From the New York Times:
Mortgages Give Wall St. New Worries
After the first cracks in the subprime mortgage business appeared late last year, several large lenders were forced into bankruptcy.
Now, the stress is sending tremors down Wall Street, as investment funds that bought a stake in those loans are starting to wobble.
Industry officials say they expect this second act to be longer and slower, unwinding over the next 12 to 18 months. The fallout could further constrict consumers with weak, or subprime, credit while helping to prolong the housing downturn.
On Wall Street, the impact could be far more significant: It could force banks, hedge funds and pension funds to acknowledge substantial losses, which had been tucked away in complex investment vehicles that are hard to evaluate. In turn, that could limit the money available for mortgage lending.
Yesterday, two hedge funds operated by a division of Bear Stearns, an investment bank that is a dominant player in mortgage bonds, fought for their survival as three lenders — Merrill Lynch, Citigroup and JPMorgan Chase — asked Bear Stearns to put up more capital.
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Bad bets on risky subprime securities and the direction of an index that tracks subprime bonds caused the High-Grade Structured Credit Strategies Enhanced Leverage fund of Bear Stearns to tumble 23 percent in the year through the end of April. A related fund has fallen less.The leveraged fund, which had raised $600 million in investments when it was started 10 months ago, leveraged itself, or borrowed, about $6 billion from numerous Wall Street banks and brokerage houses. When losses began mounting this spring, some investors stepped forward to redeem their money. In May, the fund stopped allowing redemptions.
So far, the distress has been muted, which has surprised some investors and analysts who believed that rising defaults by homeowners would have left investors with sizable losses by now.
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“We don’t really know the ripple effects,” said one industry official who spoke on the condition of anonymity because of the sensitivity and gravity of the situation. “It is causing a revaluation of the securities, some of which may lead to additional liquidations. That’s possible, but it’s not set in stone.”