Hedge funds in New York City such as Paulson and Co (and others as well) have been profiting from the sub-prime mortgage mess by shorting an index called the ABX and by using credit default swaps that act as insurance . As the ABX index fell, they made tremendous profit, but as it rises, they stand to lose billions. What could cause them to lose on these bets is if the sub-prime loans get re-written to more favorable terms and that's exactly what they're trying to prevent.
Part of the problem with sub-prime mortgages are that their rates (and monthly payments) are set to adjust up, sometimes by hundreds of dollars per month. These "automatic adjustments" were written into loans which were originally written at affordable rates, enticing borrowers with bad credit to borrow in order to get into the home of their dreams.
There's good chance that if a sub-prime loan is re-written to more favorable terms the borrower would be able to stay out of foreclosure. Jobs are plentiful so in theory, most of these homeowners would be OK if they can maintain their payments at current levels. The problem is that in order for the loan originator to re-write the terms, they have to either find a new source of capitol, or sell the loans to another entitiy that does.
This is where investment bank Bear Sterns comes into the picture. They've been buying up sub-prime loans and want to be able to re-negotiate the terms, making foreclosure less likely and allowing distressed homeowners to keep their homes. Don't think of Bear Sterns as some kind of "knight in shining armour" though, because Bear Sterns stands to make billions if the loans don't default. That's their motivation.
Caught in the middle of this are the homeowners who could more easily have their terms re-written, if not for the Hedge funds that bet against them.
The question now is how involved regulators and other banking officials are going to be and the answer is likely to be a lot. Paulson and Co have written to entities such as the Federal Reserve, claiming that Bear Sterns is performing "market manipulation" by making "uneconomic transactions" in re-writing terms. The politicians, smelling a hot-button issue in election season, are sure to get involved as well.
If Paulson and Co and the other Hedge Funds that bet with them aren't successful in stopping Bear Sterns-a debacle could occur that will make Long Term Capitol Management look like a picnic. Any Hedge Fund that is caught holding these short positions won't be able to unload them. Billions of dollars are likely to be at stake.
As this starts to play out-it could create some panic on Wall Street, because the money placed on these short positions was likely borrowed in the credit default swap market, a major source of the liquidity that has driven global stock markets to their lofty heights this year. Any threat of a Hedge Fund meltdown or dried-up liquidity will cause equity traders to run for the nearest high window.
Greedy hedge funds, distressed homeowners, stock market meltdowns, and politicians. This could turn into one of the biggest stories of the year.
Part of the problem with sub-prime mortgages are that their rates (and monthly payments) are set to adjust up, sometimes by hundreds of dollars per month. These "automatic adjustments" were written into loans which were originally written at affordable rates, enticing borrowers with bad credit to borrow in order to get into the home of their dreams.
There's good chance that if a sub-prime loan is re-written to more favorable terms the borrower would be able to stay out of foreclosure. Jobs are plentiful so in theory, most of these homeowners would be OK if they can maintain their payments at current levels. The problem is that in order for the loan originator to re-write the terms, they have to either find a new source of capitol, or sell the loans to another entitiy that does.
This is where investment bank Bear Sterns comes into the picture. They've been buying up sub-prime loans and want to be able to re-negotiate the terms, making foreclosure less likely and allowing distressed homeowners to keep their homes. Don't think of Bear Sterns as some kind of "knight in shining armour" though, because Bear Sterns stands to make billions if the loans don't default. That's their motivation.
Caught in the middle of this are the homeowners who could more easily have their terms re-written, if not for the Hedge funds that bet against them.
The question now is how involved regulators and other banking officials are going to be and the answer is likely to be a lot. Paulson and Co have written to entities such as the Federal Reserve, claiming that Bear Sterns is performing "market manipulation" by making "uneconomic transactions" in re-writing terms. The politicians, smelling a hot-button issue in election season, are sure to get involved as well.
If Paulson and Co and the other Hedge Funds that bet with them aren't successful in stopping Bear Sterns-a debacle could occur that will make Long Term Capitol Management look like a picnic. Any Hedge Fund that is caught holding these short positions won't be able to unload them. Billions of dollars are likely to be at stake.
As this starts to play out-it could create some panic on Wall Street, because the money placed on these short positions was likely borrowed in the credit default swap market, a major source of the liquidity that has driven global stock markets to their lofty heights this year. Any threat of a Hedge Fund meltdown or dried-up liquidity will cause equity traders to run for the nearest high window.
Greedy hedge funds, distressed homeowners, stock market meltdowns, and politicians. This could turn into one of the biggest stories of the year.