Wall Street funds apparently found a way to make big money from the residential-mortgage crisis and leave U.S. taxpayers with most of the risk. The process begins with a hedge fund or a private-equity fund buying a block of mortgages at a deeply discounted price. Then homeowners are offered a principal reduction on their mortgages in return for refinancing the debt into new mortgages backed by government-sponsored entities such as the Federal Housing Administration. The mortgages can then be sold to another government-backed entity, such as Ginnie Mae.

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