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Bear Stearns Faces Collapse of
$6 Billion Sub-Prime Unit

June 14, 2007 (EIRNS)—Bear Stearns put up $4 billion in Mortgage Backed Securities (MBS) for sale in a desperate effort to shore up its losses in the sub-prime blow-out. Two of its hedge funds are in trouble, and if both are liquidated, as many on Wall Street expect, then a subsidiary of Bear Stearns, Everquest Financial, could go out of business as well, just as it was about to conduct an IPO.

One of the endangered funds, the "High-Grade Structured Credit Strategies Enhanced Leverage Fund," has $640 million in invested capital, plus $6 billion in borrowed capital, mostly from Goldman Sachs and Bank of America. It could be liquidated if the $4 billion MBS sale fails. The Wall Street Journal notes that the $4 billion sale is "a sliver of the $7 trillion residential mortgage backed bond market, but it is still a large amount to be sold at one time, and a potentially troubling sign for the broader mortgage-backed bond market." The fund has lost 23% this year through April, and has blocked investors from further requested withdrawals of about 40%.

Bear Stearns is expected to report a 6% drop in earnings in the 2nd quarter compared with last year. They are also the largest firm being attacked by the hedge funds, who are protesting their renegotiation of mortgages with homeowners who default. These attempts to renegotiate are not due to "humanitarian instinct," but to the fact that Bear Sterns faces paying up to 100 times the value of each defaulted mortgage, in lost derivatives bets to the hedge funds!

The context for these events: The Mortgage Bankers Association reported a record level of delinquencies in the subprime sector in the first quarter: 15.75% of all subprime ARMs are 30 days-plus delinquent, up from 14.44% in 2006's fourth quarter, which was already the highest on record. The subprimes going into foreclosure (usually 90 days-plus delinquent) in first quarter were 3.23%, up from 2.70% the previous quarter, and the highest on record. This survey covers 5-6 million subprime mortgages "worth" about $1.5 trillion; note that it is an out-of-date snapshot of a situation which clearly got worse through May.

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