Bear Stearns announces that its hedge funds are almost worthless. - 18-Jul-07 - Generational Dynamics

The defaulting hedge funds that almost caused a broad market meltdown a few weeks ago are now almost worthless, according to a letter that the company sent to its investors on Tuesday afternoon.

The hedge funds are based indirectly on money earned from collateralized debt obligations (CDOs) and other credit derivatives based on mortgage payments made by individual homeowners across the company. As mortgage foreclosures have surged across the nations, the values of the CDOs have been falling, forcing the hedge funds to fall in value.

According to a faxed copy of the letter, appearing on the Wall Street Journal web site, one of the hedge funds has "very little value," and the other has "effectively no value left." Here are some excerpts:

"Let me take this opportunity to provide you with an update on the status of the High-Grade Structured Credit Strategies and High-Grade Structured Credit Strategies Enhanced Leveraged Funds managed by Bear Stearns Asset Management (BSAM). A team at BSAM has been working diligently to calculate the 2007 month-end performance for both May and June for the Funds. This process has been much more time-consuming than in prior months due to increasingly difficult market conditions.

[[Notice the names of these funds. Imagine what a Very Important Person you'd have to be to own shares in the High-Grade Structured Credit Strategies Enhanced Leveraged Funds. Wow! Just mention that name to a girl and you'd have her in bed before you reach the word "Funds." Too bad though, 'cause you're getting screwed in other ways as well.]]

As you know, in early June, the Funds were faced with investor redemption requests and margin calls that they were unable to meet. The Funds sold assets in an attempt to raise liquidity, but were unable to generate sufficient cash to meet the outstanding margin obligations. As a result, counterparties moved to seize collateral or otherwise terminate financing arrangements they had with the Funds. During June, the Funds experienced significant declines in the value of their assets resulting losses of net asset value. The Funds' reported performance, in part, reflects the unprecedented declines in the valuations of a number of highly-rated (AA and AAA) securities.

Fund managers and account executives have been informing the Funds' investors of the significant deterioration in performance for May and June. The preliminary estimates show there is effectively no value left for the investors in the Enhanced Leverage Fund and very little value left for the investors in the High-Grade Fund as of June 30, 2007. in light of these returns, we will seek an orderly wind-down of the Funds over time. This is a difficult development for investors in these Funds and it is certainly uncharacteristic of BSAM's overall strong record of performance."

Separately from the letter, Reuters learned that the value of the High-Grade fund is about 9 cents on the dollar.

This must be a disaster to the investors who had each invested millions or tens of millions of dollars in the fund. Even after the Bear Stearns debacle in June, investors were still hoping to get 50 cents on the dollar, but now are learning that they'll get next to nothing. I wonder how many people learned on Tuesday that they've lost their life savings?

News of letter came after the market closed on Tuesday, which means that the results weren't reflected in the ABX index values for the day.

Index price of low-quality ABX-HE-BBB- 07-1 credit derivatives and high-quality ABX-HE-AAA 07-1 credit derivatives from Jan 19 to Jul 17, 2007 (Source: Markit.com)

There are 15 ABX indexes, representing mortgages from before 2006 (06-1), before the second half of 2006 (06-2) and before the first half of 2007 (07-1); for each of those time periods, there are five quality ratings from the lowest (BBB-), representing the weakest subprime mortgages, where foreclosures are most likely, to the highest (AAA), representing the strongest and most creditworthy mortgagees, for a total of 15 different indexes.

By the time that the market closed on Tuesday, and before the letter was disclosed, 14 of the 15 ABX indexes has fallen to their lowest values ever. (The remaining one is very close to its lowest.)

Tuesday's news from Bear Stearns means that the indexes still have a lot farther to fall.

If you look at the two graphs, you'll see what a "crash" would look like if they were graphs of a stock market index.

The second and third of these situations will not happen until there's an investor stock market panic. But the first of these is already in progress, and is continuing to spread to other markets.

From the point of view of Generational Dynamics, a generational stock market crash is overdue. If you go back through history, there are of course many small or regional recessions. But since the 1600s there have been only five major international financial crises: the 1637 Tulipomania bubble, the South Sea bubble of the 1710s-20s, the bankruptcy of the French monarchy in the 1789, the Panic of 1857, and the 1929 Wall Street crash. We're now overdue for the next one. It could happen next week, next month or next year, but it will come with absolutely certainty, and will come sooner rather than later. (18-Jul-07) Permanent Link
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Generational Dynamics Web Log for 18-Jul-07
Bear Stearns announces that its hedge funds are almost worthless.

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Generational Dynamics Web Log for 18-Jul-07 Bear Stearns announces that its hedge funds are almost worthless.

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Generational Dynamics Web Log for 18-Jul-07
Bear Stearns announces that its hedge funds are almost worthless.