bear stearns has gone into $1.6 billion worth of damage control with the near collapse of two of its hedge funds that had invested heavily in highly rated pieces of collateralized debt obligations, or CDOs.

What exactly is a CDO? It's basically a bundle of risky debt, that includes mortgages, bonds backed by some of the riskiest home loans in the subprime market, credit card debt, loans to private equity. All this parcelled up into neat little sections, or tranches. Needless, to say the banks make a killing out of it by bundling it all up and then creating a buy/sell spread in the secondary market.

Sounds solid? Don't you believe it. The banks have been selling these risky tranches to the big pension funds which, as Bloomberg's David Evans wrote earlier this month, are called "toxic waste". No surprises then that the Securities and Exchange Commission has launched investigations related to securities backed by sub-prime mortgages, reports the Los Angeles Times.

And how did the Bear Stearns hedge funds get in trouble? Let's ignore the crap of the financial jargon and cut to the chase. What happened was that these highly paid experts made some bad bets on the US housing market, and now they've run into trouble. What makes it worse is that the banks that had loaned the funds money to make those bets now want it back. And guess what? The funds don't have it.

As Pollit & Co analyst Fabrice Taylor writes in the Globe and Mail, the fallout from this mess is going to spread and it won't just hurt investors who were silly enough to park their money in the US housing market.

"Lest you think you'll escape any damage because you have no investments related to U.S. housing, think again. Subprime gets a lot of press, but it's a small part of the overall repackaged debt industry. Where do you think some of the debt issued for aggressive buyouts ends up? Or binges of consumer spending?

"There will be shocks, both in terms of asset writedowns and lower earnings or losses. More important, though, is that asset prices themselves will fall if investors learn the hard way that they mispriced the money they've been lending and, in true form, turn the spigots off entirely."

The problem is that this could have devastating implications for the US, and by extension, the global economy. The savings rate in the US is in negative territory. As a result, US consumers have been relying on being able to borrow money against the ever-increasing value of their homes for a long time. They've had to do it in part because wage growth has not been that spectacular.

And the trouble is now they won't be able do that anymore because house prices are falling. That leaves them with two options: cut back on spending, or earn more.

These are now testing times for the US economy, the global economy and stock markets.