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Out of fear that a cleanup of bad loans would trigger widespread defaults, Japanese banks got themselves deeper and deeper into trouble by hushing up the problems. We are talking about the crisis at Bear Sterns’ subprime hedge fund. The crisis shows that major adjustments on how the market prices risks are overdue; this may have negative implications for stocks, bonds, and commodities, as well as the US dollar.

Bear Sterns is a leading provider of services to hedge funds; it is also one of the largest originators of subprime-backed collateralized debt obligations. CDOs are what their name implies: a security backed by collateral. CDOs are created when mortgages with various risk profiles are grouped into different tranches or segments. Among others, Bear Sterns would create a CDO in a bundle according to a client’s specifications. Indeed, Bear Sterns would work with a rating agency, such as Moody’s, to obtain the desired rating (a practice likely to face more scrutiny as some allege that Moody’s no longer acts as an independent rating agency, but as a syndicator in the offering).

The explosive demand in this sector has attracted ever more creative structures. Investors should have grown concerned when dealmakers started suggesting that one can create a higher-grade security by grouping together a couple of lower-grade securities; it is rare that 1 + 1 = 3. As these instruments have grown more complex, the clients buying these instruments often do not have a full understanding of what they buy.

How do you make a best-seller better? You introduce leverage. Not only can leverage be introduced in the credit derivatives that define some of these securities, but brokers eager to attract hedge-fund business may also accept CDOs as collateral to lend money. The hedge fund now attracting so much attention is Bear Sterns’ High Grade Structured Credit Strategies Enhanced Leverage Fund, launched only 10 months ago. It shall be noted that Bear Sterns did not put much of its own money into the fund, but supplied many of the CDOs. A total of US$600 million in invested capital was boosted with borrowings of about $6 billion.

The collateral provided by the fund had the highest ratings by Moody’s. However, a high rating does not ensure that the CDOs are liquid, ie, that they can be sold off on short notice. This became painfully clear as bets of the fund were creating heavy losses and some lenders asked for more collateral for the loans extended. In the industry this is called a margin call. Bear Sterns told other lenders, including Merrill Lynch, JPMorgan and Citigroup, that the fund was unable to provide more collateral. On a side note, it is rather grotesque that Merrill, JPMorgan and Citigroup are among the larger investors in a fund managed by Bear Sterns. The company put little of its own money into the fund.

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As Merrill went public with its plan to auction off the collateral, others tried to rescue the fund. There was talk that Citigroup would inject $500 million and Bear Sterns might inject $1 billion. And the Blackstone Group was very interested in supplying much-needed capital. Blackstone’s offer required the brokers to abstain from further margin calls for 12 months. Such restrictions may be common in the private-equity world that Blackstone is active in, but was not acceptable to Merrill.

As the rescue plan fell through, Merrill stated that it would go ahead with its auction yet again. In the meantime, JPMorgan was front-running Merrill by trying to unload collateral it held for the Bear Sterns fund. When all was said and done, it wasn’t clear how much which broker was able to sell, but the sales were halted once again, and the parties seem to have agreed on an “orderly unwinding” of the positions.

This had the hallmark of the biggest financial crisis since the bailout of Long Term Capital Management. In 1998, the US Federal Reserve coordinated a bailout that led to the orderly unwinding of a fund that threatened the stability of the financial system. But this time is different: the instruments involved are so complex that journalists have had difficulty relaying the issues to the public, but the multiple calling and canceling of auctions by Merrill highlight the behind-the-scenes maneuvering to avoid fallout to the rest of the industry and beyond.

Omi’s comments, which echoed those made at recent Group of Seven meetings on carry trades — borrowing a low-yielding currency to buy higher-return assets such as the New Zealand dollar — prompted the yen to jump against the dollar and euro.

“This erosion was in the making for some time now [certainly since the scary June 8 drop],” said Jon Nadler, an analyst at Kitco Bullion Dealers. “People ignored the subtext of risk aversion becoming trendy — and now they are suffering the consequences.”

“Technicals have converged with short-term fundamentals to yield a pivotal tone change in the market,” he said in e-mailed comments.

Gold for August delivery closed 1.4%, or $9.40, lower at $645.30 an ounce on the New York Mercantile Exchange after tapping a low of $642.80. It is trading at the contract’s weakest intraday level since Jan. 16. On Monday, the contract shed $2.30 to close at $654.70.

Silver futures followed suit, with its July contract dropping to a low of $12.15 an ounce, its weakest intraday level since Oct. 25, 2006. It closed down 4.6%, or 59.7 cents, at $12.28.

“Expectations of a more hawkish stance on interest rates by the world’s central banks looks set to keep gold on a back footing in the coming sessions,” said James Moore, analyst at TheBullionDesk.com, in a research report.

All that is needed, claims Global Resource Corporation (GRC), is a finely tuned microwave and – hey presto! – a mix of materials that were made from oil can be reduced back to oil and combustible gas (and a few leftovers).

Key to GRC’s process is a machine that uses 1200 different frequencies within the microwave range, which act on specific hydrocarbon materials. As the material is zapped at the appropriate wavelength, part of the hydrocarbons that make up the plastic and rubber in the material are broken down into diesel oil and combustible gas.

GRC’s machine is called the Hawk-10. Its smaller incarnations look just like an industrial microwave with bits of machinery attached to it. Larger versions resemble a concrete mixer.

“Anything that has a hydrocarbon base will be affected by our process,” says Jerry Meddick, director of business development at GRC, based in New Jersey. “We release those hydrocarbon molecules from the material and it then becomes gas and oil.”

In its annual report, the Bank for International Settlements noted that the conditions that led to the Great Depression of the 1930s and the Asian crises in the 1990s reflected the current environment.

“Each downturn was preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a ‘new era’ had arrived,” the bank said.

The BIS, the ultimate bank of central bankers, pointed to a confluence of worrying signs, citing mass issuance of new-fangled credit instruments, soaring levels of household debt, extreme appetite for risk shown by investors, and entrenched imbalances in the world currency system.

“Behind each set of concerns lurks the common factor of highly accommodating financial conditions. ‘Tail’ events affecting the global economy might at some point have much higher costs than is commonly supposed,” it said.

The BIS said China may have repeated the disastrous errors made by Japan in the 1980s when Tokyo let rip with excess liquidity.

“The Chinese economy seems to be demonstrating very similar, disquieting symptoms,” it said, citing ballooning credit, an asset boom and “massive investments” in heavy industry.

About 40 per cent of China’s state-owned enterprises are loss- making, exposing banks to likely stress in a downturn.

It said China’s growth was “unstable, unbalanced, uncoordinated and unsustainable” borrowing a line from Chinese Premier Wen Jiabao.

The group said the fast-moving crisis at two Bear Stearns hedge funds had exposed the underlying rot in the US sub-prime mortgage market, and the vast nexus of collateralised debt obligations known as CDOs.

“Excess liquidity in the global system will be slashed,” it said. “Banks’ capital is about to be decimated, which will require calling in a swathe of loans. This is going to aggravate the US hard landing.”

Charles Dumas, the group’s global strategist, said the failed auction of assets seized from one of the Bear Stearns funds by Merrill Lynch had revealed the dark secret of the CDO debt market. The sale had to be called off after buyers took just $200m of the $850m mix.

“The banks were not prepared to bid over 85pc of face value for CDOs rated “A” or better,” he said.

“God knows how low the price would have dropped if they had kept on going. We hear buyers were lobbing bids at just 30pc.

“We don’t know what the value of this debt is because the investment banks shut down the market in a cover-up so that nobody would know. There is $750bn of dubious paper out there in the form of CDOs held by banks that have a total capitalisation of $850bn.”

US property writer Paul Muolo described the Bearn Stearns crisis as the “subprime Chernobyl”, saying the bank had created a “cone of silence”.

Abandoned by fellow banks, Bear Stearns has now put up $3.2bn of its own money to rescue one of the funds, a quarter of its capital.

This is the biggest bail-out since the Long-Term Capital Management crisis in 1998, which Bear Stearns refused to join at the time. Bear Stearns is now alone, a case of rough justice being served.

Lombard Street’s warning comes as fresh data from the US National Association of Realtors shows that the glut of unsold homes reached a record of 8.9 months supply in May. Sales of existing homes slid to an annual rate of 5.99m.

The median price fell for the 10th month in a row to $223,700, down almost 14pc from its peak in April 2006. This is the steepest drop since the 1930s.

The Mortgage Lender Implode-Meter that tracks the US housing markets claims that 86 major lenders have gone bankrupt or shut their doors since the crash began.

The latest are Aegis Lending, Oak Street Mortgage and The Mortgage Warehouse.

“There isn’t a recovery about to happen,” said Ara Hovanian, head of the building group Hovanian Enterprise.

Nouriel Roubini, economics professor at New York University, said there were now concerns about “systemic risk fall-out” from the Bear Stearns debacle as investors look more closely at the real value of CDOs.

“These highly illiquid securities have been priced so far on unrealistic and distorted credit ratings as the ratings industry has been complicit,” he said.

“They have not been rerated in a way that is consistent with rising subprime default rates. “That is why Wall Street is in a panic. “Losses will be massive once these assets are correctly priced to market.”

Lombard Street said the Bear Stearns fiasco was the tip of the iceberg. The greatest risk lies in the “toxic tranches” of lower grade securities held by the banks.

Much-trumpeted claims that banks had shifted off the riskiest credit exposure on to the asset markets was “largely a fiction”, said Mr Dumas.

The worst of the US property crisis has yet to hit since there is an overhang of $2,000bn of mortgages with adjustable rates which have yet to be reset. Many borrowers could see payments jump by half, or even double.

At the same time, a spike in 10-year US bond yields by 0.65 percentage points over the last six weeks has drastically repriced the cost of fixed mortgages, knocking away a key prop for the US housing market.

The National Association of Realtors reported Monday that sales of existing single-family homes and condominiums dropped by 0.3 percent to 5.99 million units in May, the slowest sales pace since June of 2003.

Four years ago almost to this day, Joseph Briseno Jr. was shot in the back of the head at point-blank range in a Baghdad marketplace. His spinal cord was shattered, and cardiac arrests stole his vision and damaged his brain.

The 24-year-old is one of the most severely injured soldiers — some think the most injured soldier — to survive.

“Three things you would not want to be: blind, head injury, and paralyzed from the neck down. That’s tough,” said Dr. Steven Scott, head of the Polytrauma Rehabilitation Center at the Tampa VA Medical Center, where Briseno has twice been hospitalized for extensive care. In recent days, Briseno was hospitalized yet again, this time at the Washington, D.C., VA Medical Center.

As a high schooler, Briseno liked the Discovery Channel and CSI, and wanted to be a forensic scientist or investigator. He was 20, attending George Mason University, when he was called up from the reserves and sent to war.

After he was shot, he was flown to Kuwait and then to a military hospital in Landstuhl, Germany. His parents and two sisters rushed to his side.

“They told us, ‘Prepare for his service.’ That’s how bad he was,” said his father, Joseph Briseno Sr., a retired career Army man.

But he survived. From Germany, he went to Walter Reed Army Medical Center in Bethesda, Maryland, then to McGuire VA Medical Center in Richmond, Virginia. In December 2003, he went home, to Manassas Park, Virginia, where his parents, Joseph Sr. and Eva, quit their jobs to care for him.

“All our savings, all our money, was just emptied … the 401(k)s, everything,” said Joseph Briseno, who took a new job a year and a half ago to make ends meet.

Various charities, especially Rebuilding Together, raised money to renovate their basement, supply a backup generator for the medical equipment, and install a lift so they can hoist “Jay,” as they call him, into a chair and bathe him in a handicapped accessible bathroom.

“If you asked me this from the very beginning, if we can handle it, I wouldn’t lie to you. I would say no, that there is no way. There’s no way that we’re going to learn all these things. But my wife and I, we learned everything. We are the respiratory technician, we are the physical therapists, occupational therapists, speech therapists … his wound care nurse,” Joseph Briseno said.

“It’s a lot of work and it’s hard, and some days are harder than the other days. But we don’t take this as a burden for us because he’s our son. We will do everything for him.”

The family has help from VA-provided nurses, but not around the clock. Jay’s mother and father often do overnight duty, making sure their son is turned every four hours so he does not develop bedsores, which can become infected and threaten his life. If they do not turn him and keep him on schedule, he does not sleep well and becomes agitated.

At the Tampa VA, a nurse taught Jay Briseno to swallow his saliva — a big step that allowed him to have some pureed foods instead of just tube-feeding. He has not been able to handle any solid food, though — his injuries are too profound.

More recently, the Tampa staff tried to wean him from the respirator. This involved painstaking therapy to strengthen his diaphragm by placing weights on his belly and gradually increasing the air pressure on the machine to try to create resistance and muscle strength. So far, it hasn’t worked.

He has had other trials: surgeries, procedures and medications for bladder problems, high blood pressure, the opening for his breathing tube, dead tissue on his tongue — even an ingrown toenail. The latest is the bone disease, osteoporosis.

He can respond to questions by grunting or grimacing, and occasionally can say “mom” or “go,” but not consistently. He often opens his mouth.

“We believe he is very frustrated because he wants to say something. Those are the hardest times for us, especially when he’s sick or not feeling well. He just lays there. We don’t know what’s wrong with him,” Joseph Briseno said.