Fire sale at Bear Stearns alarms Wall Street as hedge funds plunge
Thursday, 21 June 2007
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A planned fire sale of assets from two crippled hedge funds has been attracting the attention of a nervous Wall Street, for fear it could reveal billions of dollars of hidden losses across the financial system.
Bear Stearns, the investment bank formed in 1923, was last night still struggling to save its two funds, which got into trouble after the US sub-prime mortgage market collapsed. But creditors including Merrill Lynch moved during the day to auction off more than $1bn (£500m) in assets seized as collateral for loans.
The two funds had raised about $1.5bn from investors but were using debt and derivative instruments to make bets of about $30bn on the financial markets. Its investments were mainly in complex financial instruments backed in part by sub-prime mortgages.
The number of sub-prime borrowers - Americans given high-priced home loans, despite being deemed a poor credit risk - who have got into arrears or had their homes repossessed has spiked to a record level, and the effects of rising defaults are rippling through the financial system.
The mortgages have been parcelled together with other investments into products called collateralised debt obligations (CDOs), which are sold on piece-by-piece to other investors. Their sheer complexity is such that their value is usually calculated using mathematical models rather than open-market prices.
Demand for new CDOs backed by sub-prime mortgages has already dried up. If the price existing assets fetch in an auction proves disappointing, hundreds of banks, hedge funds and other investors could discover they are sitting on losses they did not realise. Hank Paulson, US Treasury secretary, warned yesterday that there would continue to be "after-shocks", but insisted they would be contained and would not damage the overall economy.
Late on Tuesday, Merrill Lynch rejected a rescue plan for the two funds that would have involved Bear Stearns putting in more money. Instead, it began yesterday handing out details of some $800m in CDOs and other assets that it had seized and planned to auction. Deutsche Bank was among other creditors rumoured to be doing the same. The UK's Barclays also has an unquantified exposure to the two funds.
The funds were set up and run by Ralph Cioffi, a Bear Stearns mortgage-bond veteran, who successfully auctioned off $4bn of higher-quality assets last week as he battled to satisfy creditors and save the fund.
Investors have been clamouring for their money back since sub-prime mortgage market bets went awry in April and the fund suddenly found itself down 23 per cent from the start of the year.
The first two lenders to unwind their positions, Goldman Sachs and Bank of America, reportedly did so directly with Bear Stearns, rather than dumping billions of dollars of bonds on the market. JP Morgan pulled its auction of seized assets at the last minute yesterday in order to do the same, but it appeared that Merrill Lynch was going ahead.
