Subprime Bets Made by 50 Hedge Funds, Greg Lippmann Told FCIC

Date: Thursday, January 27, 2011
Author: Jody Shenn, Bloomberg

Greg Lippmann, who gained fame for his bets against subprime mortgage securities, brokered wagers against the bonds to at least 50 hedge funds during 2006 and 2007, the former Deutsche Bank AG trader told the Financial Crisis Inquiry Commission.

The trades, made through credit-default swaps on low-rated securities that would pay off if the debt defaulted, may have been placed by as many as 100 funds, the panel wrote in a 545- page book outlining its conclusions set for release today.

Most of the opposite “long” bets were sold to UBS AG, Merrill Lynch & Co. and Citigroup Inc. “because they were the most aggressive underwriters” of collateralized debt obligations, Lippmann said in a May 2010 interview with the commission, according to the book. The banks retained much of the risk, the panel wrote.

Many of the buyers of the riskiest slices of mortgage-bond CDOs, which repackaged home-loan securities and related derivatives into new debt with varying risks, paired their bets with wagers that mortgages would default, according to the commission. Purchasers of the riskiest portions of mortgage bonds that weren’t placed into CDOs also often entered into “short” bets against home-loan debt, the panel said.

“These types of trades changed the structured finance market,” the commission said. The buyers of the most default- prone slices had traditionally worked to monitor the credit risk of the deals, so “it was no longer clear who -- if anyone -- had that incentive,” the FCIC said.

Lippmann, who co-founded hedge fund LibreMax Capital LLC last year, declined to comment.

In the second half of 2006, more than half of the “equity tranches” of CDOs were bought by hedge funds that also shorted other portions, according to the FCIC, which cited a survey of 170 managers. It was a “common strategy among medium-sized hedge funds,” according to the report.

The largest hedge funds by June 2007 held $25 billion of low-ranking tranches of mortgage bonds, as opposed to CDOs, and $45 billion in “short positions,” the survey found.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net