I've talked a lot about the depressed state of financial services stocks in my Strategic Advantage service, and the picture does not appear to be getting any better. When a major company like Bear Stearns has the sort of risk-management failure that leads to the knockdown of billion-dollar funds devoted to mortgage backed securities, it just has to get your attention.

This type of failure just doesn't happen often. Companies like Bear Stearns (BSC) have entire departments devoted to risk control to prevent these types of mishaps from occurring. In contrast, many other fund-management firms have just one or two people, who are often the portfolio manager's brother-in-law or step-cousin's best friend's ex-wife. Risk management officers are just not very appreciated at funds because they don't make the firms money. They are usually considered to be nerdy, uptight types who are always trying to say "no" to the high-salaried risk-takers at a firm who have a gleam in their eyes. So, if type of risk management failure can happen at Bear, imagine how bad it must be at the smaller firms with the same positions.

The failure of Bear's two mortgage bond hedge funds will likely turn out to be largely the story of a company that strayed too far out on the edge to try to bring in marginal new dollars. They thought that they could use computers to model and control the risk of securities whose values were tied to sub-prime mortgages. But those models appear to have failed in the real world where bids are no longer theoretical. When push came to shove back in May and June, there was no one to buy bonds at the prices that the computer models projected. Bear tried to step in with its own money, throwing as much as half a billion dollars at the problem, but to no avail. When fear paralyzes a market, there are no bids. And if there are no bids, there is no worth. It's very simple.

It's endlessly fascinating to me that the stock market anticipated this problem. Even as stocks were broadly rising this year, I repeatedly called my subscribers attention to the fact that the financials were not participating. This was obviously a yellow flag, and, fortunately, we were able to avoid owning them. I hope you did, too.