The Bear Stearns-NEW Connection: Time To Short Select Investment Firms

By now New Century Financial (NEW) has surely become a household name. Trading was halted yesterday as its creditors cut funding. While bankruptcy appears certain for NEW, it behooves us to ask, who will be left holding the bag?

A commenter at CalculatedRisk forwarded a list that answers that question. It was originally posted on capitalstool.com.

[1] NEW originated mortgages
[2] NEW borrows money from Wall Street via warehouse financing
[3] NEW provides borrower with cash and receives note payable (the mortgage)
[4] NEW bundles up mortgages and ships them back to Wall Street less processing fee and covers its original borrowing
[5] Wall Street packages and then slices and dices and sells derivative securities (collateralized by the mortgages) to pension funds, insurance companies , money market funds, foreign investors, etc.
[6] Home owners begin to default on these mortgages thus effecting the mark-to-market value of the derivative securities
[7] Pension funds, insurance companies , money market funds, foreign investors, etc. go to Wall Street and demand that they take back these securities
[8] Wall Street goes back to NEW and asks them to buy back the original mortgages
[9] NEW ain't got no money -- they never did -- it was Wall Street's money

Now that domino #9 has fallen, it's time go back up the list! By the way, in the middle of NEW's free-fall, it nonetheless received an upgrade from Bear Stearns.

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According to this NY Times article published on Sunday, Mar. 11:

The Bear Stearns analyst who upgraded New Century, Scott R. Coren, wrote in a research note that the company’s stock price reflected the risks in its industry, and that the downside risk was about $10 in a “rescue-sale scenario.” According to New Century, Bear Stearns is among the firms with a “longstanding” relationship financing its mortgage operation. Mr. Coren, through a spokeswoman, declined to comment.

Hmmm, are you thinking what I'm thinking? It can't be that Bear Stearns was trying to cover its own behind with that upgrade, can it? The question on everyone's mind should be, "How much are they on the hook for?"

My brokerage couldn't find any IAI for me to short, so instead I shorted Bear Stearns (BSC) and Merrill (MER) yesterday. Major Wall Street investment banks are reporting this week, to be led off by Goldman Sacks (GS) this morning. It's going to be interesting!