Thursday, June 21, 2007

Bear Stearns' subprime shock

Bear Stearns shocks, Saigon shakes, and Hanoi rocks.

The markets are shuddering over the collapse of two Bear Stearns-run hedge funds which were heavily exposed to the subprime-laden collateralized debt obligations (CDO) market.

Now bankers fear the possibility of a domino effect collapse in the hedge fund world should panic level pricing of CDOs show these rather opaque instruments to be overvalued.

Here's more on that from Bloomberg.com:

The Merrill Lynch & Co.'s threat to sell $800 million of mortgage securities seized from Bear Stearns Cos. hedge funds is sending shudders across Wall Street.


A sale would give banks, brokerages and investors the one thing they want to avoid: a real price on the bonds in the fund that could serve as a benchmark. The securities are known as collateralized debt obligations, which exceed $1 trillion and comprise the fastest-growing part of the bond market.

Because there is little trading in the securities, prices may not reflect the highest rate of mortgage delinquencies in 13 years. An auction that confirms concerns that CDOs are overvalued may spark a chain reaction of writedowns that causes billions of dollars in losses for everyone from hedge funds to pension funds to foreign banks. Bear Stearns, the second-biggest mortgage bond underwriter, also is the biggest broker to hedge funds.

``More than a Bear Stearns issue, it's an industry issue,'' said Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York. Hintz was chief financial officer of Lehman Brothers Holdings Inc., the largest mortgage underwriter, for three years before becoming an analyst in 2001. ``How many other hedge funds are holding similar, illiquid, esoteric securities? What are their true prices? What will happen if more blow up?''

We'll have more on this tomorrow in our "Features of the week" post, so stay tuned.

For now, see Bloomberg Markets' recent cover story on the CDO market highlighted in last week's "Features" post.

You can also check out our recent post, "Asset backs, subprime: shades of 1990?".