(snip)"Comparison with LTCM

Long Term Capital Management failed in 1998. It was the last truly serious financial collapse which threatened the financial system. When LTCM went under, the bail-out fund required was $3.65 billion. The fund itself was leveraged to about $125 billion of assets using a similar style of wheel financing to the one described above for Bear Stearns' hedge funds.

There was also the presence of off-balance sheet devices called interest rate swaps – not so different in principle from the CDS described above.

Last week's rescue package announced for Bear Stearns smaller fund has been announced at $3.2 billion. We are awaiting the figures for the larger and more serious case. We believe the overall liabilities of both funds are in the $20-$25 billion range.

Back in 1998 LTCM was ploughing a lonely furrow. Its investment view was something to do with Russian bonds and the Japanese Yen. It was off the main investment spectrum, and there were few copy-cats putting the same market view into action in the same way.

That is where things are very different this time. The data produced by Standard and Poors above show just how conventional a strategy Bear Stearns has been following – all of it trailing the worldwide boom in housing markets. Many banks and funds are involved. Perhaps they are not quite so exposed as Bear Stearns, but it is only a matter of degree. This makes the size of the problem potentially much larger, and of much greater risk to the whole financial system.

How large? Well, the equity lost can be very roughly estimated from first principles. There are about 6,000,000 subprime mortgages in the USA. They typically result from re-financing deals – topping up to utilise whatever equity has accumulated in a house usually to pay off credit card debt; so they stay near 100% outstanding. The average house price in the USA is about $190,000, but we can reduce that to $150,000 on the assumption that we're at the lower end of the market. That gives us a principal sum of $900,000,000,000, which is 7 times the size of the LTCM exposure.

But the more serious figure – the housing equity lost to falling prices – is currently estimated at approaching 8% which is $72 billion. That doesn't include an adjustment for synthetic CDOs created by investment bankers to short the weakest MBSs, which is what they did with Delphi Corp.

Now you can see the difference in scale between LTCM and the subprime bust. This may be 20 times worse than LTCM. And it's getting worse – daily."(snip)