Hedge fund managers are accusing Bear Stearns of trying to manipulate the market in securities based on subprime mortgages, the Wall Street Journal reported in its online edition.
The confrontation provides a rare look into the complex trading in the mammoth U.S. mortgage market, which played a critical role in financing the housing boom, and the complicated relationships between hedge funds and investment banks, the paper said.
Hedge funds that had sold short such securities made profits when an index tied to a basket of subprime bonds was falling. But the index has recovered in recent weeks, leading to howls of protest from hedge funds, according to the report.
The chief critic, John Paulson of Paulson & Co., a $12 billion fund, says Bear Stearns wanted to prop up faltering mortgages-backed securities by purchasing individual mortgages that were rapidly losing value to avoid doling out billions in swap payments, the Journal reported.
Bear Stearns is one of Wall Street's largest players in the market for credit default swaps. By selling swaps, Bear bet the subprime home loan market would improve or at least turn out to be healthier than expected.
Neither Bear Stearns not Paulson & Co. immediately returned calls seeking comment. The head of Bear's mortgage business denied the allegations, according to the report.
A downturn in the U.S. housing market this year has led to rising defaults in the subprime mortgage market, which caters to borrowers with weak credit histories. More than two dozen subprime lenders have collapsed, while others have tightened their lending standards.