Subprime Puts Bear Stearns Fund On Brink

[DrBob]

http://www.ft.com/cms/s/f92171f6-1eb7-11dc...0b5df10621.html

Subprime puts Bear Stearns fund on brink

Last updated: June 20 2007 00:03

A highly leveraged Bear Stearns hedge fund that made bad bets on the subprime mortgage market was on the brink of failure on Tuesday after Merrill Lynch rejected a proposed rescue plan and prepared to auction off $850m of assets that the fund had pledged as collateral.

In addition to large losses for investors and lenders to the Bear Stearns fund, some analysts feared that a failure of the fund could accelerate losses in the subprime mortgage-backed securities market and perhaps trigger a loss of confidence in the wider market for complex structured finance securities.

That, in turn, could lead to heavy selling and losses for investors, including Wall Street banks that hold some debt instruments before they are packaged and sold to investors. The Bear Stearns fund,

which raised $600m from investors and borrowed at least $6bn more

, presented a rescue plan on Tuesday to Merrill and other creditors.

Merrill’s rejection could lead other creditors to seize and sell collateral held by the fund, known as the High-Grade Structured Credit Strategies Enhanced Leverage fund. That would mean the fund would likely be forced to liquidate remaining assets to repay creditors and investors.

I hadn't realised the amount of leverage that these hedge funds use! The fund "raised $600m from investors and borrowed at least $6bn more". A few unexpected market moves could take a lot of hedge funds to the wire.

The real fun, though, will come when a large private equity fund fails!

[MarkG]

I hadn't realised the amount of leverage that these hedge funds use!

Where do you think that Yen carry trade credit has been going?

Edited June 20, 2007 by MarkG

[Realistbear]

Reminds me of one of those dark sci-fi films where the heroes are trying to exit a rusty old ship with a computerised woman's voice telling them how many minutes are left before the thing self-evaporates.

The warning lights are flashing orange and are about to go to red. Any assets that went bubble during the miracle years are about to go into melt-down.

[stuckmojo]

and the "secured" funds are not so secure anymore...

[eightiesgirly]

With the simply huge amounts of leverage these funds have it will scare the bj's out of the finance world if a big one explodes. That would be interesting!

[Realistbear]

If anyone has been following Bill Gross (the Bond King) it is interesting to see how the bond market reacts to risk in the market place. Too much of it and bond yields soar. If a big one does go down we can expect some more huge moves in bonds with IR accelerating to the upside very quickly.

The property market is doomed and I suspect its too late to get out now that the inventories are skyrocketing and the LR is reporting significant falls. In a skittish market any sign of a fall is bad news as the overgeared and BTLers rely on continued double digit appreciation to stay alive.

GC2 is here folks.

[dude wheres my house]

http://www.bloomberg.com/apps/news?pid=206...&refer=home

June 20 (Bloomberg) -- Bear Stearns Cos.'s attempt to rescue its money-losing hedge funds was thrown into doubt after Merrill Lynch & Co. decided to seize and sell $800 million of bonds held as collateral.

Merrill Lynch, a lender to the fund, distributed a list of the bonds to investors late yesterday, according to people with knowledge of the offering. New York-based Merrill Lynch postponed a smaller auction two days ago while Bear Stearns worked on a plan to bail out the hedge funds.

A slump in the U.S. housing market is leading to rising delinquencies on home loans, especially so-called subprime mortgages, made to homebuyers with poor credit or heavy debt loads. That's pushing down the value of securities backed by mortgages. The subprime crisis has already forced lenders such as New Century Financial Corp., the second-largest subprime lender last year, and ResMae Mortgage Corp. into bankruptcy, and caused the closure or sale of dozens more this year.

``This escalates'' concern about potential losses from a slump in the market for subprime loans, said Jim Vogel, a fixed- income analyst at FTN Financial in Memphis, Tennessee.

Two lenders, Goldman Sachs Group Inc. and Bank of America Corp., agreed to unwind complicated transactions directly with New York-based Bear Stearns without dumping the bonds on the market, the Journal said.

That was nice of them

The banks may want to avoid an asset sale because that could force them to revalue lower their own investments and loans they made to other funds, said Josh Rosner, managing director at New York-based investment-research firm Graham Fisher & Co.

You can fool some of the people some of the time but those bills are going to have to get paid

[benj]

I hadn't realised the amount of leverage that these hedge funds use! The fund "raised $600m from investors and borrowed at least $6bn more". A few unexpected market moves could take a lot of hedge funds to the wire.

It's pretty severe, but it's a far cry from the debt LTCM were carrying when they collapsed, which was something like $120bn.

However, it's still quite conceivable that there will be a general flight to liquidity as smart investors abandon any hedge fund with the slightest whiff of a mortgage-backed security in its portfolio. At which point, they are left massively over-leveraged with no obvious choice available to them other than to dump their assets as quickly as possible before anyone else notices.

How many of these damn hedge funds are there, anyway? And more to the point, do any of the big banks have healthy-enough balance sheets to put together a rescue package this time around?

[dude wheres my house]

And the market goes wild

http://www.bloomberg.com/markets/rates/uk.html

http://www.bloomberg.com/markets/rates/index.html

Thats alot isnt it?

Edited June 20, 2007 by dude wheres my house

[DrBob]

Subprime sector hit by $1bn assets sale

Last updated: June 21 2007 00:33

http://www.ft.com/cms/s/6ca1b14c-1f51-11dc...0b5df10621.html

http://www.ft.com/cms/s/6ca1b14c-1f51-11dc-ac86-000b5df10621.html' rel="external nofollow">

The giant market for securities backed by US subprime mortgages was thrown into turmoil on Wednesday as lenders struggled to sell more than $1bn of assets seized from two Bear Stearns hedge funds that suffered heavy losses on subprime bets.

The rout highlights the risks investors take when they buy illiquid and hard-to-value securities. Fire sales in times of stress can trigger dramatic changes in pricing in such markets, perhaps leading other holders of assets to mark their values down and triggering demands for additional collateral from lenders.

Kathleen Shanley, analyst at research firm Gimme Credit, said the unravelling of the Bear Stearns funds was “at best an embarrassment for Bear Stearns, and at worst it threatens to have a ripple effect on valuations across the subprime sector”.

One mortgage investor said that while the CDO assets for sale carried high credit ratings, they were backed by such risky mortgages as to be “junk in investment-grade clothing”.

And the relevance of this to the UK housing market is that mortgages have been packaged as CDOs here too, and we are in an international market. Although the 'subprime' market here is ostensibly smaller, huge numbers of interest-only and self-certification mortgages have been issued, which cannot be regarded as 'prime' risks. If extra risk is now priced into CDOs, mortgage providers (in the UK too) will be more reluctant to lend or will offer higher interest rates to less-than-ideal applicants. The development of a credit crunch is playing out.

The most amazing factor is that subprime mortgages were successfully dressed up into CDOs with high credit ratings. Someone must have made a lot of money out of this trick. Unfortunately pension funds will have bought many of these, effectively loading their books with the debt equivalent of junk bonds.

[Justice]

Reminds me of one of those dark sci-fi films where the heroes are trying to exit a rusty old ship with a computerised woman's voice telling them how many minutes are left before the thing self-evaporates.

The warning lights are flashing orange and are about to go to red. Any assets that went bubble during the miracle years are about to go into melt-down.

Fantastic RB as you are starting to say it as it is

what i know is that for every household in america you will find over half a million $$ dedt and that simply can not continue.

Yeas you can make money from nothing but weath is another matter.

[The Colour]

This has been going on for a while now.

http://www.businessweek.com/bwdaily/dnflas...0612_748264.htm

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.

"At the end of the day, I'd like someone to be honest with me about what's going on," says one investor in the hedge fund, which bet heavily on bonds backed by subprime mortgages, or home loans to consumers with shaky credit histories. 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.

That would p*ss me right off.

[benj]

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.

Probably isn't even his money. He probably borrowed it at 2.5% in Switzerland and dumped it into a hedge fund based on an expectation of 20% returns.

And if you borrow money to buy shares in a company that borrows money to buy debt-derivatives issued by a company that borrows money to buy debt from individuals who borrow money without thinking about whether they can pay it back, you deserve everything you get.

[Selling up]

And if you borrow money to buy shares in a company that borrows money to buy debt-derivatives issued by a company that borrows money to buy debt from individuals who borrow money without thinking about whether they can pay it back, you deserve everything you get.

Could this be the definitive single-sentence definition of a hedge fund?

[tenroom]

Probably isn't even his money. He probably borrowed it at 2.5% in Switzerland and dumped it into a hedge fund based on an expectation of 20% returns.

And if you borrow money to buy shares in a company that borrows money to buy debt-derivatives issued by a company that borrows money to buy debt from individuals who borrow money without thinking about whether they can pay it back, you deserve everything you get.

Why. Because he's been clever enough to make money out of nothing ??

I s'pose you wouldn't welcome his income, would you ?

[benj]

Why. Because he's been clever enough to make money out of nothing ??

Yeah, I bet he's feeling really clever right now!

Making money out of nothing is a nice trick, but only if you can keep the illusion going. Losing money you don't have is an even better trick, in that it's much more fun to watch.

And since you asked, I am perfectly happy with my own income, thanks. Which incidentally is almost entirely derived from making things for people who want those things made, and doing things for people who want those things done. Profitable enterprise, the old-fashioned way.

[Guest grumpy-old-man]

Yeah, I bet he's feeling really clever right now!

Making money out of nothing is a nice trick, but only if you can keep the illusion going. Losing money you don't have is an even better trick, in that it's much more fun to watch.

And since you asked, I am perfectly happy with my own income, thanks. Which incidentally is almost entirely derived from making things for people who want those things made, and doing things for people who want those things done. Profitable enterprise, the old-fashioned way.

the best & only way, but a way that the greedy, slimy modern bean counters financial managers just don't understand. It's about morals & decency you see imo.

ps - I don't like bean counters btw.

[DrBob]

Barclays faces hit over sub-prime loans turmoil

http://www.telegraph.co.uk/money/main.jhtm...2/cnbarc122.xml

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/06/22/cnbarc122.xml' rel="external nofollow">

Last Updated: 1:31am BST 22/06/2007

Barclays Capital is at the centre of concerns over its exposure to two Bear Stearns hedge funds facing collapse. Sources said the bank may have lent far more money to the high-risk funds than originally thought, much of it linked to the lower tier "sludge" category of sub-prime mortgages most vulnerable to rising US default rates. "This could hit Europe harder that people realise," said one banking specialist. "We understand that Barclays Capital has lent $1.2bn (£603m) to these funds."

Merrill appears to be having second thoughts about the forced sale after receiving "pitiful" prices for some of the riskier tranches of debt

. All the creditors are under intense pressure to avoid an auction process that could set off a chain reaction, causing a wholesale markdown in prices.

The risk is of a sweeping downgrade of mid-quality debt that forces mass liquidation by institutional investors.

Chris Cox, head of the US Securities and Exchange Commission, said he was keeping a close eye on the Bear Stearns crisis. "Our concerns are with any potential systemic fall-out," he said.

CDO issuance exploded to $503bn last year.

There is now over $1,000bn in outstanding CDO debt.

Well chaps, you were all right! The banks are doing everything possible to avoid a drop in CDO prices or a downgrade in their rating. Now we need just one more large hedge fund to go under, or a bank to break rank and auction off some the dodgy CDOs. Crunch!

[sikejsudjek]

No one should kid themselves that these 'investors' are anything other than leeches. Most don't pay any tax in the UK at all and are domiciled outside the UK. When they fail what tends to happen is that keeping the system going is seen as more important than the consequences of bail out. Why ? Because printing more money just passes on the burden to the rest of us via inflation. This is in effect a tax on middle and lower income earners who are hit hardest, as well as other businesses who are actually doing something useful for the economy.

Hedge funds are not some new financial wizardry benefiting the economy, they are risk takers of the casino, playing with other peoples pensions, investments, and income. The massive debts and high risks they are allowed to use are the result of weak regulation. They are asset strippers of the highest order, ruining perfectly good businesses for their private gain. When they fail more often than not its the rest of us who are asked to pick up the pieces. NuLabour and the Tories are both in their pockets.

Just wait until one large fund does down and you hear the phrase ' a rescue package has been put together by the Bank of England and international banks as failure wouldn't be in the public interest'. Then you know your being screwed yet again.

[DabHand]

Just wait until one large fund does down and you hear the phrase ' a rescue package has been put together by the Bank of England and international banks as failure wouldn't be in the public interest'. Then you know your being screwed yet again.

If you owe the bank £10,000 its your problem.

If you owe them a million its the banks problem.

If you owe them a billion its the taxpayers problem.

This is why its out of control, large financial entities know they have the lender of last resort. i.e. us and inflation tax we suffer when the BOE magics the rescue money out of thin air. There is no risk for these parasites.

[DrBob]

If you owe the bank £10,000 its your problem.

If you owe them a million its the banks problem.

If you owe them a billion its the taxpayers problem.

Brilliantly put!

I have the disconcerting sensation of watching a car crash in slow motion.

[The Colour]

http://www.ft.com/cms/s/f92171f6-1eb7-11dc...0b5df10621.html

A highly leveraged Bear Stearns hedge fund that made bad bets on the subprime mortgage market was on the brink of failure on Tuesday after Merrill Lynch rejected a proposed rescue plan and prepared to auction off $850m of assets that the fund had pledged as collateral.

The book's asset value is actually more like $778,785,807 according to a spreadsheet on now and futures:

http://www.nowandfutures.com/download/EMCR...tiesForSale.xls

Edited June 22, 2007 by The Colour

[drrayjo]

Insightful from minyanville.com;

John Succo

Jun 21, 2007 9:45 am

The Wall Street Journal yesterday reported two Bear Stearns (BSC) hedge funds that invested heavily in securities backed by subprime mortgage loans are close to being shut down. This is not surprising given the reality (which no one seems to recognize) that the market in credit derivatives is far from liquid.

In times of stress, the seemingly tight spreads that exist when the market is going up and everyone is seeking risk, rapidly disappear and disintegrate into vapor. Even those who own the protection and are seemingly in the driver's seat will quickly find out monetizing gains will be difficult, if not impossible, as dealers significantly widen their markets (if they are making them at all) and those trying to cover their exposure will be paying prices only the brokers see and not the customers monetizing.

In light of these developments, I wanted to revisit and update something I wrote about a little over a month ago. Earlier this year I was struggling to figure out exactly what I was missing with respect to Collateralized Debt Obligations (CDO) structuring. Specifically, I wanted to know why is the market so sanguine in the face of deteriorating collateral values in the mortgage market? One of my firm's theses has been that as the mortgage market deteriorates, investors holding CDO as an investment would realize losses and this would feed into other risky asset classes. Why aren't losses being seen when the market is so clearly deteriorating?

So I asked a large broker firm to send over its smartest math person on CDO structuring. The team that came over was headed by a very smart gentleman. He was very good at math and very straightforward. Working for a broker, I was prepared for some sugar coating. I didn't get any.

The answer is simple and scary: conflict of interest.

He explained that due to the many layers of today's complicated credit products, the assumptions used to dictate the pricing and outcome of CDO are extremely subjective. The process is so subjective, in fact, that in order to make the market work, an "impartial" pricing mechanism must exist that the entire market can rely upon. Enter the credit agencies. They use their models, which are not sensitive to current or expected economic activity, but are based almost entirely on past and current default rates and cash flow to price the risk. This, of course, raises two issues.

First, it is questionable whether "recent" experienced losses over the last few years really represent the worst of the credit market (conservative). But, even more importantly, it raises a huge conflict of interest: the credit agency's customers are the very issuers of the tranches they rate. The credit agencies, therefore, need to compete for business based in part on the ratings they are willing to give these tranches. As a result, they will only downgrade when forced to by experienced losses; not by rising default rates, not a worsening economy, but only actual, experienced losses. Even more disturbing, they will be most reluctant to downgrade the riskiest tranches (the equity tranches), since those continue to be owned by the issuers even after the deal is sold.

So even though the mortgage market has deteriorated substantially, mark-to-market losses by those holding the CDO paper have generally not been realized, simply because the rating agencies have not changed their ratings for all of the above reasons. Accounting rules only require holders of the paper to mark prices according to the accepted model, not actual prices. For example, below is a chart of the actual BBB minus tranch of the mortgage-backed securities pool from November '06 to present. The actual prices where traders can buy and sell are substantially lower than where investors are marking their positions.

The levels at which investors are carrying the paper is not reflecting the underlying reality of the holders simply holding their collective breath and the rating agencies ignoring a worsening environment.

I asked them what would force the rating agencies to change their ratings. The response was, "it's just a matter of time. If the market continues to deteriorate, the agencies at some point will be forced by the cumulative losses to acquiesce." Because these losses have been compressed, any re-adjusting of ratings by these agencies is likely to result in a massive repricing of risk. We may be there now.

[sossij]

If you owe the bank £10,000 its your problem.

If you owe them a million its the banks problem.

If you owe them a billion its the taxpayers problem.

If you owe them a trillion its the planet's problem.

[stormymonday_2011]

If you owe them a trillion its the planet's problem.

Yes, this partcular little bet is probably too big even for the Federal Reserve to cover.

The CDO market is almost as big as all of the UK's personal debt including mortgages.

Worse the liabilities can expand exponentially as this poster on the housing bubble blog explains

My understanding….

The entire financial system is based on a CDO being worth what is owed to it. John Q Public deposits $250K with a hedge fund. Joe Schmoe borrowed $250K to buy a house, that loan was packaged into a CDO for $250K, then bought by the hedge fund with the investors money….

Then, the $250K CDO is used as colatteral to borrow $2.5 million to buy more CDOs containing mortgages made to 10 more Joe Schmoes. This way, a 1% move in the market means the initial hedge fund investors make 10% on their money.

Repeat…. until there is over $1 trillion in CDOs used as colatteral for loans to buy the CDOs.

well, let’s say a few of the Schmoes start defaulting on their loans. No big deal. Foreclose and sell for $250K to cover the debt…. OOOPS!!!!! That $250K house that Schmoe bought, can’t be sold for $200K.

So, those CDOs start to drop in value just a touch. Suddenly, the 1% move = 10% ROI turns around. 1% drop = 10% loss. 10% drop =…

Well, when the hedge fund borrowed the money to buy the CDOs, there was an agreement to hold a certain value in assets. As the accets drop, margain calls means you have to sell the assets to repay your loans… it all unravels.

Well, if Merril sells the Bear Stearns CDOs for far less than “book”, suddenly everyone has to revalue, and all have margin calls which means they have to repay their loans, which means more CDOs sell at lower price, meaning more revalues and more margin calls and more liquidations.

In short, the whole financial system based on leverage (using a small amount of money as collateral to borrow a lot) unwinds.

Think 1929.

http://thehousingbubbleblog.com/?p=2986#comments