How Derivatives Traders Can Also Be Heroes

What’s the opposite of a vulture? Vulture funds, in popular imagination (if

not in reality), buy up

debt on the cheap and then profit from the distress of others by trying to maximise

the amount of money they can extract from their debtors. But what would you

call someone who buys up debt on the cheap and then tries to profit by helping

out the debtors as much as possible? If you’re a normal person, you might call

such a trader a hero. If you’re hedge-fund manager John Paulson of

Paulson & Co, however, you accuse

people of market manipulation.

The problem seems to be that Bear Stearns has sold credit protection on subprime-backed

securities to Paulson. If Bear does nothing, it has to pay out on its insurance

contract. But if it buys up the underlying mortgages and restructures them so

that the homeowners don’t end up defaulting, then Paulson gets nothing.

That’s a great trade. Good for Bear. Paulson just got out-traded, is all.

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