An index that tracks the subprime market hit a low last week as a group of Wall Street banks participated in an attempt to rescue two hedge funds that suffered severe losses in them.
The banks, which had lent money to the funds, run by Bear Stearns, agreed to sell some of the mortgages used as collateral for the loans slowly and privately. To replace their capital and try to shore up at least one of the funds, Bear Stearns will commit more of its own money.
One investment adviser warns that continued weakness in the subprime market could bode ill for stocks. The potential source of trouble is not just what investors know about the subprime market and the hedge funds, run by Bear Stearns and others, that made big bets on it, but also what they do not know.
“It’s all out there in front of us, and it will all come out in the wash,” said Henry J. Herrmann, chief executive of Waddell & Reed. “We just don’t have any idea when the washing machine will finish its cycle. It could be two weeks or two years.”
It is also unclear who might be taken to the cleaners. Further losses in subprime mortgages could send yields higher on other forms of risky debt, including the borrowing that serves as fuel for corporate mergers.
If such yields rise, “a lot of private equity transactions may not go on because they’ll be more expensive and less lucrative, and that could affect the stock market,” Mr. Herrmann said.
Whether troubles in the subprime market result in a widespread increase in yields and further damage to hedge funds and other assets “is the fundamental question,” he said.
“I don’t have the answer,” he added, “but with all the leverage in hedge funds and other vehicles, losses could be substantial and the consequences great.”
