Hedge Funds Seek SEC Help For CDS Worries

Jun 14 2007 | 9:06am ET

Showing there’s no shortage of cheek in the industry, a group of hedge funds is calling on the Securities and Exchange Commission to be vigilant on possible market manipulation in the subprime mortgage-backed securities. While many hedge funds—notably the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leveraged Fund, which has lost a whopping 23% this year—are taking a bath in the sector, those that have bet against mortgage bonds are making a killing, and they want to make sure that regulators are protecting that cash cow.

New York-based $11 billion hedge fund Paulson & Co., in a letter to the regulator, warns that investment banks may try to avoid losses in derivative investments by buying bad loans at inflated prices to keep the bonds from defaulting, Bloomberg News reports.

“We hope you will clarify the application of the anti-manipulation provisions of the federal securities laws to credit default swaps in order to assure market participants that no one will be allowed to engage in manipulative practices,” the firm wrote to Erik Sirri, head of the SEC’s market regulation division.

According to Paulson Senior Vice President Michael Waldorf, his firm leads a group of about 10 hedge funds calling itself the ABS Credit Derivatives Users Association. Dallas-based Hayman Capital Partners is also a member, and New York-based Basswood Partners has said it is considering joining the group.

This is not the first time the hedge fund group has called for regulatory action: It complained to the International Swaps and Derivatives Association after Bear Stearns sought ISDA approval to change asset-backed default swaps agreements to permit loan buyouts, a move Bear made after Paulson called on Markit Group to change the CDS rules it recommends to investors. Bear has since dropped its ISDA request.

According to the May 14 letter, the group has “made little progress to date trying to develop solutions to this problem by approaching derivatives dealers on an individual basis,” though Waldorf told Bloomberg the group has no evidence of market manipulation.


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