On Friday, Citigroup Inc. (NYSE: C) filed suit in U.S. District Court in Manhattan against rival Morgan Stanley (NYSE: MS) for allegedly breaching a credit-default swap agreement. The suit seeks unspecified damages.

The complaint alleges that Morgan Stanley, which recently announced that its CEO will step down, failed to live up to its obligations regarding the 2006 agreement. Citigroup's Citibank unit says it entered into CDS with Morgan Stanley to protect the bank against losses from a revolving credit line that it entered into with a collateralized debt obligation known as Capmark VI. The CDO was scheduled to mature in 2038, but its performance declined substantially after July 2006 as a result of the global financial crisis.

BusinessWeek reports that The Bear Stearns Company's (NYSE: BSC) $642 million High-Grade Structured Credit Strategies Enhanced Leverage Fund is not letting investors get their money out.

Why not? Well for one thing, the fund has lost 23% of its value this year. And another problem is that the fund has borrowed money -- three dollars for every dollar's worth of Collateralized Debt Obligation (CDO) -- to bet on an increase in the value of subprime mortgage-backed CDOs. (As I've posted, this is not necessarily a great bet.) So it lacks the funds to pay back those frustrated investors.

Too bad this Bear mauling is not limited to the investors in this fund. With interest rates rising, a trillion dollars worth of adjustable rate mortgage borrowers will be required to pay more over the next five years. And since these borrowers could not afford a conventional mortgage, many are likely to default. With foreclosures up 90%, this means more properties will be thrown on the market.

Housing prices will continue to decline and more subprime investors will be burned -- as will the banks like Bear Stearns which profited so handsomely from packaging these subprime mortgages into CDOs.

Peter Cohan is president of Peter S. Cohan & Associates, a management consulting and venture capital firm. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned in this post.