Don’t look down

Posted by Josh Friedlander | No Comments

Dealbreaker has the best analysis yet of what’s happening with the two Bear Stearns hedge funds that threaten the stability of our beautiful capital markets. The issue, if you’re not into this stuff, is that these hedge funds had borrowed a LOT of money to buy some pretty worthless stuff (that they should have known was worthless).

That “worthless stuff” is a bunch of subprime mortgages…you know, those things that financed all the overpriced home purchases in the past five years by people with crappy credit. Well, as soon as that worthless stuff was recently acknowledged as worthless, its value as collateral went down the tubes. When that happened, the banks that lended Bear the money wanted some more collateral to secure their loans, but if they now sell that collateral into the market they will depress the value of the worthless stuff even further leading to more margin calls, and so on. For now, they have decided to very quietly try to sell the collateral, but they won’t be able to keep this up forever and the price will decline.

So, who cares? Well, you should if you like our shiny economy. Because as soon as all that worthless stuff is acknowledged as worthless, the market for buying mortgages is going to concentrate much more on the good stuff only and lower-rated borrowers will be out of luck. And so there will be fewer potential buyers. Prices will have to drop. And so on….

Good luck refinancing your house to pay off the credit card bill (again)!

In short, by flinching from auctioning off the CDOs, JP Morgan and the other banks that reached deals with Bear Stearns may have prevented what some feared would become the much heralded “systemic event” in which the collapse of one hedge fund brings down all the others. But the cost of doing so appears to be keeping the actual market values of many of these assets more or less financially illegible. And keeping markets and regulators illiterate when it comes to reading the risks of these products.

One trader we spoke to described the outcome as a “cartoon moment.”

“As long as Wiley Coyote doesn’t realize he’s run off the cliff, he won’t fall,” he said. “These guys don’t want to look down because they are afraid there may be no there there.”

Just another “emperor has no clothes” day on Wall Street!

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