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TEXT OF STORY
Tess Vigeland: At this hour, two major hedge funds are on the brink of collapse. Victims of their own decision to tap into the subprime mortgage market.
The hedge funds are managed by the investment bank Bear Stearns. They got involved in the subprime mess by buying up securities that were essentially a repackaging of all kinds of risky mortgages.
Now that the housing market has gone south, investors and lenders are scrambling to get their money back. Marketplace’s Amy Scott tells us it’s not just the big banks that could find themselves in trouble.
Amy Scott: The two hedge funds invested heavily in securities backed by subprime mortgages. As more borrowers have defaulted on those mortgages, the value of Bear Stearns’ investments has plummeted.
Janet Tavakoli heads consulting firm Tavakoli Structured Finance. She says what’s worse, the funds used leverage to finance their investments. That means they borrowed a ton of money from banks.
Janet Tavakoli: Leverage can be very good when everything is rosy. But when you run into snags, leverage of course compounds your problems.
Now, the banks want their money back. Merrill Lynch seized $800 million in mortgage-backed bonds from the hedge funds and held an auction today.
Joseph Mason teaches finance at Drexel University. He says this isn’t just a Wall Street problem. Your 401k or pension fund may be invested in similar mortgage-related securities.
Joseph Mason: Those hedge fund investment managers create investments that are bought by our pension funds and mutual funds. Charitable foundations are invested in these. It’s a broad investor base, and it’s not the rich versus the poor.
The trouble is, Mason says, it’s hard to know who’s at risk. Investment managers don’t have to report their holdings. And unlike stocks, these securities aren’t quoted on an open market. Meaning it’s hard to know exactly how much they’re worth until they’re sold — or in this case, auctioned off by Merrill Lynch.
In New York, I’m Amy Scott for Marketplace.