Saturday, June 23, 2007

The Subprime Mortgage Disaster Hits The Hedge Fund Industry

Bear Stearns Companies, the investment bank, pledged up to $3.2 billion in loans yesterday to bail out one of its hedge funds that was collapsing because of bad bets on subprime mortgages.
It is the biggest rescue of a hedge fund since 1998 when more than a dozen lenders provided $3.6 billion to save Long-Term Capital Management.

The crisis this week from the near collapse of two hedge funds managed by Bear Stearns stems directly from the slumping housing market and the fallout from loose lending practices that showered money on people with weak, or subprime, credit, leaving many of them are now struggling to stay in their homes.

Bear Stearns averted a meltdown this time, but if delinquencies and defaults on subprime loans surge, Wall Street firms, hedge funds and pension funds could be left holding billions of dollars in bonds and securities backed by loans that are quickly losing their value.
Think of what this report is saying. Your pension fund could be impacted as a result of this financial crisis. In May I posted this entry describing the subprime mortgage crisis. This situation could have far reaching effects into all areas of our economy.
Nervousness about the souring subprime loans and rising oil prices sent the stock market plummeting. Already down almost 60 points, the Dow Jones industrial average fell sharply after the announcement of the bailout and closed down 185.58 points.
You must be asking why would any financial institution get involved in such a risky venture? The answer is simple. Their clients were demanding greater and greater returns.
The first fund, the Bear Stearns High-Grade Structured Credit Fund — the one bailed out yesterday — was started in 2004 and had done well, posting 41 months of positive returns of about 1 percent to 1.5 percent a month. But investors were clamoring for even higher yields, which would require more aggressive bets on riskier mortgage-related securities and significantly higher levels of borrowed money, or leverage, to bolster returns.
12% to 18% return on their money was simply not good enough where for the average middle class person returns of that size would be welcomed. It is this greed that threatens the economic security for us all. It is time for strong regulation of the Hedge Fund Industry which operates now with nearly no regulations. It is the rich man's game but all of us are at risk.

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