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The mystery behind the mess in subprime mortgages has been: Where did the risk go? Well, we're starting to find out that the answer is: into many nooks and crevices of the financial markets worldwide. This is way beyond hedge funds.
Recent casualties include IKB Deutsche Industriebank AG and Commerzbank in Germany; the bonds of U.S. investment banks, which have lost $1.5 billion of face value this month; insurance company Radian, which may have to write off a $518 million investment in mortgage servicer C-Bass; and even bond fund State Street Global Advisors, whose investments in subprime mortgage-backed securities has lost $90 to $120 million this month, according to Total Securitization. Even research departments are being hit: Nomura Securities is closing its fixed-income research department as it exits the residential mortgage-backed securities business.
All of this so-called spillover was beyond the ken of Ben Bernanke or any of the renegade subprime mortgage originators in Southern California – at least, I think it was. That doesn't excuse them.
The most striking thing about the subprime mortgage meltdown is its predictability. It most definitely was not a black swan – a hard-to-predict event beyond the realm of normal expectation. More than two years ago it was evident that subprime mortgage originators were making very questionable loans, introducing risky products and not pricing for that risk.
If any more European banks suffer significant losses, U.S. financial regulators, in the words of Ricky Ricardo, will "have some 'splaining to do."
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