when Paulson approached it looking for a way to extend its bearish bet on the housing market, the SEC complaint alleges. The CDO management business at ACA was headed by Laura Schwartz, a former Merrill Lynch investment banker who previously worked in divisions of the bank that originated securities backed by U.S. subprime loans and commercial mortgage debt.

Ms. Schwartz was a main point person in the discussions between ACA and Goldman and was at an early 2007 meeting with representatives of Paulson and Goldman, according to Goldman’s responses to the SEC’s “Wells” notice of possible civil charges, regarding the issue. After that meeting, Ms. Schwartz emailed a Goldman employee to ask for feedback on the meeting and said she wasn’t clear about how Paulson wanted “to participate in the space,” the Goldman papers said.

Ms. Schwartz, when reached on her cellphone, did not stay on the line. She no longer works for ACA. A representative for ACA Financial didn’t comment.

Last fall, when Goldman responded to the SEC’s Wells notice, the securities firm argued that whether ACA perceived Paulson to be the so-called “equity” investor in the CDO–and therefore having a “long” position–was “of no moment.” ACA, Goldman has argued, was supposed to be an independent expert on selecting mortgage assets.

Goldman argued in documents it submitted to the SEC that Ms. Schwartz, who was deeply involved in selecting the assets for the Abacus deal, should have known from previous ACA-managed deals that hedge funds could have both long and short positions in a CDO. Goldman cited an ACA-managed CDO that closed in late 2006 whose equity investor was a hedge fund called Magnetar Capital that also took short positions in the same deal. “Certainly, ACA could have questioned Paulson about its interests if the information was significant to it,” Goldman’s Wells response to the SEC said.

At ACA, Ms. Schwartz’s roles included reviewing and approving securities that would be part of investment pools the firm oversaw. In presentations to investors, she often talked about her extensive experience analyzing residential mortgage-backed securities and ACA’s expertise and ability to select mortgage securities, according to people familiar with the matter.

ACA Management managed CDOs put together by several Wall Street firms including Bear Stearns Co. and UBS AG (UBS), according to records reviewed by The Wall Street Journal. At the end of 2007, ACA Management was overseeing around $19 billion in CDOs, the bulk of them bundles of mortgage-backed or asset-backed securities. Of about 30 CDOs managed by ACA, more than half were issued during 2006 and 2007, according to the company’s financial statements.

The man who wrote the book on Paulson
JOANNA SLATER
19 April 2010
The Globe and Mail

NEW YORK — Gregory Zuckerman is a senior writer at The Wall Street Journal and author of The Greatest Trade Ever: The Behind-the-scenes Story of How John Paulson Defied Wall Street and Made Financial History.

Thanks to a huge and successful bet that the U.S. housing market would crumble, John Paulson’s firm, Paulson & Co., made $15-billion (U.S.) in 2007. He personally took home $4-billion (U.S.).

Here, Mr. Zuckerman speaks about the controversial 2007 deal that made Paulson & Co. $1-billion and prompted the Securities and Exchange Commission to file civil fraud charges against Goldman Sachs Group Inc. on Friday.

In your book, you describe some of the exact transactions that have now landed Goldman in hot water. How did you hear about them?

Covering the story at the Journal I heard rumblings and complaints for over a year. All kinds of competitors levelled accusations. There were investment bankers, at some of the top firms on the street, who criticized [Paulson] behind the scenes. So there was a lot of smoke – so I figured there must be some fire as well.

Many of the accusations were blatantly wrong. I got to the point where I was comfortable reporting what had happened. Then there’s the question: Was there something improper or not? I’m of the belief that it’s a really fascinating grey area. Especially for Paulson, one can level criticism and there may be some ethical issues, but it’s much harder to say it’s illegal.

You wrote that not every bank was willing to do these kind of deals. So why some and not others?

The ironic thing is that at Bear Stearns, of all places, a senior banker there turned Paulson & Co. down. They may have had some notion of how it might look on the front pages, which is what Goldman Sachs is seeing right now. Clearly, selling these deals to investors is a whole other level than what Paulson did, which was going to the banks and asking them to create this … paper.

You also have to remember what the period was like back then. This was late 2006, early 2007, when people still thought that John Paulson was tilting at windmills, that he was a merger-arb [specialist] who didn’t know that much about real estate. Now we look back and say, “How do you not warn investors that Paulson had a role in creating these things?” At the time, even if he told investors, I’m not sure how many of them would have run the other way.

Some reviewers have said you’re too nice to Mr. Paulson in the book.

I don’t see him as either as a hero or a villain. He’s a great character to me and I love great characters. I’ve been accused of lionizing John Paulson, but he has condemned the book and won’t speak with me … If some people think he was unethical I can understand that view. Other people think he did nothing wrong whatsoever. I’m open to that argument as well. I don’t think it’s my job to shove an opinion down the throat of my reader.

You can argue that he should have been satisfied in betting against billions of dollars of potentially dangerous mortgages and he shouldn’t have taken the step of going to various investment banks and asking that they create more products so he could short them. By the same token, he didn’t sell any of the stuff to investors.

Yes, more toxic mortgage assets were created because of John Paulson and his team, but someone had to be on the other side. These were big boys and sophisticated investors, and [Paulson] had no obligation whatsoever to tell them not to take the other side of this trade. Paulson was very, very focused on making a lot of money from what he saw as a coming collapse of the mortgage market. I don’t believe they saw [these deals] as improper.

Do you think more investigations connected to similar deals will be forthcoming?

You would think so, because this was one of many that John Paulson and his team entered into and that other hedge funds also worked on. I know there are lists of CDOs that [regulators] have been examining since late 2008, if not earlier, so they clearly have been digging into all this stuff. It could be this one was the worst.

In the book, you profile others who also bet against the housing market, including some little-known investors who made huge profits. What did these people, John Paulson included, have in common?

It’s just startling to me, and remarkable, that the experts who should have known better got it wrong and it’s these outsiders who made the most money: John Paulson, who was a merger-arb [specialist]; Paolo Pellegrini, who just a couple of years before doing this trade was living in a one-bedroom apartment with no money in the bank and no job; Michael Burry, a doctor-turned-investor, who knew stocks, but didn’t know anything about mortgages.

It took some outsiders to figure out that a historic collapse was coming. In some ways it gives all of us encouragement that maybe we know a little bit more, and have a little bit more of a perspective than perhaps those on Wall Street, the so-called experts.