Itís War: Hedgies Go Head-To-Head With Banks

Date: Thursday, June 7, 2007
Author: Wall Street Journal

Ever since the subprime market fell out of bed, hedge fund traders savvy enough to short securities backed by iffy mortgage loans in advance have been making a fabulous killing. But the house party now could be over, as investment banks like Bear throw a lifeline to struggling homeowners and borrowers by snapping up these shaky mortgages.

Just a few months ago, bets against securities backed by shaky subprime-mortgage loans were among the most alluring trades on Wall Street.

But the market for those securities has since stabilized, potentially hurting those who bet against it, and left a messy squabble in its wake. A band of hedge-fund managers accuse Wall Street's Bear Stearns Cos. of attempting to manipulate the market for securities backed by subprime loans by purchasing shaky mortgages. Bear retorts that it has the right to repurchase mortgages and that sometimes it can help a struggling borrower. Meanwhile, an industry association that oversees derivatives trading has been drawn into the middle of the matter.

The confrontation provides a window into complex trading -- and complex ethics -- in the nation's mammoth mortgage market, which played a critical role in financing the housing boom.

Hedge funds might not win much sympathy for making indirect bets against the financial health of struggling homeowners. But they say they are trying to protect the integrity of a burgeoning derivatives market that stands at the center of the controversy. The episode also shows the complicated relationships between hedge funds and the investment banks, which trade with them and often fund them.