1. Paulson learned housing prices had climbed 1.4 percent from 1975 to 2000, after inflation, but had soared 7% from 2000 to 2005, a 40% margin of Housing price correction. Paulson bet the Housing price would experience and down turn and he profited $4 billion from his prediction.

2. In 2007, Paulson and Company made $15 billion. Paulson bet the housing market would turn. Paulson started buying Credit Default Swaps (CDS) insurance policies. Paulson believed the CDS premiums would raise as Mortgage defaults increased and he would sell the CDS at a profit. Paulson was willing to lose 8% a year to buy the Insurance policies. By 2006, Paulson had managed to raise $147 million and launched his fund. Paulson met bankers at Bear Stearns, Deutsche Bank, Goldman Sachs and asked them to create securities called collaterized debt obligations (CDOs) that Paulson Company could wager against. The banks would sell CDOs to clients that thought the assets would appreciate and Paulson bought CDS on the mortgage betting the assets would fall. Paulson could wager a $1 billion that the mortgage backed securities would fall. Paulson worked with the banks to short CDOs. The Hedge fund was the impetus for the CDO transaction being sold to the investor.

3. Paulson Company eventual had $5 billion worth of bets against CDOs valuations. Months later Paulson had profited $4 billion by himself. One of the biggest loser was Deutsche bank.

4. By the middle of 2009, one in ten American were delinquent or in foreclosure. Housing prices had drop 30 to 40 percent from their 2006 peak price. Paulson analysis proved correct, housing prices had dropped 30/40 percent because of overvaluation.

5. Paulson realized, the next area of profit was the declining dollar. Paulson realized the supply of dollars had increase 120%, a sure prediction of a drop in value, and eventual surge in inflation. Paulson started to buy billions of dollar worth of Gold and bet against the dollar. The biggest force pressuring Bond yields to move upward is the trillions of dollars the Treasury has to sell to finance the 2009 budget. Reserve assets, such as treasuries are accumulated in good times (yield downward) and sold in bad times (yield upward). Bond Yields climb during bad economies. Money supply has increased to $3,818 Billion / 262 Billion = 15-Fold Increase in US monetary base since 2008. Soaking up the liquidity will be impossible because Bond price is declining and yield is increasing. The Fed will find it impossible to sell the bonds and withdraw the dollars in the Money Supply.

How Hedge Funds profit from CDS?

1. The Hedge funds wanted a way to bet against the housing market, believing Housing prices would decline and they could profit by selling short. The Hedge Fund started the plan by working with the Banks buying insurance against collaterized debt obligations, risk. The Bank sold the hedge fund an insurance policy called a credit default swap (CDS) to insure against CDOs losses. If the housing market declines and affects the CDO yield, the Bank pays money to the hedge fund.

Two scenarios could happen: (Hedge Fund Wins) The Hedge fund profited when the housing market declined by claiming money from the CDS insurance policy given by a cash payout by the bank. Or, (The Bank Wins) ,if the housing market prices remained stable or increases. The insurer profits from the insurance premium paid by the Hedge Fund.

2. A collateralized debt obligation (CDO) is a redistribution of credit risk. The CDO is a portfolio of securities in the form of bonds with different ratings according to how safe they are. Bond safety is determined by risk against default. The safety of the bond is called a tranche. The CDO Tranches are then sold too Tranche A to pension funds, Tranche B to mutual funds, and Tranche C to hedge funds. The CDO portfolio, payouts a specific yield amount each year, in interest payments.

If the securities contained in the CDO have zero defaults then CDO value is 100 percent safe bond collection. If a percentage of the CDO default then there is less confidence in the safety of the CDO bond collection and a lower rating would be assigned by the rating agency.

What happens when a CDO experienced yield shortage? The CDO pays out on both principle payment and interest payment dependent on the terms of the financial instruction. A reduction in income will produce less money for the investors. The difference would have be paid by a CDS payout. The CDS premiums would increase as the risk of default increases. In the case of the Hedge fund when the CDO experienced yield shortage the difference came in the form of a CDS payout.

3. Deutsche bank created offshore companies known as collateralized debt obligations (CDO). The offshore companies holding CDOs is called static residential CDO.

4. In 2005, AIG acquires mortgage risks held by START, earning $10 million for every $1 billion insured (CDS). An unlimited number of CDS can be written on a debt obligation (CDO). The bank transfer its insurance risk too AIG. In essence, AIG was betting the housing market would remain stable and CDOs would not default.

5. When AIG credit rating was cut then AIG paid out $800 million too START.

6. Money moved from AIG too START, too Deutsche bank, and too the Hedge funds (CDS payouts).

7. AIG runs out of money and the government must provide $170 billion in bailout funds to prevent bankruptcy and owns over 80 percent of AIG.

Why did Credit Default Swaps (CDS) outstanding grow so quickly?

1. The Financial Times reported they grew from $34.8 trillion to $62 trillion outstanding in a single year, 2008.

2. Structured credit and Collateralized Debt Obligations which use CDS for credit enhancement slowed considering in 2007. The increase in CDS growth catches the attention. Companies adjust their risk exposure by trading into CDS contracts. International Swaps and Derivatives Association celebrated Over-the-counter derivatives equaling $455 trillion at the end of 2007.

What would I like?

I would like a book written called, "Why Are we so clueless about the Bond Market?"