Fears of Bear Stearns Spillover Drag Down Market

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“The fear is that this Bear situation is the tip of the iceberg and it could lead to other funds being liquidated.”

Todd Clark (subscription required), Director of Stock Trading, Nollenberger Capital Partners

“There’s fear of further liquidations.”

Jeffrey Gundlach (subscription required), Chief Investment Officer, TCW Group

The big story yesterday and today is two large Bear Stearns hedge funds (High Grade Structured Credit Strategies and High Grade Structured Credit Strategies Enhanced Leverage), involved with subprime mortgage bonds, that are on the brink of collapsing.

Because these bonds held by the Bear Stearns hedge funds are relatively illiquid and because other hedge funds have similar holdings people are concerned that if Bear Stearns and its investors are forced to sell these holdings at firesale prices, other funds with the same holdings will have to mark down their value and may also be forced to sell them

This can create a kind of “domino effect” crippling the price of these subprime bonds, hurting alot of investors invested in these hedge funds and generally creating a sense of fear and panic on Wall Street.  This is what Todd Clark means when he says the fear is that this is “the tip of the iceberg” and that it could lead to other funds having to liquidate as well.

As a result, everybody on Wall Street is fixated on a set of new and relatively obscure indexes, the ABX indexes, which measure the implied value of mortgage bonds.  This morning’s Wall Street Journal tells the story of these indexes, the company that publishes them, Markit Group, and it’s founder Lance Uggla in a story aptly titled “Index With Odd Name Has Wall Street Glued; Morning ABX.HE Dose” (subscription required):

When an upstart company called Markit Group Ltd. started indexes of the subprime mortgage market last year, there was no fanfare.

They were called the ABX.HE Indexes, and for many months, most investors had no idea of the market measures with the wonky name.

Now, the indexes are some of the most closely watched barometers on Wall Street.  They are a focal point for trading in the US subprime debt markets – which lately have come to dominate attention on Wall Street becasue of problems at two big Bear Stearns Cos. hedge funds.

As I wrote on Monday, the index that specifically focuses on BBB-minus rated subprime mortgage bonds (ABX.HE.BBB-07-1 ; “ABX” = Asset Backed; “HE” = Home Equity; BBB = BBB rated bonds), hit an all time low last Friday of 60.95 on the heels of a bunch of downgrades by Moody’s.  As you can see at Markit’s website, the index closed yesterday below 60 at 59.79 and, if you click on the index to get the chart, is down almost 40% this year.

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