As has been widely reported in the business media, New York-based Bear Stearns recently announced a $3.2 billion bail out of two of its hedge funds, due to investments in subprime mortgage loans (basically, home loans to borrowers with bad credit). Although the funds had been using fair value accounting to calculate the assets’ worth, the collapse caught many by surprise—largely because it is extremely difficult to value assets that do not have a ready liquid market. The funds ran into trouble when a downturn in parts of the housing market negatively impacted the funds’ investments in complex securities backed by subprime mortgages; since the securities are not frequently traded, the “fair value” is difficult to determine. Borrowed money was used in an attempt to save the funds.
