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Paulson & Co. push subprime bets

In our last post, we talked about T. Boone Pickens' plans to create a Texas water pumping district and a water transport pipeline, whose right of way will be pieced together with the help of eminent domain laws.

Today, we'll focus on another hedge fund manager who may take advantage of some helpful legislation. Legislation that, if passed, could aid his short positions in the subprime market.

We posted an interesting profile on John Paulson and the outperformance of the Paulson Credit Opportunity Fund back in September. For those of you who haven't seen it yet, give it a read. You'll find an excellent interview in which Paulson discusses the firm's highly rewarding subprime bets.

Having successfully positioned themselves this past year on the short side of the subprime mortgage bond market, Paulson & Co. has recently announced that it has scaled back its bets against subprime backed securities.

Details from Bloomberg:

Paulson & Co. scaled back bets against subprime-mortgage securities, recording investment profits that helped the New York-based hedge-fund manager double assets to $24 billion this year.

``We felt it advisable to lock in most of the gains'' in its merger and corporate event-driven funds, the firm said in a third-quarter report to investors obtained by Bloomberg. Paulson cut holdings of securities linked to subprime home loans by 86 percent across its eight funds in those two strategies.

The firm told investors it expects more profits as home prices decline and delinquencies soar. Its Credit Opportunities funds, with about $8 billion in assets, kept subprime-related ``short'' positions to benefit from that forecast, according to a second report to clients of the credit funds.

Still, as Bloomberg reports, the Credit Opportunites funds have kept some of the subprime short positions on, as Paulson & Co. still expect to see further home price declines and rising delinquencies.

Now here's where the legislation and political angles come in. You may recall that back in October, Paulson & Co. were in the spotlight for giving $15 million to "borrower advocates" who were "backing bankruptcy legislation that would further reduce the value of subprime loans".

It seems that the legislation these groups were advocating would allow bankruptcy judges to forgive mortgage debt exceeding the value of a home, and this change would further devalue securities backed by the loans of subprime borrowers.

These are the class of securities that Paulson & Co. correctly and profitably shorted earlier in the year and of which they remain short (with their scaled back position).

You can read more about this in Bloomberg and BusinessWeek's articles on the subject.

Are Paulson & Co. just providing a service to homeowners in need of legal assistance, or are they shrewdly positioning themselves to profit more quickly from homeowner defaults and debt forgiveness? Tell us what you think.

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