We often take pleasure in the woes of Bear Stearns (because, take your pick, there are many), but how bad is this whole mess that they’ve late gotten themselves into actually and how bad is it for Wall Street? Yesterday the bank sold off $3.86 billion in their highest quality (AA and AAA) mortgage bonds. The auction was reportedly well-received by the market, despite fears by the Street that the market would be (and could still be) saturated with low-quality mortgage securities. And Merrill Lynch offered $1.6 billion of new securities backed by subprime loans, to much investor interest. Subprime Apcolypto or Subprime ApocolypNo?
Accrued Interest notes with noted calm that this is just how things are done. “Hang around while the product is hot, create as much in fees as you can, invent new structures or create your own investing vehicles if you have to, and cash your chips in at the first sign of trouble.”
People want to talk about how it’s Long Term Capital Management all over again, and what a nightmare that was, but is Bear’s hedge fund even big enough to cause the same kind of disaster? Probably not. AI does find some parallels between LTCM and the sub-prime market:
So are there any sub-prime funds large enough to cause a LTCM-type result? Maybe not. But its really not that hard to imagine a major contagion scenario:
1) A large number of investors in higher quality CDO tranches (A and AA) are burned by sub-prime defaults.
2) This causes a re-pricing of CDO spreads, and causes a drastic slow-down in deal flow.
3) In turn, this eliminates the "CDO Put" in the credit market. This is where any widening of credit spreads made forming new CDO's that much more attractive, thus creating a back-stop for spreads generally. If the CDO market disappears, even temporarily, this "put" is gone.
In that scenario, we finally see the widening of credit spreads everyone's been waiting for. And given that real money has been so reluctant to over-weight high-yield, the widening could be quite dramatic.
Subprime Woes Pinch Bear's Mortgage Star [WSJ]
So... you got your reward and you're just leaving then? [Accrued Interest]