“One of the biggest bets on Wall Street rests on a theory that also deeply unsettles Wall Street.
“The provocative theory is that the big banks have not paid enough in recent legal settlements to make amends for their role in stoking the subprime housing boom and bust. Hedge funds, contending that the banks have so far underpaid, have bought subprime mortgage-backed bonds, which they hope will rise in value. That would happen if Wall Street banks ultimately pay out a lot more money to settle other, more stringent litigation tied to these bonds. And the hedge funds holding the bonds may often be behind these more demanding lawsuits.
“The notion that the big banks are getting off lightly in these settlements might seem stretched. After all, in recent months, several large banks have agreed to deals with government authorities and alliances of private investors that carry substantial penalties. The $13 billion that the Justice Department extracted from JPMorgan Chase last year was a record.
“Around the same time, JPMorgan entered into a $4.5 billion settlement with a range of prominent investment firms, BlackRock and Pimco among them, over allegations that it packaged mortgages into bonds before the financial crisis that didn’t meet certain agreed-upon standards.”
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