Friday, June 01, 2007

Funds attack banks’ aid for subprime borrowers

Funds attack banks’ aid for subprime borrowers
By Saskia Scholtes in New York
Copyright The Financial Times Limited 2007
Published: May 31 2007 22:10 | Last updated: May 31 2007 22:10

Hedge funds are attacking bank decisions that help delinquent US mortgage borrowers remain in their homes in a move that pits some of the country’s richest people against its least well-off.

The dispute centres on derivatives contracts that pay money to investors when bonds backed by subprime mortgage loans – extended to people with past credit problems – run into trouble. The $1,200bn (€890bn) US subprime mortgage bond market has been hit recently by rapidly growing defaults, and hedge funds have profited from the crisis by buying such derivatives.

Some hedge funds say they are concerned that banks that both sell the derivatives contracts and handle mortgage payments could be involved in a form of market manipulation. The funds fear that banks are making concessions on the underlying mortgages to avoid making good on derivatives contracts that pay off in cases of default.

The controversy pits hedge fund interests against those of stretched US mortgage borrowers and politicians who want to help them keep their homes, underscoring the political dilemmas created by the growth of the mortgage bond market

A group of more than 25 funds has asked the International Swaps and Derivatives Association, the derivatives industry body, to act on their concerns, according to a letter seen by the Financial Times.

“ISDA should actively promote an industry solution that assures market participants that no one can engage in practices that are manipulative and prohibited by existing securities laws,” the funds said. ISDA declined to comment.

The hedge funds’ concerns centre on loan modifications that are often used to help overextended borrowers keep up with payments. In such cases, 40 per cent of the modified loans fall back into arrears within a year, credit analysts say.

Yet, these changes do not automatically trigger write-downs on the bonds, which would result in a payment to purchasers of the credit-insurance derivatives.

One member of the group that wrote to ISDA said the hedge funds were not trying to force subprime borrowers from their homes – just to make sure that banks were keeping the interests of their trading desks and their mortgage arms separate.


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