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There was always a danger that a leveraged buyout firm would bid for the home- building company and cause the stock to rise, which would cost anyone shorting the stock money.

Understanding the Trades The new, standardized mortgage bond derivative contracts created a strategy with less risk and greater profit potential.

The new subprime derivatives amplified the risks of the underlying mortgages, and now investors are reaping the consequences.

An index designed to be a proxy for the lowest investment-grade subprime mortgage bonds sold in the second half of 2005, the ABX-HE-BBB- 06-01, traded as high as 102.19 cents on the dollar when it started in January 2006 and today trades at about 30 cents on the dollar.

' I'm thinking, `That's the guy you want to bet against,''' Bass says. He says he got on the phone with a senior loan officer, identified himself and said he was interested in the mortgage business.

As Bass tells it, the conversation sealed his determination to short Quick Loan's mortgages.

``When someone explained to me that it was a synthetic CDO that takes the other side of my trade, it took me a month to understand what the hell was going on.'' Bass and Fournier hired private detectives, searched news reports, asked Wall Street underwriters which mortgage companies' loans were at risk of default and called those lenders directly.

In this blizzard of research, Bass turned up the California mortgage lender Quick Loan Funding and its proprietor, Daniel Sadek.

The investment bank, which Bass declines to identify, owned billions of dollars in mortgage-backed securities.Bass and investors like him saw opportunity in a range of new investment tools that banks created to sell subprime securities worldwide.These included mortgage bond derivatives, contracts whose values are derived from packages of home loans and are used to hedge risk or for speculation.In his earlier sales jobs, Bass had sold securities to Fournier. On the other side of their trades would be investors chasing the high yields from securities based on subprime loans. They were reassured by the securities' investment-grade ratings, even as foreclosures started in some parts of the U. The traditional way for a speculator to wager against, or short, the housing market was to sell the stocks of major home- building companies with borrowed money and repurchase them for a lower price if the shares fell.This group included Wall Street firms, German and Japanese banks and U. Bass had tried that strategy in the past and found there were limits on its effectiveness, he says.

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