While everyone fell blindly in love with risky mortgages and housing over the past few years, one guy bet against it all and won big.

John Paulson earned $3.7 billion last year. That’s a pretty impressive number alone, but when you take into account that almost everyone else lost huge amounts of money in the market, it makes you think this guy is a genius.

Paulson, a hedge fund manager and founder of the Paulson & Company hedge fund, took a good look at the state of the financial universe in 2005 and didn’t like the way things were headed. When many of the big banks were slicing and dicing risky sub-prime mortgages to get substantial sales, he saw the whole thing was headed for a major collapse. He realized then what we are unraveling now. When thousands of potential home-owners easily get approved for mortgages they can’t afford, someone is going to pay for it. The New York Times explains exactly how he did it:

Paulson began betting that complex mortgage investments known as collateralized debt obligations would decline in value, much as Wall Street traders bet that shares will drop in price. In that case, known as shorting, they borrow shares and sell them, wait for the price to fall, buy the shares back at a lower price and return them, pocketing the profit.

To put it simply, hedge funds are very into this short-selling strategy where they ‘bet against’ a certain stock or bond, hoping it will fail. Paulson bet that a whole industry would fail and put up mucho dinero covering that bet. It paid off. Big time.

The key to this guy’s success was realizing that the bubble was going to burst soon. He could have drank the Kool-Aid and invested in mortgages along with everyone else. He probably would have made some good money at the time. But when Paulson went against the grain and held steady on it, he was writing his own legacy.

New York Times: Wall Street Winners Get Billion-Dollar Paydays, April 16, 2008