The Crash of 1929: Are We on the Verge of a Repeat?

Indeed, the subprime loans that carved America's cash cow for the last few years were rated just as poorly as Milken's junk bonds and ended up pretty much the same way: with the scattering of investors and players from a hailstorm of collapsed debts, besmirched reputations and impending government oversight. While Milken's house of cards was built on leveraged buyouts (LBOs), where an acquirer issued a bond to pay for an acquisition that he would pay back with funds yet to be earned, the engine that made subprime's train roll off the tracks are collateralized debt obligations (CDOs), which are intricately structured and packaged strategies pooled together to decrease the risk generated by the fact that they are usually home equity, car and credit loans so poorly rated that they promise only collapse for those who get them and seized assets for those who offer them.

Like I said, same scam, different name.

But this time the outlook is worse. For one, the subprime housing implosion has been a disaster for the market as a whole. Consider the case of Bear Stearns: Their hilarious hedge holes -- the CDO-heavy High-Grade Structured Credit Strategies Enhanced Leverage Fund and its sister, High-Grade Structured Credit Fund -- cratered in early June, going from about $10 billion to a few hundred million in assets within a matter of months, even though the hedge fund itself had been barely up and running for more than 10 months.

But here's the thing about hedge funds that makes them so lucrative: You can play both sides against the middle -- the middle class, come to think of it -- and still win. Huge. So it was no surprise when the Wall Street investment titan decided to bail out its own hedge fund, to which it had committed only around $35 million, with over $3 billion and counting. As Bear Stearns Chief Financial Officer Sam Molinaro explained in a conference call, "There continues to be significant value in it."

For those who work there, maybe. Meanwhile, those who invested in Bear Stearns' hedge funds are out of money, and those crushed beneath their so-called high-grade structures are out of their homes and cars, which are in turn seized and put back into the asset pool. Not a bad business if you can get it.

And while Molinaro's estimation of Bear Stearns hedge fund may sound rosy, the hemorrhaging of the housing market is anything but. Open up any newspaper to the business section and look for any headlines involving plummeting home sales or declining property values, and you'll taste the bitter pills, because Bear Stearns is by no means alone. Swiss wealth management powerhouse UBS shuttered its Dillon Read Capital Management hedge fund after losing over $120 million invested in the subprime Kool-Aid. Then there was Amaranth Advisors, which pulled off the biggest hedge fund collapse in history when it blew almost $6 billion of its $9 billion in assets in a mere week after a highly leveraged bet, although it threw its chips down on the price of natural gas

That's not the housing market, you say? Good point. In fact, the point altogether. As we shall see, hedge funds spread their bets across the entire economic table, and they are armed with that most virtual of investment strategies. It is called the naked short.

Getting naked with shorts

For those who don't know how hedge funds work, consider the casino table favorite known as craps. And for those who make their living or leisure playing it, forgive this short introduction.