Paulson & Co. signed up last year with the three main providers of so-called first-loss funds to pursue the wagers, according to a March regulatory filing. These deals with Topwater Capital, Prelude Capital Management and Boothbay Fund Management allow Paulson to lever-up his own capital many times over after he squandered much of it on wrong-way bets. 

Here’s how first-loss works: Managers like Paulson put their own money into an account within a first-loss fund, and any of the three firms contribute nine times as much from their investors. Managers get to keep about 55 percent of the trading profits, more than double the standard industry cut.But should the strategy go awry, all of the losses come out of their invested capital until it’s gone.

“The upside, if you do well, is good,” said Karl Cole-Frieman, whose law firm advises hedge funds on seeding deals and other structuring issues. “The downside, if you do poorly, is disastrous.” […]