Will Main Street Sink Wall Street?
Mounting mortgage defaults by American homeowners with shaky credit have claimed their first Wall Street casualty, as investment banking giant Bear Stearns shuffled the leadership of its asset-management division and lost billions in the risky hedge fund market last month.
Two Bear Stearns hedge funds that invested heavily in subprime mortgage securities racked up huge losses last month after they made bad bets on complex securities backed by risky mortgages. The meltdown of the two funds has sent tremors through financial markets, causing investors to reassess their appetite for this type of risk.
Alarmed by the huge losses, Bear Stearns stepped in to bail out one of the two funds (and its many creditors) by providing a $1.6 billion line of credit. Bear Stearns does not plan to bailout a $1.1 billion struggling fund, according to a Reuters story. Furthermore, to contain the damage, Bear Stearns brought in Jeffrey Lane on June 29, from rival Lehman Brothers and named him chief executive officer to replace Richard Marin, who gets the courtesy title of senior adviser to the asset-management division.
The near-collapse of the two Bear Stearns hedge funds proves that the depth of America’s foreclosure fiasco is far from over. While it is unlikely to bring down the savvy Wall Street firm, the firm may become a potential target for government regulators, class-action lawsuits and expose the investment bank to a hostile takeover. Moreover, the episode is a black eye to the firm’s reputation — and to Wall Street overall.
The wizards on Wall Street — worried that the subprime mortgage debacle will blow up another hedge fund or a bank, or a bunch of them — fear that financial instability can spread into blind panic. Fear and anxiety could trigger a massive sell-off, exposing other Wall Street financial institutions to the same excesses of America’s housing bubble on Main Street.
Ironically, the rapid expansion of risky subprime lending has linked the fortunes of Wall Street to the fortunes of Main Street. While struggling borrowers are left to their own fate, Bear’s subprime blood bath might be a dress rehearsal for something bigger and scarier.
According to RealtyTrac, subprime loans made a major contribution to the more than 430,000 foreclosure filings reported during the first quarter of 2007. As for the remainder of the year, should this trend continue, RealtyTrac expects the number of foreclosure filings nationally to exceed 1.7 million by year’s end.