I was working as a CFO for a large Orange County insurance brokerage in 1994. At the time, the large investment houses, including Bear Stearns, Merrill Lynch and Lehman Bros, were making the rounds selling derivatives on margin. These were the same investment products that the Comptroller of Orange County had recently purchased, and they were being heavily touted throughout the Orange County institutional and commercial investment market as a result.
I sat through a presentation at our office in Tustin given by Merrill Lynch. My boss, the CEO, was an MBA (Ohio State) and a former Bear Stearns guy. I remember feeling somewhat embarrassed because I had no idea what the hell the Merrill guy was talking about, but figured that my boss did. Lo and behold, he was just as confused as I was. We both agreed that we shouldn’t invest in something neither of us understood. Shortly thereafter, Orange County went bankrupt due to a margin call on their derivatives position.
The point I am making is this: All of these CDO (collateralized debt obligations) and CDS (credit debt swap) products backing these mortgages (sub-prime and Alt.A) are part of a largely unregulated and little understood section of the market. I don’t think we (the general public) have clue one as to how bad the fallout could potentially be, but if Orange County in 1994 is any example, it could get real ugly.
Your comment on valuation was bang on the money. What Bear Stearns is facing in particular right now is the investor backlash surrounding misrepresented value (overstated) and risk (understated). Bear Stearns has a $20B position in the sub-prime market, and is absorbing losses at a frightful pace right now.
