Did Hedge Funds Help Stabilize the Mortgage Market?
Monday, April 28, 2008 : PermalinkConde Nast Portfolio- It’s easy to be awed by the sums of money made by John Paulson and the Goldman Sachs mortgage desk. But compared to the amount of money tied up in RMBS, the profits made by shorting mortgage-backed securities have been tiny. For Paulson to have played a significant role in stopping the mortgage-backed credit bubble from continuing to exapand, he would have had to have been orders of magnitude larger than he was.
But more to the point, the ABX index is an index of CDS spreads referencing subprime RMBS. The chain of arbitrage which would lead from shorting the ABX to RMBS prices falling is long and convoluted: first any drop in the ABX would have to be arbitraged by buying the ABX whilst selling buying protection on the underlying CDS contracts. Then any widening in those underlying CDS contracts would have to be arbitraged by selling protection on the RMBS while at the same time shorting the underlying bonds. (Good luck trying to do that.