Making sense of the mortgage mess

If investors continue flocking to the safety of Treasuries, the subprime mess could claim a surprising victim: Private equity firms, which have been issuing gobs of junk bonds and loans to finance the leveraged buyout boom of the past few years. Lower demand for those could dampen the LBO craze, which has been supporting stock prices. So far the dislocations have been minor. Risk premiums for junk debt have increased a bit, says Jensen, but the change is barely visible in multiyear charts. Steven Miller of S&P's leveraged finance unit says it's too early to tell what might happen.

But it's not too early to count the losses among mutual funds, Wall Street banks, and hedge funds, which appear to have been blindsided by the subprime sell-off. Citigroup bought New Century shares just a few weeks before they plunged to 69 cents after the lender stopped making new loans and its credit lines were pulled. Mutual fund companies Vanguard Group and Hotchkis & Wiley Capital Management were also big holders. Hedge fund Farallon Capital Management amassed a 7.8% equity stake in Accredited Home Lenders, whose shares have plunged 85% this year. The funds with biggest stakes in Fremont, whose stock has fallen 59% this year, include Fidelity, Vanguard, and Putnam Investments.

Holders of the individual stocks are hurting, too. Alan Gold, a Chicago area commercial real estate broker, bought New Century shares two years ago. In the past month, New Century has said it would restate its 2006 earnings, disclosed a federal criminal investigation into its accounting practices and trading in its securities, and said the SEC has launched an investigation. "As investors we were innocent bystanders," says Gold, "relying on the audits and the so-called reputation of New Century."

As usual, the worst damage is being felt by those closest to the fire. The larger economy, at least so far, has only been singed.

Subprime meltdown Lenders willing to help struggling homeowners Six-month moratorium on foreclosures urged Regulators testify on subprime meltdown BusinessWeek: Making sense of the mess Blacks suffer most in U.S. foreclosure surge Q&A: Will woes ripple through economy?

The biggest winners? Without a doubt, they're the top executives at subprime lenders who sold shares before the collapse. Over the past eight months five directors and officers at New Century sold shares worth about $29 million, with most of the selling coming between August and November, when the stock was flying high. One of the biggest sellers was co-founder and Vice-Chairman Edward F. Gotschall, who grossed in $19.3 million. Gotschall did not return phone calls seeking comment.

The sellers at New Century weren't the only subprime executives heading for the exits before the roof fell in. Edward W. Mehrer, a director of NovaStar Financial Inc., grossed more than $1.1 million from sales from November through January. His last trade was on Jan. 23, when he sold 8,000 shares, generating $172,080 in proceeds. On Feb. 21, NovaStar's stock plunged 43% after it reported an unexpected fourth-quarter loss and offered a dismal outlook for 2007. A NovaStar spokewoman declined to comment.

MORE FROM BUSINESSWEEK

BusinessWeek Section Front

Stock Market Shrugs Off Jobs Report Oracle's Sun Deal: Oracle May Need to Loosen Its Grip Stocks: Five Market Mistakes to Avoid Referendums 2009: Gains for Government Spending, Gambling Banks' H1N1 Flu Vaccines Stir Outrage Intel-Dell Dealings Under Fire A Bold Plan for Chrysler Drugmakers' Payments Draw Heat Augmented Reality: Getting Beyond the Hype Stocks Finish Mixed BusinessWeek Section Front