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The Spokesman-Review Newspaper
Spokane, Washington  Est. May 19, 1883

Subprime fallout

Tim Paradis Business Writer

NEW YORK – It’s their house, but you don’t have to live by their rules.

Wall Street can’t seem to make up its mind about the risks posed by rising mortgage defaults; one day it seems fearful and the next, the market seems to cast off doubt and move higher. But the average investor need not be so indecisive.

While the fluctuations might leave some individual investors exasperated and unsure of what to do, it could also serve as a lesson in diversification – the best play for regular investors might just be to avoid trying to anticipate every move in the market.

Indeed, Wall Street’s up-one-day-down-the-next mentality owes in part to recurring concerns about the threat posed by subprime loans gone bad – and the fact that investors at times find the extent of the problem difficult to quantify.

This month, however, Bear Stearns Cos. said two of its hedge funds were left essentially worthless following bad bets on the subprime lending market. And Federal Reserve Chairman Ben Bernanke stoked some concerns by warning that the situation with subprime loans would likely grow worse before improving.

Subprime loans are those made to borrowers with spotty credit. As home values have moved sideways or even fallen in parts of the country, and interest rates have risen, many of these borrowers have been defaulting.

So what does this mean for investors? Well, some of those subprime loans have been packaged and sold off to other investors as a type of bond. Some big investors like mutual funds and hedge funds invest in this type of debt.

To be sure, though, most individual investors aren’t likely to have direct exposure to subprime loans.

“For most mutual fund investors, the impact will be quite small,” said Andrew Clark, head of research, Americas, at fund-tracker Lipper Inc. “This is a market that’s been played in by the institutions.”

He noted that the vast majority of loans are prime, or higher quality.

“There has been no spillover into the prime market and nobody is talking about that.”

Still, there are a handful of bond funds that could suffer some direct hits.

The Morgan Keegan Select High Income Fund, for example, is down 5.5 percent so far this year in part because it has invested in bonds that carry greater risks than the safest bond types. With about $1.06 billion in assets, the fund’s three-year annualized return is about 6.96 percent and its five-year annualized return is about 9.35 percent.

“It’s a high-yield fund that has suffered quite badly this year,” said Andrew Gunter, an analyst at investment research provider at Morningstar Inc.

The broader risk to investors could well be an erosion of the confidence that has underpinned the market’s advance in the past year. Making it more difficult to access credit could hurt the dealmakers who have put together many of the corporate buyouts seen in this time. Such deals have helped leaven market sentiment and push stocks higher.