Hedge Fund Sues Banks Over Collateral Demands in Credit Default Swaps
A hedge fund has sued Citigroup Inc. and Wachovia Corp., claiming the banks made it pay increasing amounts of collateral to back insurance it had sold on subprime mortgages bundled into securities.
In one of the suits, VCG Special Opportunities Master Fund Ltd. says Citigroup breached the insurance agreement, known as a credit default swap, when it sought collateral that nearly equaled the $10 million in insurance protection the bank had purchased from the fund to protect against defaults, the Wall Street Journal reports (sub. req.). VCG, formerly known as CDO Plus Master Fund Ltd., also claims Citigroup misrepresented the level of risk associated with the credit-default swap, Bloomberg News reports.
The other suit claims the hedge fund put up almost $9 million in collateral to satisfy requests by a Wachovia unit, but refused a final request for $1.49 million more. Wachovia foreclosed on the collateral.
Steven Mintz is the lawyer for the fund, which had just $58 million in capital when Citigroup bought $10 million in protection. “We are concerned that Citi and Wachovia are attempting to take advantage of smaller hedge funds to seek return of capital … to minimize their own exposure in the marketplace,” he told the Wall Street Journal.
The banks claim the suits are without merit.
A Wall Street Journal story written in 2005 explains that credit-default swaps offer more than protection when borrowers can’t pay on mortgages that are bundled into securities; they have also become a way for investors to bet against the housing market. As mortgage-backed securities become more risky, insurance already sold on the securities rises in value. So an investor who owns the insurance can then sell it for a profit.
Hedge funds have “played both sides of this market,” sometimes selling insurance, and sometimes buying it and trading it for a profit, the newspaper says.
