Bear Stearns offers take on five tough weeks.

Recent events on Wall Street have left real estate professional full of questions: How does securitization really work, and what caused all the turmoil? Is the commercial mortgage-backed securities market here to stay? Are conduit quotes and commitments reliable?

The standard answers are hardly worth writing down: "Of course we're in for the long haul," and "the quotes are good as gold," - however the mechanics of securitization are a big secret.

What follows is the straight story from Bear Stearns, a firm that quoted, committed and closed loans dally for the past four weeks - while continuing to trade CMBS bonds actively.

How does Securitization Really Work, and What Caused All the Turmoil?

Imagine borrowing $1 billion, lending it out in $5 million chunks, and having the $1 billion come due - you sell the loans, pay off the $1 billion, and keep the difference. If the loans aren't worth $1 billion, you have an immediate loss.

That's how securitization works: By creating mortgage-backed securities, sellers usually get the highest prices for their loans.

What can go wrong during those six months?

* Underwriting is Poor: Lenders try to underwrite loans on prices and terms that deliver a profit upon sale. Their underwriting is judged first by rating agencies, then by the bond market. Some lenders don't realize that their underwriting was aggressive until their loans are packaged, rated and sold.

* Interest Rates Change: Good underwriting can't guard against changes in interest rates. A lender holding a 7 percent loan faces a gain or loss if lending rates, in absolute terms, rise or fall.

In response, lenders hedge their portfolios. In a perfect world, lenders would hedge against movement in commercial mortgage rates. In the real world, no such hedge exists. Instead, lenders commonly hedge against U.S. Treasury bonds - using financial instruments that are readily available and reasonably inexpensive.

* Spreads Change: So if lenders hold loans that yield more than the Treasury rate, and are protected against movements in the Treasury rate, what happens when mortgage rates move relative to Treasury rates? That is, what happens when spreads change?

That's what caused all the turmoil. Lenders were holding loans that they had underwritten at a given spread level, and suddenly faced a market where spreads were much larger. In other words, the premium that the bond market charges for bearing real estate credit risk shot up dramatically.

Lenders were immediately confronted with two facts: the loans that they were holding could be sold for substantially less than they expected, and new loans would require higher spreads to be profitable.

That is not to say the new loans would necessarily require higher coupon rates. Most of the market movement was Treasury rates falling while commercial lending rates stayed more or less constant. Commercial lending rates are still historically low; it was securitization profits that vanished.

Is the commercial mortgage-backed securities market here to stay? The CMBS market has fundamental advantages that will carry it through turbulent times:

* CMBS bonds allow the high bidder to set loan pricing. Life insurance companies, banks, mutual funds, pension funds and foreign investors routinely buy and sell CMBS. Broad capital market access means competitive financing rates.

The last few weeks generally saw CMBS performance worsening, but recently there were signs of improvement. A buyer stepped up and purchased some AAA-rated CMBS at a narrower spread (that is, a higher relative price) than was prevalent the day before.

Who was that buyer? A middle-sized bank from Europe. At that moment, that bank was the cheapest source of money for U.S. commercial real estate. The next day, it was someone else. Securitization means access to the best source of funds.

* The CMBS market delivers a quote. If the capital markets move, the money doesn't leave the system, loan pricing just changes. While that may seem harsh, at least borrowers know the cost of money and can get their deals done. With more traditional lenders, loan pricing is not as volatile - there's just the occasional period when the money dries up.

* The CMBS market has good disclosure. If a single loan goes delinquent anywhere in the CMBS market, everyone knows by the end of the month. Lenders are less likely to remain too conservative or too aggressive for a very long time. As more of the market is securitized, the chances of a credit crunch or a supply-led real estate recession diminish.

Are conduit quotes and commitments reliable? That depends on the conduit. Over the last five years, as real estate markets steadily improved and interest rates steadily fell, conduit lending was an easy business. A little lack of discipline rarely hurt - in a few cases, lenders stumbled into extra profits.

However, this downturn in the capital markets will start a much-needed shakeout in the conduit lending business. The well capitalized, disciplined firms will thrive.