July 18, 2007

FLASH: Bear Stearns Tells Hedge Fund Investors There's `No Value Left'

Ruh-roh! Mark to market anyone? Anyone?

You gotta wonder how many more "suprises" are out there

Hint: Lots.

July 18 (Bloomberg) -- Bear Stearns Cos. told investors in its two failed hedge funds that they will get little if any money back after ``unprecedented declines'' in the value of AAA rated securities used to bet on subprime mortgages.

Estimates show there is ``effectively no value left'' in the High-Grade Structured Credit Strategies Enhanced Leverage Fund and ``very little value left'' in the High-Grade Structured Credit Strategies Fund, Bear Stearns said in a two-page letter. The second fund still has ``sufficient assets'' to cover the $1.4 billion it owes Bear Stearns, according to the letter, which was obtained yesterday by Bloomberg News from a person involved in the matter.

``This is a watershed,'' said Sean Egan, managing director of Egan-Jones Ratings Co. in Haverford, Pennsylvania. ``A leading player, which has honed a reputation as a sage investor in mortgage securities, has faltered. It begs the question of how other market participants have fared.''

Bear Stearns provided the second fund with $1.6 billion of emergency funding last month in the biggest hedge fund bailout since the collapse of Long-Term Capital Management LP in 1998. The losses investors now face underscore the severity of the shakeout in the market for collateralized debt obligations, or CDOs, investment vehicles that repackage bonds, loans, derivatives and other CDOs into new securities.

Ralph Cioffi, the 22-year Bear Stearns veteran who managed the two funds, sought to minimize risk by investing in the top- rated portions of CDOs, hence the ``high-grade'' label. Under Cioffi, 51, the funds also borrowed money in an effort to boost returns. Instead, as defaults surged on subprime mortgages, they grappled with declines in the values of AAA and AA securities, Bear Stearns said in the letter.

Market Implications

``That has implications for credit weakness in the next several days and weeks,'' said Peter Plaut, an analyst at New York-based hedge fund Sanno Point Capital Management. ``There's going to be more risk aversion.''


the puntiff said...

If Bear Stearns can't claw back its earnings, I guess it'll have to grin and bear it. Either way, it's looking pretty grizzly out there.

Anonymous said...

Another shudder to the system.

But right now the Bulls are in a state of euphoria. The market probably trades down for the first hour, then sideways for an hour, then rips up on another short squeeze. But CNBC will report it as "solid international growth".

I feel the need to compliment Dylan Ratigan though. He may emerge as the Walter Cronkite of the coming stock market debacle. Anyone one who watched Fast Money tonight on CNBC saw a very fair hand treatment of Bill Fleckenstein as he explained why he's "a bear on the market, though not willing to short it yet." Simply put, Ratigan is showing the ability to rise above the senseless cheerleading often put forth on CNBC.

Anonymous said...

The irony will be the collapse of the credit market. The funds which survive will be under strict orders not to purchase any mortgage products unless they have full transparency and are backed by substantial skin in the game from the homebuyer (return to 20% down.) In their greed, appraisers, realtors, brokers, lenders, financial companies, have slayed the golden goose. Now what? Oh yeah, new careers as repo men!

Anonymous said...

Tipping Point

Anonymous said...

Anyone got a list of who else owns this toxic waste? Golden Sacks?

Anonymous said...

Secret "mark to market" in action??

Anonymous said...

The funds' manager Ralph Cioffi and his team at Bear have been trying to "mark to market" the subprime securities that primarily make up their collateralized debt obligations -- pools of loans and bonds backed by subprime paper. Insight into how much these funds are actually worth and how they priced these assets will help the rest of the market assess the potential damage at other funds, and the potential liquidity-drying ripple effects

Anonymous said...

The fear is that such a worst-case scenario with the valuations could cause many more funds than expected to mark-to-market their portfolios. The next domino would be banks further tighten the strings on their lending to hedge funds through their prime brokerage business. This means investors that borrow to invest may have to pay more for the money they've been using. This might mean funds sell other assets to cover those costs, and that could include high-yield bonds and leveraged loans, both of which have also suffered losses of late.


Anonymous said...

Can Wall Street be trusted to value risky CDOs?

NEW YORK (Reuters) - The complex models that Wall Street uses to analyze risky investments in subprime mortgages may be as suspect as some of the securities themselves.

With a surge in defaults on subprime home loans jolting credit rating agencies and two Bear Stearns hedge funds in recent weeks, some fear that these models may overlook swift market downturns or corrupt loan data. That could spell further turmoil for credit markets.

The worry is that well-heeled hedge funds, Wall Street proprietary trading desks and ratings agencies may be too optimistic when analyzing or valuing exotic mortgage investments. As a consequence, future drops in market prices may be more severe and possibly trigger panic selling by sophisticated investors.

"These models end up breaking down rather dramatically during abnormal times," said Andrew Lo, a finance professor at Massachusetts Institute of Technology. "And, of course, those are exactly the times that we should and need to worry about."


Anonymous said...

``This is a watershed,'' my ass! Unless you think about all the people going to rebell against this government soon.

JC!!!! said...

"These models end up breaking down rather dramatically during abnormal times," said Andrew Lo, a finance professor at Massachusetts Institute of Technology. "And, of course, those are exactly the times that we should and need to worry about."

Abnormal times, what's abnormal, it's the logic behind the speculation in CDO's that's abnormal, one might say even twisted.

This is nothing more than excuse making for the rich and powerful, as though this wouldn't have happened if it wasn't for "abnormal" times.

anonymous wimp said...

Enron? What is this Enron you speak of?

Anonymous said...

can someone say lawsuits?....

Anonymous said...

Hey, I know the cure!

The second derivative! (From calculus people...)

In fact we can keep taking the derivative until we get down to a constant, then the game is over for the derivative of a constant is zero.

buyerwillepb said...

Bear Stearns Cos. told investors in its two failed hedge funds that they will get little if any money back after ``unprecedented declines''

How about getting the money back from the massive bonuses paid out last year?

Civil lawsuits anyone?

Anonymous said...

To those suckers who gave their money to Bear Stears!


Rembmer, just because they wear a tie, and work for Bear Sterns doent mean they are SMART.


Keyser Soze said...

Billy Ray Valentine to the Duke Brothers, circa 1985: "Sounds like you a coupla bookies to me."

Ophellia to Winthrop: "I'm just protecting my investment.....shut up and go to sleep."

Pension funds are Suzzaned. said...

This is just the tip of the iceburg. Wall Street is the money behind the subprime mess.

Lehman bros is even worse off than Bear Stearns. Goldman Sacs owns and has sold alot of subprime toxic waste as well.

And don't forget all the pension funds that bought this CDO crap with promises of double digit returns.

Anonymous said...

"It begs the question of how other market participants have fared."

OK. "Beg the question" is not a fancy way of saying "ask the question", or "pose the question".

To beg the question means to leave a question unanswered, or to avoid answering a question. (Think of the way a typical politician answers a question.) Question begging is a type of logical fallacy.

Magoo said...

So BS basically told the group of people who are asking (aka "investors") that all your money is of course gone, but we still plan to hold off marking the securities to market in an effort to soften the blow to creditors and the rest of the market?

Better hope there isn't some poster boy pension invested in these funds to parade across the evening news.

benevolentstranger.blogspot.com said...

I love your posts by the way you are the best. I am so glad you actually pick up on what is really going on out there. I had to dig to really get the inside scoop. I saw this tiny note on my nvestment feed last night. But with you it is always fresh and on the front page. Thanks again!

your benevolent stranger

Anonymous said...

Best as I can tell this is how this went down:

1-Collect money from investors who want higher yields but stay in the safety of bonds (i.e. debt)

2-Leverage investor cash in a 10-1 margin ratio (amt borrowed to investor cash in one funds situation is was 10 billion borrowed and backed by 1 billion in investor cash)
---I think this is an illegal margin arrangement in stock brokerage accounts but I guess hedge funds or Bond fund have different rules?

3-Use the borrowed cash to purchase CDOs backed by MBSs backed by sub-prime mortgages backed by overpriced/overvalued illiquid realty assets and people with poor credit and/or fraud.

4-CDOs are rated as being = to AAA paper by the tranching process which is too odd to explain so watch the video Keith had previously posted: http://www.youtube.com/watch?v=0YNyn1XGyWg

5-The CDOs & MBSs are not realy traded to valuation is done on a mark to market basis (a process made famous by the Enron scandal) http://en.wikipedia.org/wiki/Mark_to_market
which basically means we waived our magic wand & sprinkled some pixie dust and decided it has value "X" which = the 10 billion borrowed.

6-Consider steps of bullet # 3 to be a steep hill w/ the sub-prime borrower at the top. In some fashion they collapse and the $h!t starts rolling down hill.

7-At some point a margin call is made and the fund now must sell an illiquid asset that no-one now wants because its viewed as worthless.

8-The fund has no choice but to "unwind" (A term used for when a partnership or corporation goes bankrupt, sells its assets and settles its debts (in the order of secured to unsecured to equity holders) and when the assets run out anyone still standing in line gets nothing, e.g. the investors who will be last in line for their money!!

K.W. - Southern Ca. said...

Tigher lending standards means fewer borrowers.

More empty houses on the market.

Lower and lower prices.

We "hit bottom" when demand can finally keep pace with supply -
no one can really say when this will happen.

RJ said...

Here's what happens to investors when the trouble begins:

"Investors tried to get out of the funds, but in May, Bear Stearns halted redemptions. Shortly after that, several banks and brokerage firms that had provided loans began demanding more cash as collateral. On June 26, Bear Stearns said it would offer a $1.6 billion loan to shore up the more conservative fund and unwind its positions.

In yesterday’s letter to clients, Bear Stearns said that some $1.4 billion of the loan remains untapped."

If, as some analysts have pointed out, the stock market lags the housing market by about six months, now would be a good time to get the hell out. True, the markets can remain liquid for quite a while through credit, but that has probably played itself out.

Anonymous said...

The FHA, Fannie Mae and Freddie Mac have been ordered to buy more MBS's. Paulson is also urging China to buy more martgage securities.

jellybelly said...

"Can Wall Street be trusted to value risky CDOs?"

Sure, just like we trust the government to release honest numbers for economic growth and inflation. With a former money-center guy like Paulson at the helm of Treasury, their word is bond.

You can take it to the bank - LOL!

Anonymous said...

Alright you Punsters...

Looks like Bear Steans got Seared and Burned!

Out at the peak said...

They are having trouble with the AAA rated bonds?

The real collapse is with lower grade bonds.

ABX-HE-AAA 07-1....95.23
ABX-HE-AA 07-1.....88.11
ABX-HE-A 07-1......68.50
ABX-HE-BBB 07-1....47.09
ABX-HE-BBB- 07-1...45.02

Note: This data might not be directly related to the particular hedge fund, but it's definitely incredible.

KaliExPat said...

Haha, the fraudsters on Wall St. never seem to run out of suckers!

Remember this;

"Bear Stearns' Profits Rise 8% Despite Housing Slowdown"

"Posted on Mar 15th, 2007 with stocks: BSC"

"Bear Stearns Companies said this morning its Q1 2007 profit was up 8% on strong bond-trading revenues. Net income climbed from $514 million to $554m, on a rise in revenues from $2.19 to $2.48 billion."

This is Enron all over again, but this time the broker and investment bankers can't fail because they'll take the global system down with them! ROFLMAO

As a reporter that's been on Wall St. for 15 years I can't believe anyone's surprised, this is just the tip of the iceberg folks ;-)


Shakster said...

OH,now I get it.They didn't steal the money. They Borrowed it!

Anonymous said...

The SEC and Fed regulates margin levels for individual investors in stocks.

There is no regulation for institutional investors in bonds.

By the way, LTCM's failure was in exactly the same situation:

they were very levered and trading what seemed to be very "safe" bonds. (treasuries, in fact). They didn't have defaults, but an abnormality in the term structure persisted and went the 'wrong' way for much longer than naive models would predict.

In the present circumstance (packaging of mortgages) the underlying facts are that the supposed facts about the underlying mortgages going in are just plain lies. Garbage in, garbage out.

The thing about the bond market is that 'volatility' is nearly a point process. 99.99% of the time, barely nothing happens, and then one day you're whacked.

Ironically, if the hedge funds had been invested in something really obviously volatile like emerging market equities, it wouldn't have blown up because that volatility is consistent enough that it gets into the models and the lenders won't allow as much leverage.

Let's remember though, somebody else is on the other side of most of these trades. Amaranth collapsed in natural gas---and another hedge fund on the other side of them made out like bandits.

There will be de-leveraging and destruction of money and credit though.

When you start to get forced margin calls at the various funds and banks have to sell for "institutoinal" or "regulatory" reasons (and not economic/trading ones), then you ought to take the other side of these trades.

At some (low enough) price level, these toxic waste bonds will be a great buy---ironically again better than Treasuries whose returns will be inflated away.

Actually the problem is with the "AAA" bonds, not the low ones now.

AAA bonds should virtually never go below 99.9 or so---it's supposed to be the same credit rating as the US Treasury and GE for god's sake! The Bank of Japan doesn't have AAA any more, but we know that of course this is more creditworthy than some junk mortgages.

raynla said...


I think the real question is... Who are these "investors" who just lost a lot of money?


borkafatty said...

The Jig is up!

Anonymous said...

bear stearns is getting all lawyered up now ,it would appear. i think they are on the hook for some heavy cash because of this. they mislead a lot of people. them and the rating agencies are in deep doo doo because of this...i think some serious class action stuff whill be going on now. surely there will be more of these blow ups too.....

oh well......as al gore said one time....

everything that is up is down and everything that is down is up.......imagine that.....

DrNo said...

Anonymous said...

``This is a watershed,'' my ass! Unless you think about all the people going to rebell against this government soon.

No one is going to rebel.

Right now the pentagon is planning on how to squash domestic insurrection.

Why do you think all those Marines are being railroaded by the UCMJ?
It's to keep the rest of them inline when the SHTF.

Once the first few "protests" are crushed the rest of you, I'll be one of the dead ones, will herd like cattle into the re-education camp to be implanted(branded)with a microchip(MOTB)before being pimped out to China to pay back our debt.

Tanks and cruise missiles beat pistols and shotguns every time.

Anonymous said...

Enjoy the side show,

Basis Capital Australia, now says it is worth 50 cents to a dollar.

2b melted to 1b.

Seems to be "contained explosion"

Osman said...

Why no coverage on this? From yesterday's WSJ:

Insiders at Reit's Like What They See

Some investors have abandoned real-estate investment trusts lately, but REIT insiders have been rushing in.

REIT executives and directors spent close to $60 million on their companies' stocks in the second quarter, the largest amount in the past 26 quarters, according to research by Thomson Financial.

After performing strongly in recent years, REITs have come down sharply this year. The result is that REIT stocks are trading at a significant discount to the value of their underlying real-estate assets, said John Lutzius, chief executive of REIT research-and-trading firm Green Street Advisors...

Full Article (subscription req'd)

edd said...

This one Bears summary ...
Ann Ominous posted:
1. … but stay in the safety of
bonds (i.e. debt)
2. Leverage ...in a 10-1 margin...
3- …CDOs backed by MBSs backed by
sub-prime …
4- … tranching process …
7- … a margin call is made …
8- …"unwind"…(in the order of
secured to unsecured to equity
holders) and when the assets
run out anyone still standing
in line gets nothing …

[and I add:'To Hell with Kudlow !'
& "Save the USD !"]

Anonymous said...


America IS one BIG ENRON.

Have a nice day SUCKERS !

borkafatty said...

I'll be one of the dead ones:


As will I..but I am taking as many as possible before I expire