How Bear Stearns' Subprime Bets Really Cracked

Editor's note: Jim Cramer presents this special series on the fallout from Bear Stearns' hedge fund woes while he is on vacation. Check back every day through July 3 for more of his contrarian view. He'll return to his regular blogging on July 5.

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Be sure to read Part 1, Part 2, Part 3, Part 5, Part 6 and Part 7.

The media's theory that everything went to heck all at once in the mortgage market is just plain wrong, but I have to go through the whole debacle's history to get you there. First, though, some facts.

There's a vintage of mortgage paper -- subprime, bad-credit paper -- that has had a very high default rate. That's the part that was crafted just when the crest in housing occurred and when Dumb and Dumber -- as I call the two Bear Stearns (BSC - commentary - Cramer's Take) hedge funds involved in this mess, High-Grade Structured Credit Strategies Fund and High-Grade Structured Credit Strategies Enhanced Leverage Fund -- levered up.

The default rate on this paper ranges anywhere from 5%-6% for the better stuff, but lower-rated paper can see as much as a 10%-12% default rate for the real junk, depending on the issuer and the geography. That 10%-12% was and remains real junk because it was largely no-money-down paper where people could afford to walk away from homes and many speculators bought homes to flip. That went on extensively in 2006.

But the problem is the word "many." Again, the media want you to believe that all mortgages throughout this period, beginning with the boom in 2001, are blowing up left and right. The reality is that only the paper circa 2006 is blowing up left and right. There are some blowups with 2005 paper, but not many because lending didn't get real sloppy until there were so many players in the game that they had to lower standards to make money. That was 2006.

The media would have you believe that the default rate is 100% on this subprime paper that was written throughout the boom. The default rate is probably at worst, on a mixture of good and bad paper, 5%-6%. And there were very few funds that were like Dumber, which took mostly bad mortgage paper (remember, even Dumber had the good sense to mix the bad mortgage paper with low-rated corporates and autos), and fewer still that levered as aggressively as Dumber.

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