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Thread: weekend commentary - economic 'warfare' between banks and hedge funds re foreclosures

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    Default weekend commentary - economic 'warfare' between banks and hedge funds re foreclosures

    (snip)"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 (EU890bn) 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.
    "(snip)


    IMHO this is bad news for troubled mortgage-holders, as banks are going to be under pressure / scrutiny NOT to renegotiate even if bank management was inclined to do so in order to avoid foreclosure upon houses that they don't want and can't sell. The pressure is due to the fact that, for the first time, declaring a mortgage in default now triggers bank payoffs on credit default contracts as well as triggering write-off of the mortgage losses themselves.

    IMHO this is even worse news for banks that have lent heavily for mortgages, since the hedge funds call to enforce Securities Laws could force the banks to take a double whammy ... the immediate foreclosures and write-off of the belly up mortgages which will hit the bank's bottom line, as well as forcing those same banks to pay off on the mortgage default contracts the banks previously sold to the hedge funds which will hit the banks' bottom line a second time.

    IMHO there will only be two groups of 'winners' to come out of this conflict. The first is obviously the 'qualified investors' (i.e. people with over $1 million dollar net worth) who participate in the hedge funds, who will profit immediately. The second is bargain hunters looking to purchase housing on the cheap, who will profit a year or two down the road as more and more foreclosed homes are added to the already large pool of homes on the market that remain unsold.

    The 'bears' out there have mentioned the distinct possibility that this upcoming double whammy has the potential for sending some banks themselves into bankruptcy and/or issuing a fresh call for a gov't bailout of the banks a la the 1980's S&L crisis (with associated tax increases to pay for the bailout).


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    Last edited by Melonie; 06-02-2007 at 03:52 PM.

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    Default Re: weekend commentary - economic 'warfare' between banks and hedge funds re foreclos

    and it would appear that there is a powerful third party which will be involved in this 'battle'. If hedge funds are successful in having Securities Laws enforced re banks holding large amounts of mortgages that are technically in default but have yet to be declared as being in default, the holders of mortgage backed CDO's sold by these same banks could wind up taking huge losses !!!




    (snip)" June 1 (Bloomberg) -- Bear Stearns Cos., the fifth-largest U.S. securities firm, is hawking the riskiest portions of collateralized debt obligations to public pension funds.

    At a sales presentation of the bank's CDOs to 50 public pension fund managers in a Las Vegas hotel ballroom, Jean Fleischhacker, Bear Stearns senior managing director, tells fund managers they can get a 20 percent annual return from the bottom level of a CDO.

    ``It has a very high cash yield to it,'' Fleischhacker says at the March convention. ``I think a lot of people are confused about what this product is and how it works.''

    Worldwide sales of CDOs -- which are packages of securities backed by bonds, mortgages and other loans -- have soared since 2003, reaching $503 billion last year, a fivefold increase in three years. Bankers call the bottom sections of a CDO, the ones most vulnerable to losses from bad debt, the equity tranches.

    They also refer to them as toxic waste because as more borrowers default on loans, these investments would be the first to take losses. The investments could be wiped out.

    Fleischhacker, 45, says she doesn't associate toxic waste with the equity tranches she's selling. Pension funds in the U.S. have bought these CDO portions in efforts to boost returns.

    Many pension funds, facing growing numbers of retirees, are still reeling from investments that went sour after technology stocks peaked in March 2000. Fund managers buy equity tranches, which are also called ``first loss'' portions, even though those investments are never given a credit rating by Fitch Group Inc., Moody's Investors Service or Standard & Poor's.

    `I Have Trouble'

    The California Public Employees' Retirement System, the nation's largest public pension fund, has invested $140 million in such unrated CDO portions, according to data Calpers provided in response to a public records request. Citigroup Inc., the largest U.S. bank, sold the tranches to Calpers.

    ``I have trouble understanding public pension funds' delving into equity tranches, unless they know something the market doesn't know,'' says Edward Altman, director of the Fixed Income and Credit Markets program at New York University's Salomon Center for the Study of Financial Institutions.

    ``That's obviously a very risky play,'' he says. ``If there's a meltdown, which I expect, it will hit those tranches first.''

    Calpers spokesman Clark McKinley declined to comment.

    Because CDO contents are secretive, fund managers can't easily track the value of the components that go into these bundles. ``You need to monitor the collateral in your investment and make sure you're comfortable there will be no defaults,'' says Satyajit Das, a former Citigroup banker who has written 10 books on debt analysis.

    Tough to Track

    Most investors can't do that because it's extremely difficult to track the contents of any CDO or its current value, he says. About half of all CDOs sold in the U.S. in 2006 were loaded with subprime mortgage debt, according to Moody's and Morgan Stanley.

    Since CDO managers can change the contents of a CDO after it's sold, investors may not know how much subprime risk they face, Das says.

    As the $503 billion-a-year CDO market thrives, CDO marketers like Bear Stearns and Citigroup find buyers for the portions known as toxic waste, the equity tranches.

    A typical $500 million CDO requires a $40 million unrated equity tranche, says Fleischhacker, who addressed the 12th annual Public Funds Summit, a meeting of pension fund managers, at the Loews Lake Las Vegas Resort on March 12.

    `Lipstick on a Pig'

    Chriss Street, treasurer of Orange County, California, the fifth-most-populous county in the U.S., says no public fund should invest in equity tranches. He says fund managers are ignoring their fiduciary responsibilities by placing even 1 percent of pension assets into the riskiest portion of a CDO.

    ``It's grossly inappropriate to take this level of risk,'' he says. ``Fund managers wanted the high yield, so Wall Street sold it to them. The beauty of Wall Street is they put lipstick on a pig.''

    Seven percent of all the equity tranches sold in the U.S. in the past decade were purchased by pension funds, endowments and religious organizations, Fleischhacker says.

    Public pension funds have bought more than $500 million in CDO equity tranches in the past five years, according to data from public records requests.

    The New Mexico State Investment Council, which funds education and government services for children, has $222.5 million invested in equity tranches. The council decided in April to buy an additional $300 million of them. That investment would be 2 percent of the $15 billion it manages.

    Broker Suggested Purchases

    The General Retirement System of Detroit holds three equity tranches it bought for $38.8 million. The Teachers Retirement System of Texas owns $62.8 million of them. The Missouri State Employees' Retirement System owns a $25 million equity tranche.

    Ronald Zajac, spokesman for the Detroit pension fund, declined to comment on the fund's equity tranche investments.

    Kay Chippeaux, fixed-income portfolio manager of the New Mexico council, says it decided to buy equity tranches after listening to pitches from Merrill Lynch & Co., Wachovia Corp. and Bear Stearns.

    ``We got very interested in them just because a broker brought them to our attention,'' Chippeaux, 50, says. She says the investment is worth the risk because the fund may be able to get higher returns than it can from bonds. The council has purchased equity tranches from Bear Stearns, Citigroup, Merrill Lynch and Morgan Stanley.

    The council is relying on advice from bankers who are selling the CDOs, Chippeaux says. ``We manage risk through who we invest with,'' she says. ``I don't have a lot of control over individual pieces of the subprime.'' (snip)

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