At the center of the transactions described in the government's fraud case against Goldman, Sachs & Co. is New York hedge fund operator John Paulson, whose firm made $15 billion in 2007 by betting that Americans would default on their home loans in droves.
Paulson later teamed up with some fellow billionaires to buy one of the biggest failed specialists in nontraditional mortgages, IndyMac Bank, from the government. The group recouped its $1.55-billion investment in the Pasadena savings and loan in less than a year.
Paulson, 54, a Harvard MBA whose personal wealth is estimated at $12 billion by Forbes magazine, is not a defendant in the civil lawsuit filed Friday by the Securities and Exchange Commission. The action accuses Goldman Sachs and one of its employees of costing investors $1 billion by deceptively selling them complex mortgage investments.
Ultimately, though, the biggest beneficiary of the transactions was Paulson & Co. The SEC's complaint, filed in federal court in New York, said the hedge fund first helped to pick the mortgage bonds that were bundled into the complex securities and then profited to the same extent the other investors lost, pocketing $1 billion, by betting against the very mortgages that burned the investors.
The SEC said it was improper not to tell the investors that they'd purchased securities assembled for Goldman Sachs by people who had then shorted the same investment.
In a statement, Paulson & Co. said it "is not the subject of this complaint, made no misrepresentations and is not the subject of any charges."
It acknowledged having bought "credit protection" on the securities from Goldman Sachs -- essentially insurance that paid off when the securities lost value and were downgraded by credit rating agencies.
But, Paulson & Co. added, "we were not involved in the marketing" of the mortgage-backed securities and thus not involved in any misrepresentations that may have taken place.
During a news conference, SEC enforcement director Robert Khuzami responded to a question about Paulson's role by saying: "Look, we charged those that we feel appropriate."
"It was Goldman that made the representations to investors," Khuzami said. "Paulson did not."
Goldman Sachs denied wrongdoing, saying the securities underlying the investment were chosen in a typical way. Along with Paulson, the investors -- ACA Capital Management and the German bank IKB -- provided input in choosing the securities, Goldman Sachs said.
It added that it was "normal market practice" not to disclose to ACA, the buyer, that Paulson was taking the other side of the bet on the investment.
Paulson launched his hedge fund in 1994, often investing in corporate mergers. He's now famous for sticking to his bets on the mortgage meltdown, which ran counter to conventional wisdom when he began placing them in 2005, said Thomas Whelan, chief executive of Greenwich Alternative Investments, a Connecticut firm that advises investors on hedge funds.
"He was negative on the housing market way before anyone else, and he lost money at first. But he stuck by his guns," Whelan said. "John has the ability to see the forest despite all the trees."
Paulson is now making bets that interest rates will someday rise sharply, Whelan said.
Paulson, who is not related to former Treasury Secretary Henry M. Paulson, teamed up with fellow hedge fund operator George Soros, computer baron Michael Dell and other billionaires to buy IndyMac from the government in early 2009.
At the time, the banking industry and economy were so battered that the Federal Deposit Insurance Corp. had taken eight months to find a buyer for the failed savings and loan, which had attracted yield-chasing depositors with high-interest certificates of deposit while writing risky mortgages without requiring borrowers to provide pay stubs or tax returns.
The thrift, renamed OneWest, turned a profit of $1.57 billion last year for the investors -- more than the new capital they provided to revitalize the savings and loan under their agreement with the FDIC.
In a book about investors who profited when the housing bubble burst, "The Greatest Trade Ever," Wall Street Journal reporter Gregory Zuckerman elevated Paulson to the same lofty heights as investment mega-stars Soros and Warren Buffett.
Paulson's investments "also made him one of the richest people in the world, wealthier than Steven Spielberg, Mark Zuckerberg and David Rockefeller Sr.," Zuckerman wrote.
The SEC suit helps to explain how that came about.
Times staff writer Nathaniel Popper contributed to this report.