Liquidity, Not Credit, Crunched Bear's Funds

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 4, Part 6 and Part 7.

Back to the plot: Now 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 -- are getting more frantic, having sold the good to fund the bad as the paper doesn't rally but the redemptions from the funds of funds keep coming.

Dumb has unloaded a lot of good paper to unwind leverage and free up collateral to pay other lenders and try to pay redemptions. But the redemptions continue, because the fund-of-funds guys have sold Dumb and Dumber to their investors as consistent and top-notch, so now the f-o-f gangs look like idiots and their reputations are getting killed. Adding to the pain, the totally hard-nosed credit guys at the lenders are freaking out and demanding ever more capital.

You have to understand that the margin guys all convey to the sales guys that this stuff has to be dumped. At first, there are buyers who take it down at discounts. But given its strangeness, there can only be so many buyers. Worse, once a buyer is hit with this stuff and the price goes lower because Dumb and Dumber are still dumping, there's no place to put it. So they either stop bidding or offer the paper at a loss themselves.

The paper becomes more toxic even as the defaults don't get worse.

There's not even enough time passing for them to get worse -- even though once again the media says that's what's happening. This dichotomy is why I said Friday that the issue isn't the creditworthiness of the bonds and CDOs but the lack of liquidity in the market and the forced selling. That's what is knocking down the value -- not accelerated defaults.

So now there's all of this 2006 paper floating around, and nobody wants it. Adding to the problem is that by this point, smart hedge funds, knowing that Dumb and Dumber are in trouble, are shorting the stuffing out of the paper, betting that when the funds collapse, they can cover on dimes to the dollar.

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