by Tanta on 6/11/2007 05:44:00 PM

As I have written extensively, and to no apparent purpose, on this subject, I feel obligated to note the following letter to the editor of the Financial Times, published today:

Sir, Your articles "Hedge funds hit at subprime aid for homeowners" and "Fears over helping hand for mortgage defaulters" (June 1) mischaracterised our efforts to prevent market manipulation as somehow against loan modification. To be absolutely clear, we have no objection to loan modification; however, we are vehemently opposed to market manipulation.

Paulson & Co and other major financial institutions are concerned about credit protection sellers providing non-economically motivated credit support to mortgage-backed securities (MBS) trusts for the sole purpose of artificially influencing the value of the credit protection sold. This can be done, for example, by purchasing defaulted mortgages worth less than par from the trusts that hold them at par value. Because the credit default swaps (CDS) market is so much larger than the amount of the underlying MBS securities, a credit protection seller can spend a small amount on such credit support and achieve huge gains on related derivatives positions.

Our concerns about manipulation arose when we heard about plans by certain market participants to sell credit protection and simultaneously to provide credit support to the underlying MBS trusts. Although these transactions are market-manipulative and therefore prohibited under securities laws, our firm proposed that the International Swaps and Derivatives Association amend the language of its CDS documentation expressly to prohibit such transactions. ISDA's staff asked us to help them gather views from interested market participants, including credit protection buyers, in order to hold a meaningful discussion of the issue. The language we proposed in no way references or restricts loan modification.

The manipulative transactions we are seeking to prevent have nothing whatsoever to do with loan modification or helping subprime borrowers. Your articles suggest that our firm, as the organiser of a "group of more than 25 hedge funds", opposes loan modification. To the contrary, we support loan modification as the fastest way to resolve troubled loans in a way that helps keep borrowers in their homes. What we oppose is deliberate market manipulation.

Michael Waldorf,

Paulson & Co

So we can all stand down. It's just one of those things that is clearly "prohibited under securities laws," but apparently not prohibited under ISDA deal documents.

(Hat tip, jck)