Bear Stearns is Beat

July 18, 2007 New York Post, etc. --In a still-breaking development, Bear Stearns bank notified investors late on July 17 that the assets in its two leveraged hedge funds, nominally worth about $9 billion a month ago, are effectively worthless, shocking the dollar into a renewed fall and threatening the wipeout of hundreds of billions of dollars worth of mortgage-based securities (MBS) and derivatives like those held by these two hedge funds. The dollar fell to historic lows of $2.05 against the British pound, $1.39 to the euro, and a still-more rapid chaotic fall might be triggered after Fed Chairman Ben Bernanke's Congressional testimony today and tomorrow. "Its almost as if there's some risk aversion developing against the dollar," a Bank of America executive warned to Reuters news service.

The Bear Stearns announcement means that what was considered very bad news for international credit markets three weeks ago--that MBS and related derivatives which the Bear Stearns funds creditors were trying to sell, were worth only 30-50 cents on the dollar--would have to be considered the "good old days" as of now. Bear Stearns said that "during June, the funds experienced significant declines in the value of their assets, resulting in losses of net asset value"; that there is "effectively no value left" in the so-called Enhanced Fund, and "very little value left" in the so-called High Grade fund which it tried to bail out with $1.5 billion of its own capital in late June.

Bear Stearns called this a difficult development for investors, in a whopper of an understatement which could quickly start applying not just to its investors, but to investors in the entire several trillion-dollar mortgage-based CDO market, and then the $6 trillion market in MBS based on U.S. residential mortgages. The loss of value implicitly applies to any of the securities in those markets which hedge funds, banks, or other holders try to sell--or even without trying such sales. The threatened losses on credit markets are in the hundreds of billions.

The New York Post on July 18 cited three hedge fund managers reporting that in the last week, large investment banks like Lehman Brothers, Merrill Lynch and Bear Stearns have ended the "leverage party" for MBS investments, whereby hedge funds borrowed up to 15:1 of the capital they used to buy MBS. Leverage is down to 5:1, at maximum. A partner of an $850 million mortgage arbitrage fund said he received a "margin call" or "repo" demand for almost $50 million of additional collateral within 48 hours from Lehman and Bear Stearns early last week. The result: forced sales of other assets, and more losses.