I think there will be many more incidents like this, but the market needs to shake out before it gets better.. All the news has been about subprime loans, but watch the chatter that will occur soon about Alt-A loans,liar loans etc...it will get worse before it gets better...Though as a possible "speculative" investment, as the mortgage companies implode, it will provide an opportunity for a smart "trade" ..Keep an eye on IMH...My guess is they survive, but may get a haircut in the near term

Yes, the Bear Sterns news is ugly for housing but what about the fallout to the larger economy and the stock/bond market? Do y'all think it will be contained? I don't which is why I upped the cash position in my retirement portfolio to 1/3 about six months ago. My FIL has been playing with hedge funds and backed out his position about 4 months ago.

Nova, it is never good to try and time the market. For example, YTD, the DJIA is up 7.13%, NASDAQ is up 6.7%, and the S&P 500 is up 5.6%. International markets are up even more. And that is even after shedding quite a bit over the past several trading days. I doubt that your cash has done even 1/2 as well over the same time period. (And remember, those are YTD returns, on an annualized basis that would be more than 14%, 13% and 11% respectively for the first six months of the year.) How much has that cost you?

Retirement accounts should be set at a level of risk that you're comfortable with and adjusted for your retirement timeline. For example, you may want a mix of 60% equities, 30% bonds, 10% cash. Once that is set, it should be adjusted periodically as your timeline changes and to ensure that the account doesn't get out of balance. However, it shouldn't be changed just because you think that current market conditions warrant a change. This is a long-term investment strategy. If you want to "play the market," you should do so with an after tax account.

Just my two cents, FWIW. YMMV

I thought that Alt-A and stated-income (liar's loans) ARE subprime.

Alt-a

A mortgage risk categorization that falls between prime and sub-prime, but is closer to prime. Also referred to as "A minus".

My DH manages a $2B+ mortgage portfolio. Currently & historically, they do not write ANY Alt-A loans. My DH is negotiating now with a potential secondary market purchaser for Alt-As. So, they might be writing a few going forward but only pre-sold. They do a few stated-income loans but only to borrowers with FICOs of 800+.

They consider a FICO score of 660 or less to be sub-prime.

The term 'sub-prime' generally refers to credit score rather than a type of loan product. We're hearing a lot about ARMs, however, many ARM products were sold to people with excellent credit. Those loans are not the sub-prime being discussed in the news.

/T

Bear Stearns raised almost $2 billion from investors for the two funds and borrowed more than $10 billion against that equity to make bigger bets and earn higher returns.

And that's the reason why this hedge fund--and many others--will implode. And it's not just hedge funds anymore. Mutual funds, pension plans, private equity buyouts--all loaded up w/ debt to spike returns. But since everyone's doing it, it doesn't increase returns much. But it does increase risk. A lot.

I'm dumping my bond funds in favor of intl stocks.

Hey Bethesdamadman, you provide excellent advice. Market timing is not my game. You'll get no argument from me on the dangers of trying to time the market while failing to manage risk, asset allocation, diversification within asset class, and rebalancing. They're great rules of thumb that I used to preach to my financial clients.

That being said, I failed, in my previous post, to clarify that the my particular portfolio concerns had to do with CDO exposure in any of my high-yield bond funds. Hedge funds aren't the only buyers of CDOs. They don't fit my risk profile so I ditched the bond fund that had, for me, an uncomfortable level of exposure. I maintained my stock exposure. I pared back my bond fund exposure a bit and upped my cash position. My treasuries and CDs may have yielded a little less than a high yield bond fund...but that's okay, I'm sleeping better.

Report: U.S. Banks To Curb Lending, Call in Existing Loans
By AMBROSE EVANS-PRITCHARD
The Daily Telegraph
June 26, 2007

America faces a severe credit crunch as mounting losses on risky forms of debt catch up with the banks and force them to curb lending and call in existing loans, according to a report by Lombard Street Research.

The group said the fast-moving crisis at two Bear Stearns hedge funds had exposed the underlying rot in the American sub-prime mortgage market, and the vast nexus of collateralized debt obligations known as CDOs.

"Excess liquidity in the global system will be slashed," it said. "Banks capital is about to be decimated, which will require calling in a swathe of loans. This is going to aggravate the U.S. hard landing."

The groupÂs global strategist, Charles Dumas, said the failed auction of assets seized from one of the Bear Stearns funds by Merrill Lynch had revealed the dark secret of the CDO debt market. The sale had to be called off after buyers took just $200 million of the $850 million mix.

"The banks were not prepared to bid over 85% of face value for CDOs rated ÂA' or better," he said.

"God knows how low the price would have dropped if they had kept on going. We hear buyers were lobbing bids at just 30%.

"We don't know what the value of this debt is because the investment banks shut down the market in a cover-up so that nobody would know. There is $750 billion of dubious paper out there in the form of CDOs held by banks that have a total capitalization of $850 billion."

American property writer Paul Muolo described the Bear Stearns crisis as the "subprime Chernobyl," saying the bank had created a "cone of silence."

Abandoned by fellow banks, Bear Stearns has now put up $3.2 billion of its own money to rescue one of the funds, a quarter of its capital.

This is the biggest bail-out since the Long-Term Capital Management crisis in 1998, which Bear Stearns refused to join at the time. Bear Stearns is now alone, a case of rough justice being served.

The warning comes as fresh data from the U.S. National Association of Realtors shows a glut of unsold homes. The median price fell for the 10th month in a row to $223,700, down almost 14% from its peak in April 2006. This is the steepest drop since the 1930s. The Mortgage Lender Implode-Meter that tracks the American housing markets claims that 86 major lenders have gone bankrupt or shut their doors since the crash began.

Source : The NY Sun

The NY Sun is a step above, maybe a 1/2 step above, the National Enquirer and The Star...And that statement(mine) is coming from someone who has been concerned about the housing market since last June...

triciae - one more fund to add to your growing list of troubled funds...

Subprime shakeout claims another fund
Caliber Global, which controlled almost $1 bln in assets, to shut down
By Alistair Barr, MarketWatch
Last Update: 2:12 PM ET Jun 28, 2007

SAN FRANCISCO (MarketWatch) -- Caliber Global Investment Ltd., a London-listed fund that controlled almost $1 billion of mortgage assets, said on Thursday that it's shutting down after turmoil in the subprime market cut demand for its shares.
Caliber (UK:CLBR: news, chart, profile) , run by Cambridge Place Investment Management, plans to sell all of its assets over the next 12 months and return as much money as possible to shareholders, the fund said in a statement. The plan needs to be approved by investors at an extraordinary meeting in August, Caliber added.
Caliber is the latest casualty of rising delinquencies in the subprime mortgage market, which caters to poorer borrowers with blemished credit records. Bear Stearns Cos. is trying to salvage two of its hedge funds that focus on the space, while another run by UBS AG shut down earlier this year.
Subprime mortgage problems have also disrupted some initial public offerings. Everquest Financial, which had ties with Bear's troubled hedge funds, pulled its IPO registration earlier this week. See story on Everquest IPO plans.
Carlyle Group, one of the largest private-equity firms in the world, cut an IPO of a mortgage bond fund by 25% and dropped the price, Bloomberg News reported on Thursday.
Caliber had already been hit hard by the subprime mortgage downturn. The fund had gross assets under management of $908 million at the end of March. It was almost six times leveraged and recently had a market capitalization of about $115 million.
More than half its assets were residential mortgage-backed securities and over 60% of its portfolio was from the U.S. Three quarters of the assets were investment grade and the rest were either junk-rated or unrated.
The net asset value of the fund has dropped by more than a quarter to a range of $6.50 to $6.60 at the end of May, Caliber said on Thursday.
"Following discussions with major shareholders, the board has concluded that the company should pursue an orderly return of all of its capital to investors over the next twelve months in order to maximize value for shareholders," Caliber said in a statement.
"The Board and its advisers recognize that there is insufficient demand currently for investment through listed investment companies exposed to this asset class," the fund added.
Caliber shares jumped 25% to $4.70 on Thursday. The stock is still down more than 40% so far this year.
Queen's Walk Investment Ltd. (UK:QWIL: news, chart, profile) , a similar London-listed fund run by Cheyne Capital, one of the largest hedge funds in Europe, has also been hit by the subprime shakeout.
Queen's Walk mainly buys the equity tranches of asset-backed securities. At the end of 2006, the fund had 86% of its assets in residential MBS. U.S. assets accounted for 12% of the portfolio.
This week, Queen's Walk reported a loss for its fiscal year, which ended on March 31. The fund's net asset value fell 27% during the first three months of 2007, the fund added.
Queen's Walk shares are down 40% so far this year. A hedge fund run by Cheyne, called the Cheyne ABS Opportunities Fund LP, is a major shareholder of Queen's Walk. End of Story
Alistair Barr is a reporter for MarketWatch in San Francisco.

Source: Market Watch

Gee, Thanks!

Don'tcha wonder how many individual houses are in each of these securities??? ...coming to a neighborhood near you!

/T

Here is a really good explanation of the risks
Note this company is in the business of selling gold so take their conclusions with more than a grain of salt. Still the first part of their explanation is worth reading to get a plain English understanding

Thanks, saphire! When you read past the "gold-spiel" the far-reaching consequences of this fairy-dust economy are frightening. To think I've spurned Monte Carlo in favor of mutual funds!

I found it pretty grim too. Although I wonder if this is just thier sales approach. Still I have been reading up on this stuff and it does feel like we are in an undisclosed inflationary cycle. There just seems to be too much money around without any real source

Anyone with new information

Can you hear the credit tightening?

FROM BLOOMBERG:

Bear Stearns Tells Fund Investors `No Value Left' (Update6)

By Yalman Onaran

The headquarters of Bear Stearns Cos. in New York July 18 (Bloomberg) -- Bear Stearns Cos. told investors in its two failed hedge funds that they'll get little if any money back after ``unprecedented declines'' in the value of securities used to bet on subprime mortgages.

``This is a watershed,'' said Sean Egan, managing director of Egan-Jones Ratings Co. in Haverford, Pennsylvania. ``A leading player, which has honed a reputation as a sage investor in mortgage securities, has faltered. It begs the question of how other market participants have fared.''

Estimates show there is ``effectively no value left'' in the High-Grade Structured Credit Strategies Enhanced Leverage Fund and ``very little value left'' in the High-Grade Structured Credit Strategies Fund, Bear Stearns said in a two-page letter. The second fund still has ``sufficient assets'' to cover the $1.4 billion it owes Bear Stearns, which as a creditor gets paid back first, according to the letter, obtained yesterday by Bloomberg News from a person involved in the matter.

Bear Stearns, the fifth-largest U.S. securities firm, provided the second fund with $1.6 billion of emergency financing last month in the biggest hedge fund bailout since the collapse of Long-Term Capital Management LP in 1998. The losses its clients now face underscore the severity of the shakeout in the market for collateralized debt obligations, or CDOs, investment vehicles that repackage bonds, loans, derivatives and other CDOs into new securities.

Bear Stearns spokeswoman Elizabeth Ventura declined to comment.

Risk Soars

Shares of Bear Stearns fell 57 cents to $139.34 in New York Stock Exchange composite trading, extending their decline this year to 14 percent.

The cost of insuring $10 million of Bear Stearns corporate bonds for five years jumped as much as $2,000 to $76,000, before easing to $70,000, according to credit-default swap prices provided by broker Phoenix Partners Group in New York.

Prices for other Wall Street firms' credit default contracts also rose, led by Lehman Brothers Holdings Inc., the largest underwriter of U.S. mortgage bonds. Lehman's default swap surged as much as $10,000 to a peak of $70,000, before falling back to $64,000.

The rise was stoked by concerns that Lehman faced greater potential losses from subprime mortgages than previously disclosed, traders said. Lehman spokeswoman Kerrie Cohen denied the speculation, calling it ``unfounded.'' Lehman shares fell 1.9 percent to $71.65.

Cioffi's Strategy

More broadly, the risk of owning corporate bonds soared to the highest in two years in Europe and rose in the U.S., credit- default swap prices show.

Ralph Cioffi, the 22-year Bear Stearns veteran who managed the two funds, sought to minimize risk by investing in the top- rated portions of CDOs. Under Cioffi, 51, the funds also borrowed money in an effort to boost returns. Instead, as defaults surged on subprime mortgages, they grappled with ``unprecedented declines'' in the values of AAA and AA securities, Bear Stearns said in the letter.

``That has implications for credit weakness in the next several days and weeks,'' said Peter Plaut, an analyst at New York-based hedge fund Sanno Point Capital Management. ``There's going to be more risk aversion.''

In an interview with the New York Times published on June 29, Bear Stearns Chief Executive Officer James E. ``Jimmy'' Cayne said the debacle was a ``body blow of massive proportion.'' Sanford C. Bernstein & Co. analyst Brad Hintz estimated in a July 16 report that Bear Stearns's profit may decline 6.8 percent this year as the firm restricts lending to hedge funds and declining demand for mortgage bonds cuts trading revenue.

`Dear Client'

Hedge funds are private, largely unregulated pools of capital whose managers participate substantially in any gains on the money invested.

Yesterday's letter, addressed ``Dear Client of Bear, Stearns & Co. Inc.,'' recounts how the firm's two funds unraveled in less than a month. In early June, faced with redemption requests from investors and margin calls from lenders, the funds were forced to sell assets. When those efforts failed to raise enough cash, creditors moved to seize collateral or terminate financing.

The fund that now has nothing left for investors, known as the enhanced fund, had $638 million of capital as of March 31, according to performance reports sent to clients at the time. It also borrowed about $11 billion to make bigger bets. Bear Stearns said last week that the fund's debt had dropped to $600 million.

Tremont, Paradigm

The larger fund, which had $925 million of capital in March, is down about 91 percent this year, according to a person with direct knowledge of the performance, who declined to be identified because the figures aren't public. It borrowed almost $9 billion, and its remaining debt was taken over by Bear Stearns in the bailout.

As prices of CDOs slumped, lenders demanded more collateral, forcing the funds to sell assets and mark down the value of their investments, creating a vicious cycle. The leverage magnified the losses, wiping out investors' capital, Michael Hecht, an analyst at Bank of America Corp., said today in a report. Hecht doesn't expect the funds' losses to reduce Bear Stearns's shareholders' equity and recommends buying the stock.

Investors in the second fund include Tremont Capital Management Inc. and Paradigm Cos., two firms that place client money with other hedge fund managers. Together, they have more than $9 million at risk.

`Reputational Risk'

Bear Stearns itself invested about $35 million in the funds, Chief Financial Officer Samuel Molinaro said on a June 22 conference call. The firm bailed out the larger pool to keep lenders from auctioning off assets and driving down prices.

``For them to put up so much capital, just for reputational risk, wouldn't make sense unless they believe they won't lose money on it,'' said Erin Archer, an analyst at Minneapolis-based Thrivent Financial for Lutherans, which owns about 200,000 Bear Stearns shares.

Merrill Lynch & Co., which was among the creditors to seize collateral, considers its ``exposure'' to be ``limited'' and ``appropriately marked'' to market, Chief Financial Officer Jeff Edwards said on a conference call yesterday. Merrill reported a 31 percent increase in second-quarter profit, even after revenue in the business that includes mortgages and CDOs declined.

Mortgage Markdowns

Douglas Sipkin, an analyst at Wachovia Corp., said today in a note to clients that most securities firms probably reduced the value of their mortgage assets during the first half of the year. Any holders that continue to overvalue CDOs and subprime bonds will have to mark them down to market this quarter, he wrote. Sipkin rates Bear Stearns shares ``market perform.''

Many holders of CDO securities don't have to mark the positions to market regularly, according to a report yesterday by Bear Stearns analyst Gyan Sinha. About three-quarters of ``super- senior'' AAA classes were bought by monoline insurers, while about half of other AAAs and AAs are held by commercial banks in financing vehicles, and another 10 to 15 percent are with insurers. Those holders could be forced to sell and realize any lost value if the securities are downgraded, Sinha said.

Bear Stearns shook up its asset-management unit last month, as the losses mounted. The firm ousted Richard Marin as head of the division, replacing him with Lehman Brothers Holdings Inc. Vice Chairman Jeffrey Lane, 65. Tom Marano, 45, Bear Stearns's top mortgage trader, moved over to asset management to help sell the fund assets. Marin, 53, and Cioffi remain advisers to the firm.

In the letter, Bear Stearns said it made such moves to ``restore investor confidence'' in its asset-management division.

``Let us take this opportunity to reconfirm that the Bear Stearns franchise is financially strong and committed to meeting your investment needs,'' the letter reads. ``Our highest priority is to continue to earn your trust and confidence every day.''

To contact the reporter on this story: Yalman Onaran in New York at yonaran@bloomberg.net .

Last Updated: July 18, 2007 17:31 EDT

And..here is an excerpt on a bit of a different perspective:

"....Recurring concerns about the fallout from bad subprime mortgages at times unnerved Wall Street this past week even as the Dow Jones industrials crossed the 14,000 mark for the first time. They also prompted buying in the Treasury market as bond investors sought quality.

Those tracking the subprime market believe the current turmoil shouldn't have been completely unexpected. After all, in 2006 some $600 billion of subprime loans were extended by banks trying to cash in on the housing boom. The decline in home prices caused tens of thousands of home loans to go bad.

But, that doesn't mean all subprime loans are in jeopardy. In fact, Bernanke said Tuesday he expects losses in the range of $50 billion to $100 billion as a worst case scenario.

And, that's not a massive amount for banks to grapple with considering they've set aside billions of dollars to cover the possibility of losses to their mortgage portfolios. Meanwhile, these same banks stand to benefit -- buying up troubled loans and repackaging them as investments, such as collateralized debt obligations.

All the Wall Street shops are really licking their chops to get at these loans," said Guy Cecala, publisher of Inside Mortgage Finance, a trade publication. "They'll set up entire divisions that will do nothing but buy nonperforming loans and resecuritize them."

He also points out that the big Wall Street banks -- Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers and Bear Stearns -- "can afford to write off loans." Further, they've already made millions of dollars from underwriting securities that back the loans -- and will continue to do so.

For instance, Bear Stearns does not expect its earnings to take a hit because of the collapse of the hedge funds. The nation's biggest banks -- including Citigroup, JPMorgan Chase and Bank of America Corp. -- also raised their loan loss provisions.

And, even if there are losses, analysts believe these financial institutions will end up in much better shape. They are better positioned to handle troubled loans and investments. And, they've also shed some of the riskiest parts of their portfolios and raised borrowing standards.

"The spillover into other areas, like auto loans, has been much less than we thought it would be," said David Weiss, global chief economist for Standard & Poor's. "And the subprime problems were really a good wake-up call to those creditors that had become too complacent about default risk."

I got this from a newsletter which I highly recommend written by John Mauldin although I just read it for curiousity not investment advice

It seems to illustrate Bear Sterns is just the begining and if interest rates go up more we will be in a pickle. Altough he seems to indicate at the end that interest rates will eventually go down in response to a slow down

This Week in Outside the Box we Join Bill Gross of Pimco in his July 2007 Investment Outlook as he strives to address the implications of the Bear Stearns hedge fund debacle, the toxic waste that is Wall Streets' innovative derivative products and their respective valuation, rather, lack thereof.

If Dear reader you have not been party to the excess of the Wall Street you may have not heard of the two Bear Stearns hedge Funds focusing on the subprime market that were subsequently liquidated on account of their inability to meet margin calls, thus wiping out investors. Mr. Gross believes that while significant, we ought not to look to Wall Street to see the repercussions of our excess but to the heart lands of America and the real estate there financed via subprime loans to witness the true folly of our capitalist ways.

John Mauldin, Editor

Looking for Contagion in All the Wrong Places
Investment Outlook
Bill Gross : July 2007

Whew, that was a close one! Ugly for a few days I guess, but it could have been much worse! No, I refer not to Paris Hilton upon her initial release from the LA County pokey after serving three days of hard time, but to the Bear Stearns/subprime crisis. Shame on you Mr. Stearns, or whoever you were, for scaring us investors like that and moving the Blackstone IPO to the second page of the WSJ. We should have had a week of revelry and celebration of levered risk taking. Instead you forced us to remember Long Term Capital Management and acknowledge once again (although infrequently) that genius, when combined with borrowed money, can fail. But (as the Street would have you believe), this was just a close one. Sure Bear itself had to come up with a $3 billion bailout, but folks, most of these assets are worth 100 cents on the dollar. At least that's how they have 'em marked! Didn't wanna sell any so that someone would think otherwise...no need to yell "fire" in a crowded theater 'ya know. After all, hasn't Ben Bernanke repeated in endless drones that financial derivatives are a healthy influence on the financial markets and the economy? And aren't these assets well...financial derivatives? Besides, I direct you to the investment grade, nay, in many cases AAA ratings of these RMBS (Residential Mortgage-Backed Securities) and CDOs (Collateralized Debt Obligations) and defy you to tell me that these architects were not prudent men. (Sorry ladies, they are still mostly men!)

Well prudence and rating agency standards change with the times, I suppose. What was chaste and AAA years ago may no longer be the case today. Our prim remembrance of Gidget going to Hawaii and hanging out with the beach boys seems to have been replaced in this case with an image of Heidi Fleiss setting up a floating brothel in Beverly Hills. AAA? You were wooed Mr. Moody's and Mr. Poor's by the makeup, those six-inch hooker heels, and a "tramp stamp." Many of these good looking girls are not high-class assets worth 100 cents on the dollar. And sorry Ben, but derivatives are a two-edged sword. Yes, they diversify risk and direct it away from the banking system into the eventual hands of unknown buyers, but they multiply leverage like the Andromeda strain. When interest rates go up, the Petri dish turns from a benign experiment in financial engineering to a destructive virus because the cost of that leverage ultimately reduces the price of assets. Houses anyone?

Oh, I kid the Fed Chairman - and I should stop because this is no laughing matter, and somehow I have a suspicion that this "close one," this Paris Hilton charade of a crisis, is really so much more than just a 3 or 27 day lockup in the LA County jail. Those that point to a crisis averted and a return to normalcy are really looking for contagion in all the wrong places. Because the problem lies not in a Bear Stearns hedge fund that can be papered over with 100 cents on the dollar marks. The flaw resides in the Summerlin suburbs of Las Vegas, Nevada, in the extended city limits of Chicago headed west towards Rockford, and yes, the naked (and empty) rows of multistoried condos in Miami, Florida. The flaw, dear readers, lies in the homes that were financed with cheap and in some cases gratuitous money in 2004, 2005, and 2006. Because while the Bear hedge funds are now primarily history, those millions and millions of homes are not. They're not going anywhere...except for their mortgages that is. Mortgage payments are going up, up, and up...and so are delinquencies and defaults. A recent research piece by Bank of America estimates that approximately $500 billion of adjustable rate mortgages are scheduled to reset skyward in 2007 by an average of over 200 basis points. 2008 holds even more surprises with nearly $700 billion ARMS subject to reset, nearly ¾ of which are subprimes.

It was not supposed to be this way. 1% teasers or 3% 2/28's were supposed to be rolled with no points into something resembling...well...1% teasers and 3% 2/28's. Instead today we have nearly 7% fixed rate mortgages and not a teaser to be found. Congress, regulators, even Fed officials are stepping in and warning mortgage originators (even mortgage buyers!) that they'd better be careful and only make good loans. Those nasty capitalists! They must have gotten carried away a few years ago. Somehow all those BMWs in the New Century parking lot in Irvine, California didn't attract much notice in 2006. Now, well, there's nary a Prius to be found there, but lots of outraged politicians in Washington, that's for sure.

The right places to look for contagion are therefore not in the white-washed Bear Stearns hedge funds, but in the subprime resets to come and the ultimate effect they will have on the prices of homes - the collateral that's so critical in this asset-backed, and therefore interest-sensitive financed-based economy of 2007 and beyond. If delinquencies lead to defaults and then to lower home prices, then we have problems and the potential for an extended - not a 27-day Paris Hilton sentence. Take a look at Chart 1, which graphically points out the deterioration in subprime ARM delinquencies.

Escalating delinquencies of course ultimately lead to escalating defaults. Currently 7% of subprime loans are in default. The percentage will grow and grow like a weed in your backyard tomato patch. Now I, the curmudgeon of credit, am as sure of this as I am that the sun will set in the west. The uncertain part is by how much. But look at it this way: using the current default rate of 7% (3-4% total losses), the holders of some BBB investment grade subprime-based CDOs will lose all of their moolah because of the significant leverage. No need to worry about fictitious 100 cents on the dollar marks here. One hundred percent of nothing equals nothing. If subprime total losses hit 10% then even some single-A tranches face the grim reaper. AAA's?

Folks the point is that there are hundreds of billions of dollars of this toxic waste and whether or not they're in CDOs or Bear Stearns hedge funds matters only to the extent of the timing of the unwind. To death and taxes you can add this to your list of inevitabilities: the subprime crisis is not an isolated event and it won't be contained by a few days of headlines in The New York Times. And it will not remain confined to a neat little Petri dish in some mad financial derivative scientist's laboratory. Ultimately through capital market arbitrage it will affect risk spreads in markets completely divorced from U.S. housing. What has the Brazilian Real to do with U.S. subprimes? Nothing except many of the same bets are held in hedge funds that by prudence or necessity will reduce their risk budgets to stay afloat. And the U.S. economy? Of course it will be affected. Consumption will be reduced to say nothing of new home construction over the next 12-18 months. After all, attractive subprime pricing has been key to the housing market's success in recent years. Now that has disappeared. Importantly, as well, and this point is neglected by most pundits, the willingness to extend credit in other areas - high yield, bank loans, and even certain segments of the AAA asset-backed commercial paper market should feel the cooling Arctic winds of a liquidity constriction.

If not taken too far - and there is no hint yet of a true "crisis" - these developments may be just what the Fed has been looking for: easy credit becoming less easy; excessive liquidity returning to more rational levels. Still, PIMCO looks for the Fed to issue an insurance policy in the form of lower Fed Funds at some point over the next 6 months. And what happened to our glass half-full secular thesis of last month? We still believe in strong global growth, but...as we also suggested...that the U.S. housing downturn will affect growth and short-term yields over the next year or so. We remain consistent and resolute. Contagion? Maybe, but you won't be finding it at "99.9%" pure Bear Stearns. Look for it instead, in the subprimely financed homes of Las Vegas, Rockford, Illinois, and Miami, Florida. This problem - aided and abetted by Wall Street - ultimately resides in America's heartland, with millions and millions of overpriced homes and asset-backed collateral with a different address - Main Street.

William H. Gross
Managing Director