As I watch the Bear Stearns debacle unfold, I am reminded that things are never as good or as bad as they seem. In the case of the Bear Stearns High Grade Structured Credit Strategies Enhanced Fund, I am amazed at how a fund could raise $600 million in capital, and then turn around and invest in $11 billion dollars in securities. This goes well beyond any margin requirements I have ever heard of.
The issues with sub prime deal with Collateralized Debt Obligations (CDOs), and Collateralized Mortgage Obligations (CMO).
Having been in the brokerage industry for many years, I understood how they packaged mortgage investments, but chose to stay away because of their complexity. My rule was simple, if the investment sounds too complicated, don't invest in it.
Obviously, there are a lot of people much smarter than I. I found that anytime an investor reached beyond their level of competency for yield, they eventually got hurt. As you can see with the Bear Stearns High Grade Structured Credit Strategies Enhanced Fund, even people who think they're smart sometimes realize someone else is a little smarter.
Given the choice of a 5.25% certificate of deposit versus a 5.75%-6.00% CDO or CMO, I'll take the lower yielding CD every time.
So, how widespread is the Sub-Prime mess? If it is anything like the widespread cooking of the corporate books we saw a few years ago, we may never know the full extent of the problem. You know the story. A few will suffer the consequences, and the rest will be covered up to prevent a full scale economic panic.
None the less, we believe as traders head off for vacation in July, the stock market will focus on the potential impact of a widespread CDO or CMO disaster. The market is already softening as we speak, so July could be the first real challenging month.
