Bear Stearns

The LA Times today has a good narrative of what's been going on at Bear Stearns. See also continuing coverage at Calculated Risk. Highlights:

Worries rise as fund crashes

Anxiety intensified Friday about the toll the sub-prime mortgage meltdown is taking on the financial industry at large, as Bear Stearns Cos. pledged to lend $3.2 billion to rescue a hedge fund battered by rising defaults on home loans. The jitters sent stocks tumbling across the board.

"We know that these holdings are not unique to Bear Stearns," said Drexel University professor Joseph R. Mason [...]

The hedge fund, which is managed by a Bear Stearns division, had taken in nearly $7 billion — $600 million raised from investors plus 10 times that sum borrowed from Wall Street firms. Such a great amount of leverage would sharply boost any profit generated — as well as any loss incurred. The fund invested mostly in bonds that paid generous yields and were backed by sub-prime mortgages.

But as the nation's housing market soured, setting off a wave of defaults on sub-prime loans, the securities held by the fund lost substantial value [...]

When will they say sub-prime loans were a cause of unsustainable prices?

One of the fund's lenders, Merrill Lynch & Co., this week seized a reported $850 million in assets that had served as collateral on its loans to the fund. Other lenders were threatening to do the same when Bear Stearns stepped in with a credit line to shore up the fund.

Bear Stearns moved to prevent the fund's dissolution "because there continues to be significant value in it," Sam Molinaro, chief financial officer of the New York-based investment bank, said in a conference call Friday.

Molinaro said the credit line would allow an orderly sale of assets, preventing "massive liquidations" at fire-sale prices.

The hedge fund's troubles, Molinaro said, "appear to be relatively contained."

But stock investors weren't comforted. The Dow Jones industrial average dropped 185.58 points, or 1.4%, to 13,360.26 [...]

The Dow is down 2.1% for the week.

Mason, the Drexel University professor, expressed greater concern about the potential damage from sub-prime mortgages.

Bear Stearns, he noted, is tying up its own capital on a bet that it can hold onto the risky investments until the market for them improves. Merrill Lynch made the same bet by auctioning off only a fraction of the assets it seized from the Bear Stearns hedge fund, he said.

The problem, he said, is that sub-prime woes will grow as home prices fall in many areas and monthly payments jump over the next year on almost $1 trillion in adjustable-rate mortgages.

The familiar chart of coming ARM resets:

What's worse, he said, is that the biggest investors in mortgage-backed debt are not hedge funds, whose investors are supposed to be wealthy enough to withstand losses. Instead, they are banks, asset managers, pension funds and insurance companies that serve mainstream Americans and have put their money at risk by buying exotic mortgage securities, he said. [...]

It's beginning to unravel. How can Westside house prices not fall?