In his 2009 book, The Greatest Trade Ever, author Gregory Zuckerman recounts how, in early 2006, Paolo Pellegrini, co-manager of the Paulson Credit Opportunity Fund, estimated that U.S. home prices would have to fall about 40% in inflation-adjusted terms in order to return to their long-run, pre-bubble trend. Pellegrini presented John Paulson with a chart depicting the gap, a picture that Zuckerman described as Paulson’s Rosetta Stone, and about which the now-famous hedge fund manager remarked, “I still look at it. I love that chart… it’s the first key piece of our research.” ¹

Emboldened by Pellegrini’s basic but compelling picture, Paulson and his team continued to challenge the conventional wisdom (e.g., the notion of a national housing market is silly because since “all real estate is local”, and thus home prices can never fall simultaneously or for the same reasons across local or regional markets) and became even more committed to a “short housing” strategy that eventually amassed a $15 billion profit for his firm and clients in 2007.

Gap analysis of those market segments that had disproportionately large numbers of homes financed with subprime mortgages (e.g., low price tier homes, Southern California) would have provided Paulson & Pellegrini even stronger sell signals than those they saw at the national level in early 2006.