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June 22, 2007 (LPAC)--Bear Stearns investment bank now intends to bail out two of its failing hedge funds, by extending to them $3.2 billion in emergency loans--the latest twist in Wall Street efforts to prevent a full-blown mortgage securities market crisis. The loans have two purposes: first, to prevent the hedge funds' creditors from seizing and selling assets, and second, to prevent the hedge funds' failure from triggering a systemic breakdown of the world financial system.

This constitutes the largest bailout since then-Federal Reserve Board chairman Alan Greenspan coordinated a Plunge Protection Committee $3.6 billion bailout of the Long Term Capital Management hedge fund in September 1998. There is evidence that the secretive Plunge Protection Committee--officially, the President's Working Group on Financial Markets-- played a heavy role behind the scenes in crafting the Bear Stearns package.

The two Bear Stearns hedge funds--the High Grade Structured Credit Enhanced Leverage Fund (HGSCELF), and the High-Grade Structured Credit Fund (HGSCF)--invested in exotic and risky Collateralized Debt Obligations (CDOs). These CDOs were predominantly invested in Mortgage-Based Securities bonds, especially those of subprime mortgages. The two hedge funds borrowed what is now reported to be $9 billion, from among the world's largest commercial and investment banks, including Merrill Lynch, JP Morgan Chase, Citigroup, Deutsche Bank, and Lehman Brothers. The Bear Stearns' two hedge funds, predominantly the HGSCELF, leveraged the $9 billion in borrowings into $29.7 billion in gambling bets on CDOs linked to the housing market. However, the meltdown of the subprime mortgage market, and the rise of interest rates caused the Bear Stearns hedge funds' bets to go wrong; thus far, they lost billions of dollars, and are going under.

The fly-in-the-ointment, is that in return for receiving the loans from the banks, the Bear Stearns hedge funds gave the lending banks CDOs as collateral. As the Bear Stearns hedge funds difficulties intensified, on June 19, Lehman Brothers, one of the smaller lenders, seized and sold the collateral-- the CDOs-- on the market, but received only 50 cents on the dollar. That meant, that investors were willing to pay only 50% of what the CDOs were officially listed as being worth. A big lender, Merrill Lynch, is threatening to auction $825 million of Bear Stearns CDOs that it holds, on the market. Reportedly, Merrill Lynch sold $100 million of the higher quality CDOs. Were Merrill Lynch to have attempted to sell the remaining CDOs on the market, it may have found that they were worth only 30 to 50 cents on the dollar.

This created a huge problem. If CDOs were shown in a large sale in the market to be worth only 50 cents on the dollar, then this would expose that most CDOs, especially those linked to subprime housing, were worth only 50 cents on the dollar. The holders of CDOs would have to devalue their holdings by 50%, and not just Bear Stearns, but all financial firms that hold CDOs. This would mean the write-down of hundreds of billions of dollars worth of fictitious CDO asset valuation, wiping out overnight the $1 trillion plus CDO market, one of the fastest growing markets worldwide, constituting a key part of the financial bubble. In chain reaction fashion, this would wipe out other instruments, such as credit derivatives based on CDOs. In turn, this would rupture the $750 trillion plus world derivatives market, pulling down the world financial system.

Though in the case of the Amaranth hedge fund failure of September 2006, some of its creditors were permitted to seize and sell a portion of the assets it gave them as collateral, the City of London and Wall Street financier oligarchy could not countenance this same procedure for the Bear Sterns hedge funds, because of the shattering implications it could have. It appears that deep into the night of June 21, the Plunge Protection Committee and Bear Stearns senior executives hammered an arrangement, whereby Bear Stearns would fork out $3.2 billion in loans-- equivalent to one-quarter of Bear Stearns' $13 billion in capital-- to the two hedge funds. This would be paid to the Bear Stearns hedge funds' creditors, rather than allow the creditors to sell CDOs, and rupture the system.

The crisis is far from over.