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Wednesday, June 13, 2007 2:13 AM

A Bear's Bath

Mish Moved to MishTalk.Com Click to Visit.

I did not expect to be doing an update to Bear Tracks & CDOs do soon. But here it is. More details of the Bear Stearns debacle came out tonight in a BusinessWeek article Bear Stearns' Subprime Bath.

Hit by the subprime market's collapse, investors in a highly leveraged—and losing—hedge fund find they can't get out. Investors in a 10-month-old Bear Stearns (BSC) hedge fund are learning the hard way the danger of investing in risky bonds with borrowed money. The investment firm's High-Grade Structured Credit Strategies Enhanced Leverage Fund, as of Apr. 30, was down a whopping 23% for the year.

The situation is so bleak that Bear Stearns' asset management group is suspending redemptions at the onetime $642 million fund—meaning investors have no choice but to sit on their losses. And that's got some hopping mad.

An investor in Europe, who didn't want to be identified, says he's been trying to get his money out of the hedge fund since February.

No Questions.

He's particularly incensed that on a June 8 conference call the fund's managers set up to discuss performance, Bear Stearns officials refused to field investors' questions. "They specifically said they weren't taking any questions," says the investor. "They didn't want to say anything."

A Bear Stearns spokesman declined to comment. Several hedge fund managers also didn't respond to an e-mail request for a comment. But in a June 7 letter to investors, Bear Stearns says it's suspending redemptions because the "investment manager believes the company will not have sufficient liquid assets to pay investors." Bear Stearns' asset management group, led by Ralph Cioffi, took the action after investors stormed the gates, seeking to redeem about $250 million, sources say.

In April, the hedge fund posted an 18.97% decline, according to the June 7 letter obtained by BusinessWeek. But even more shocking than that big loss: only weeks earlier, the company had said it lost just 6.5% for April, according to a May 15 letter the firm sent fund investors. It's not clear what happened in those intervening weeks to force Bear Stearns to significantly revise upward its estimated April losses.

the trouble at Bear Stearns' hedge fund is another illustration of the danger facing funds that rely heavily on borrowed money to make investment bets. True to its name, the High-Grade Structured Credit Strategies Enhanced Leverage Fund made liberal use of borrowed money. People familiar with the fund say many investments were leveraged 3 to 1, meaning for every dollar invested in a risky bond, the fund would borrow another three. Making highly leveraged bets works well if the value of an investment rises, but it can quickly crush a hedge fund if the investment declines in value.
I Have Questions
  • Why was someone locked in all the way back in February?
  • How many others were prevented from selling that far back?
  • So what did the Bear Stearns really know and when did they know it?
  • Does any of this have anything to do with the planned subprime IPO of Everquest Financial?
  • Did Bear hope to hide the losses until the IPO? Are losses now just too big to hide?
  • In June, just what was it that made Bear Stearns realize that the April losses were not really 6.5% but a whopping 18.97%?
  • What about May? What about June? The treasury and housing markets have not exactly been robust these last two months.
  • What does this all say about the moral hazards of Bear providing the assumptions for valuing the CDO equity on the sale to Everquest and to hedge funds and pension plans?
  • What about that sales pitch "Everquest will provide attractive risk-adjusted returns" to shareholders? Attractive? Really? Risk-Adjusted? Who is determining risk?
  • Why is Bear Stearns not answering questions?
  • Bear Stearns is suspending redemptions because the "investment manager believes the company will not have sufficient liquid assets to pay investors." Is time supposed to heal this? How?
  • How long will it be before this whole leveraged CDO mess blows sky high?
  • Who will be the scapegoat?
Mike Shedlock / Mish

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