The CDO (collateralized debt obligation) blow-out at Bear Stearns recently continues to simmer on the back burner with the media doing a fine job of trying to keep the heat from being turned up.

But, here is what is interesting or should I say here is what is scary.

Following this blow-out, Merrill Lynch stepped up to the plate to take some of these smelly, putrid CDO’s off Bear Stearns’ plate. Merrill was subsequently stunned when they tried to put some air freshener on these CDO’s and re-peddle them back to the market. The market was only willing to pay Merrill a fraction of what Merrill thought they were worth. And herein lies a problem of tectonic-like magnitude.

Funds, banks and investment houses are required to carry thngs like CDO’s at market value on the balance sheets. Has Merrill done this? I would say not. Have other financial institutions properly “marked to market” their CDO’s ? I would suspect not.

In my most recent blog I argued that the current sell-off may be reaching its end. This does not mean that all is well and that markets will rebound to make new highs. No not at all. I say from here the markets will move in a trading range as the truth behind the true valuation of derivative instruments like CDO’s gets sorted out. As the market moves forward in what I think will be a trading range, nimble institutions will no doubt make money playing the swings in share prices. Sadly, the retail investor with his “buy and hold” mentality will be the one who suffers.

Times like these do not lend themselves to buying and holding. Stay alert. Watch the markets closely. Play the swings. Take smaller gains on trades and do so repeatedly. In other words…..be careful out there. The financial system is full of minor structural cracks. Put enough of these smaller cracks together and you can have a major problem. Not unlike what just happened at a certain bridge over the Mississippi River in Minneapolis. But that’s another story for another blog.