How Bear Got Burned

Don’t walk, run to Calculated Risk’s explanation for what really happened with those two Bear Stearn’s hedge funds:

"Let’s leave, for the moment, the question of the incredibly complex and
opaque layers of leverage, synthetic structures, derivatives swaps, and
mark-to-model valuations that transformed mere commonplace mortgage
loan write-downs into 23% losses of $600MM invested equity in
approximately 9 months on a fund created because its precursor fund,
which had dawdled along for two years or so generating a mere 1.0-1.5%
a month return, we are informed, just wasn’t good enough for the high
rollers who didn’t damn well put their money in hedge funds to earn
12-18% a year. This is really all about a bunch of subprime loans."

If you believe, as this NYTimes article apparently does, that its the fault of those pesky sub-prime borrowers defaulting, well, then you just haven’t been paying any goddamned attention.

Go. Now.

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  1. dblwyo commented on Jun 23

    Indeed – thanks for the pointer. And the Great Tanta’s interpretations are always worth the read. Your readers might be interested in the playblock demonstration of leverage from Jim Jubak in an MSN video:
    Jubak’s Journal: Emotions and the market
    Confidence is just an emotion, but a loss of it can cause the bond market to rumble. The recent case of a Bear Stearns hedge fund forced to liquidate billions is an example, MSN Money’s Jim Jubak says.

    And his deeper analysis of the rapidly eroding bond/credit markets:

  2. Winston Munn commented on Jun 23

    Had an interesting experience at lunch today. I walked by the table of a hedge fund manager and whispered “mark-to-market” from the corner of my mouth. Next thing I know, this guy had thrown up his lunch, pissed himself, and was running screaming out the front door.

    Guess his investors are stuck with his bill.

  3. Sammy20 commented on Jun 23

    Thank god for blogs like TBP, Minyanville, Calculated Risk, etc…

    I have seriously scaled back watching Kudlow & the Fox Saturday business shows but tuned into them this week just to see the spin.

    Kudlow practically bent over backwards to avoid the Bear Stearn’s mess and the Fox shows outdid him by not even mentioning it…not once on any of the shows!!!

    But there was a nice chat about magic diet pills….that fact that these show consider themselves financial shows is an absolute joke.

  4. speedlet commented on Jun 23

    What nobody seems to comment on is the fact that there has arisen in America a strange suicide pact between the two tiers of our voodoo-finance economy.

    There are indeed Two Americas: Subprime America and Hedge Fund America. They stand at opposite ends of the financial spectrum, yet both have leveraged themselves to the hilt using exotic instruments (derivatives, liar loans, etc.) that they probably don’t fully understand — yet. When they go down, they will go down together, in a form of Mutually Assured Destruction.

  5. m3 commented on Jun 23

    that was a great article.

    it put the blame where it belongs, the banks and their clients.

    so much of this has been put on a bunch of “dumb poor people,” rather than the investment banks, the mortgage brokers, the ratings agencies, and their clients who want a 30% return with no risk.

    the banks basically exploited the poor and their investor clients.

  6. Stuart commented on Jun 24

    “but if Fitch is to be believed, the “bailout” of Fund 1 is not an equity infusion but . . . wait for it . . . a loan modification! Apparently BSC is offering Fund 1 a collateralized repo facility with which the “financial community” can be paid off and BSC can now be collateralized by fund assets that still do or do not have any value as far as we don’t know.”

    I read that 3x in disbelief.

    “I must say I’m wondering how Bear Stearns can can offer a collateralized repo facility to a “troubled” hedge fund and not mark that sucker to market every day of its life. Can anyone explain how this is going to get unwound?”

    That was the exact thought and question pounding inside my head each time I read it. How, to mark it, how to unwind,…what a bloody mess.

    The clearing houses this weekend are burning up the lines. Can feel it.

  7. Arnie Pie commented on Jun 24

    We should be sure to give Tanta, not Calculated Risk, credit for writing it.

  8. S commented on Jun 24

    In the 1930s, when bank depositors lost confidence in the bank, they panicked and demanded their money back all at the same time. The banks frantically sold assets to try and meet the demands of the depositors, but ultimately failed. That’s commonly called a “run on the bank”.

    After the $3.2 billion infusion in the hedge funds, Bear’s balance sheet will be levered about 98%, when Debt/Assets is the metric used and debt is defined as everything above stockholders’ equity.

    Hypothetically, of course, what happens if one of the creditors looks in the mirror and says to himself, “Self, what the fuck was I thinking lending 98 cents on the dollar to a firm whose reputation is built on mortgages during a housing collapse?” Upon further reflection, he realizes that may not have been so prudent, and decides he’s not going to extend his commitments? He politely asks for his money back, thank you very much.

    Hypotheically, of course, the other creditors get nervous and say, “Hey, we know the Street will be front running the asset sales required to pay back the first guy who lost his nerve. Why should we continue playing ball and watch our collateral get marked down?” So they stop extending commitments and ask for their money back also.

    Hypothetically, of course, bank runs could never happen in the 21st century.

  9. mp commented on Jun 24

    Barry, a more appropriate title for your piece might be “Why Bear Stearns Is Burning.”

    It’s likely the fund will burn through the $3.2 billion fairly rapidly and Bear Stearns will be stuck with the loss, regardless of the terms by which the fund received the money. They ponied-up as expected and I expect they’ll eventually send even more cash down the same sinkhole.

    Now, here’s a fact with interesting implications. Molinaro stated in Friday’s conference call that the two funds’ inventories were roughly the same in terms of quantity and quality, the difference being that the fund they cut loose was highly leveraged. He wouldn’t be more specific. We know-thanks to Business Week-that the worst of the junk from both funds had already been sold to Everquest, so the paper in the two funds was probably of “reasonable” quality.

    So, what’s going to be marked to market? I’m speculating that a lot of it is not going to be paper heretofore regarded as “junk.”

  10. Winston Munn commented on Jun 24

    Subprime contained??? Well, yes, I suppose so if you are talking about to this planet.

    The Winston-Salem Journal:

    “Homeowners with about $515 billion on adjustable-rate home loans will pay more this year, and another $680 billion worth of mortgages will reset next year, analysts led by Robert Lacoursiere wrote in a research note. More than 70 percent of the total was granted to subprime borrowers, people with the riskiest credit records, they said.

    New foreclosures set a record in the first quarter, with subprime borrowers leading the way, the Mortgage Bankers Association reported.

    “The large volume of subprime ARMs scheduled to reset at higher rates in ’07 and ’08 will pressure already stretched borrowers,” forcing more loans into foreclosure, the Bank of America analysts wrote from New York. Interest payments on about $900 billion of the riskiest subprime home loans are due to increase this year and next, they said.”

    What is not being discussed is that over the last 2-3 years, CDOs have replaced mortgage companies as lenders. Banks and mortgage companies that initiate loans have turned into fee collectors who absolve their balance sheets of loans by selling them off.

    Those interest rate reset numbers of $515B and $680B are almost totally represented by bonds packaged as CDOs. 70% of those are subprime resets.

    It is a nuclear time bomb wrapped in a tidy, pretty package, passed around, and each who holds the package collects a fee if they can pass the package on – but whoever is holding the package when the bomb goes off will understand why there is a Fi-Fo-Fum connected to all those Fees.

  11. michael schumacher commented on Jun 24

    I love the headlines all over on Friday, they mostly read like this:

    Stocks down, Oil up……

    Not one mention of the pending CDO write downs as a cause.

    I guess it’s easier for us “masses” to understand that oil was the reason for almost a 200 point drop on friday.

    Hmmmmmm USO closed up a whole .30 for the day

    Yep that BIG jump in oil prices caused it all

    Effing Sheeple will beleive it too. What until the next CDO problem, I bet they don’t wait and just dump them on the market and that will get the game of musical chairs going fairly quick.

    This week should be funny to watch……at least how they explain it.


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