The Problem with Diversification

On the heels of Friday's news that investment bank Bear Stearns (BSC) was on the ropes, we are again faced with the unintended, and unwelcome, consequences of developments that were once touted as unequivocally positive.

During the good times - it's hard to believe that they only ended about a year ago - proponents argued that Wall Street banks' involvement in all sorts of financing, trading and advisory activities engendered diversification benefits that only made those institutions and the financial system stronger.

Now that the credit bubble is bursting, however, the opposite seems true, as the problems at one firm radiate outward in every direction, spawning a plethora of aftershocks. In "Global Financial System Braced for Ripple Effect," the Financial Times details a range of potential Bear-related systemic vulnerabilities.

Bear Stearns is hardly Wall Street’s biggest investment bank but its travails have far-reaching consequences for the global financial system because of its crucial behind-the-scenes role in some of the world’s most troubled markets.

Bear is a significant underwriter of mortgage securities, an active trader of derivatives and leading financier of hedge funds.

Analysts said it was almost impossible to know what impact Bear’s problems would have on its clients, its counterparties and on other investors holding securities or derivatives that Bear is trying to liquidate. ...

Comments

[johnthebear]

Looks like a scary Monday Open for all the world exchanges.

[notsosmart]

i think greenspan knew what was coming.

[Greg in Al]

I'm never investing in another bank again. Apparently, the banking industry is like a bunch of teenagers. Turn your back on them for a little while and they run amok. Pretty soon, you get the call to come bail them out of jail.

[NEH]

I've never invested in financials because they don't produce a real "product" and because I knew I could never understand them sufficiently. Though I've second-guessed myself on this a thousand times and understand the earnings I've missed, recently I have felt mightily vindicated. Maybe this is naive in some ways, but today I heave a great sigh of relief. Most of my portfolio is safe.