Mortgage loss threatens US banks

Growing housing woes have put Wall Street on alert

The US housing downturn may have major financial repercussions, experts have warned, as Wall Street faces up to the crisis in the sub-prime lending market.

Bear Stearns, a leading US finance firm, is trying to prevent the collapse of two hedge funds with major exposure to the high-risk mortgage sector.

Should it sell off investments cheaply, it is feared similar funds will follow suit, causing a crisis in confidence.

Regulators are monitoring the situation amid fears of wider financial turmoil.

Complex investments

For some time it has been feared that the sharp downturn in the housing market, which has shown little sign of flattening out, will spill over into the wider economy.

Concerns have centred on so-called sub-prime mortgages through which money is lent to low-income, higher-risk borrowers.

The market is really worried about a contagion Michael Metz, Oppenheimer & Co

As activity in the market slows down and homeowners find it more difficult to meet mortgage payments, pressure has grown on finance firms with investments linked to the housing sector.

Two hedge funds operated by Bear Stearns have lost billions of dollars from collateralized debt obligations (CDOs) - complex financial products made up of bonds, loans and derivatives which are, in turn, funded by home loan debts.

The worsening state of the market, with rising interest rates leading to increased mortgage failures, has hit these funds hard and their value has shrunk.

Banking giant Merrill Lynch, which backed the funds, recently seized assets worth $850m and according to reports, has begun to sell these off.

'Black hole'

Experts fear this could lead to a wider sell-off as investors realise that CDOs, which are rarely traded and therefore difficult to value, are worth far less than was thought.

"The market is really worried about a contagion," said Michael Metz, chief investment strategist at Oppenheimer & Co.

"It is an open-ended black hole and a lot of people are going to take to the sidelines until it is clarified. Nobody knows how serious it is going to get."

CDOs are the fastest growing segment of the bond market, with their combined value exceeding $1 trillion.

One expert said the scale of the problem could not be calculated

Bear Stearns may move to avoid a fire sale of assets, thereby averting a wholesale devaluation of the market, by reaching private agreements with the funds' creditors.

This could potentially see it assume responsibility for loans it received.

"That's in everyone's best interest because then they won't have to revalue assets in their own portfolios," said Mark Zandi, chief economist at Moody's Economy.com.

But regulators are worried about the impact on the financial sector, ranging from banks which have lent money to hedge funds and pension funds which have invested in them.

The Securities and Exchange Commission is reportedly keeping a close eye on the fate of the Bear Stearns funds amid concerns of any "potential systemic fallout".