Back on Monday, I had a whole set of unanswered
questions about the collapsed Bear Stearns hedge funds. Today, we got news
– but no answers to those questions. In fact, there are now more questions
The news is that Bear Stearns has seized substantially all of the assets of
the hedge fund it "bailed out" with a $1.6 billion credit line. $300
million of that line has been repaid already, which means that the High-Grade
Structured Credit Strategies Fund owes Bear Stearns $1.3 billion.
Are there enough assets in the fund to be able to repay the $1.3 billion loan?
That’s very unclear. Dan Gross, of Newsweek and Slate, certainly
thinks it doesn’t. He writes, in an email to me:
Reading betwen the lines, I see that Bear (which would like us to think it
doesn’t have much exposure to that hedge fund it ran) lent the fund $1.6 billion.
$300 m was paid back, so the fund still owes Bear $1.3 billion. The assets
that stood as collateral are clearly not worth $1.3 billion, and could be
worth far, far less. Of course, Bear’s public investors have no clue–are
those assets worth $100 million, 0, $600 million? Reading the press, you have
no idea, and it doesn’t seem like anybody is particularly asking…
If the assets were worth $1.3 billion, why wouldn’t the fund have sold them
and simply paid Bear back?
I think I can take a stab at that last question. CDOs are, as we all know,
very hard to value. And right now, there’s no liquidity in them whatsoever.
So Bear can’t just wander out onto the Street and find a willing buyer for its
CDO assets at any price, let alone a reasonable one.
If there aren’t any buyers, does that mean those CDOs are worth zero? No. They’re
securities which come with an income stream attached – and that income
stream does have a present value. You can use a model to work out what that
value is ("mark to model") or you can try to use the illiquid market
("mark to market") – but there are problems with both approaches,
especially when the market doesn’t have any bids.
For that reason, it’s impossible to come up with a good answer to the question
of how much the fund’s assets are "worth" – there just isn’t
One True Answer to that question. If they’re held to maturity, I reckon there’s
an extremely good chance that the cashflows they generate will end up being
much more than $1.3 billion. But if you’re trying to sell them now, then, yes,
you’ll have a hard time finding someone willing to pay you that much.
What I don’t understand is why Bear Stearns is seizing the assets in the fund.
Bear Stearns, prime broker, is unlikely to be any more adept at liquidating
those assets than Bear Stearns, asset manager. It seems that the bank has already
lost faith in the new fund management team it only so recently parachuted in.
And then, of course, there’s the second, more highly-leveraged fund –
the one with the riskier portfolio, which didn’t receive any kind of Bear Stearns
bailout. Last we heard, it had a positive net asset value, but one commenter
at least on my blog doesn’t buy it. Writes KBHedge:
The more aggressive fund is the one where investors lost 100%. You can bet
that the lenders to this fund will also end up losing money as well, although
neither Bear nor the lenders have any interest in publicizing that fact and
how much pain it will cause lenders. But the major clue to the fact that the
lenders to the fund will lose money is that Bear chose not become such a lender.
Bear has never quite come out and said that all the lenders to the second fund
will be repaid in full. Given the difficulties it is getting into as a lender
to the more conservative fund, and given the continued deterioration in credit
markets this week, I’d be inclined to agree with KBHedge at this point. It’s
hard to see that lenders aren’t going to take some losses on the Bear
Stearns funds. But so far, no one seems to be willing to admit that.