The Smart Money Is Betting Against the Fast Money

This article originally appeared in Monday's Wall Street Journal. It basically describes the way hedge funds are playing the anticipated decline in home prices. Also, it partially explains why Wall Street has had such a huge appetite for mortages that often show a larger than average probability of default. In short, the hedge fund manager is able to buy the mortgage and insurance at the same time. When the risks of holding a mortgage that could default can be mitigated by buying insurance, then the true risk of default is not reflected in the price of the mortgage.

NEW YORK -- Bryan Whalen and Ike Spirou have never met. But through the world of modern mortgage finance, their fates are inextricably linked.

Mr. Whalen, who manages a multibillion-dollar mortgage-bond portfolio at Los Angeles-based Metropolitan West Asset Management, stands to gain if Mr. Spirou, a financially stretched homeowner in New York City, reneges on his mortgage loan. That's because Mr. Spirou's $360,000 loan was packaged with thousands of others into a bond, and Mr. Whalen has entered a newfangled derivative contract -- similar to an insurance policy -- that will pay off if enough loans in the bond go bad.

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