Paulson & Co., the $23 billion hedge fund whose founder John Paulson is seeking to recover from record losses last year, said Greece may default by the end of March, triggering the breakup of the euro.
Greece may need an unprecedented 90 billion euros ($117 billion) to meet funding requirements under the anticipated agreement on private sector involvement, the recapitalization of the banks and other funding needs, Paulson estimated in a year-end letter sent to clients this month.
“We believe a Greek payment default could be a greater shock to the system than Lehman’s failure, immediately causing global economies to contract and markets to decline,” the hedge fund said in the letter, a copy of which was obtained by Bloomberg News. The euro is “structurally flawed and will likely eventually unravel,” it said.
Two years after pledging to pull Greece back from the brink, European leaders are torn between pouring more aid into the country or risking an unprecedented national bankruptcy that might force the nation out of the euro and spur renewed market turmoil.
“It seems likely that the pressure to keep the euro together becomes too great and it ultimately falls apart,” Paulson said in the 100-page letter. The firm said its biggest concern are European banks, which have borrowed more than their U.S. counterparts and don’t have enough equity to withstand a credit crisis.
Paulson, who became a billionaire in 2007 by betting against the U.S. subprime mortgage market, lost 51 percent in one of his largest funds last year as his wagers on a U.S. economic recovery went awry. He sold his entire stakes in Citigroup Inc. and Bank of America Corp. last quarter before the shares rallied this year.
“Bank of America has been the biggest disappointment in our banking portfolio,” Paulson said.
The holdings, which he began aggressively building in 2009, were among his largest last year.
“While we have seen a reasonable recovery in the U.S. with leading indicators in early 2012 trending positive and equity valuations well below historical norms, the European sovereign debt crisis remains the overriding risk in the markets,” the hedge fund said.
As a result, Paulson said it cut its so-called net exposure in its Advantage funds, which are among the firm’s largest, to 32 percent as of Jan. 31 from 82 percent at the start of last year. Those funds seek to profit from corporate events such as takeovers and bankruptcies.
Demand for Gold
Armel Leslie, a spokesman for New York-based Paulson, declined to comment on the letter.
The hedge fund reiterated its view that government spending around the world will fan inflation, supporting demand for gold and that now is the time to invest in the metal.
“By the time inflation becomes evident, gold will probably have moved, which implies that now is the time to build a position in gold,” the hedge fund said, adding that it expects the price differences between bullion and gold miners to narrow this year.
Paulson said it expects continued market volatility and the European debt crisis to affect merger activity in 2012. The firm said it still sees opportunities for investment gains in Motorola Mobility Holdings Inc., which Google Inc. is planning to acquire, as well as AMC Networks Inc., Ralcorp Holdings Inc. and Delphi Automotive Plc.
Paulson started 2011 expecting an increase in mergers and acquisitions, a position that cost the Paulson Partners Enhanced Fund, which invests in shares of merging companies and lost 19 percent last year. Heightened price swings affected the firm’s positions in takeover targets, Paulson said.
Paulson partners’ capital in the firm’s credit funds climbed to 69 percent at the end of last year from 57 percent at the end of 2010, while the portion of outside investor money dwindled after the Credit Opportunities Fund fell 18 percent in 2011. Paulson reduced its credit exposure, which includes investment-grade corporate bonds, high-yield and distressed securities, because risks related to the European debt crisis remain, the firm said.