Did Bear Stearns fail due to sub-prime mortgages way back last Summer?
Found this from JULY 2007
Bear Stearns admits two subprime mortgage funds are worthless
Submitted by cpowell on Wed, 2007-07-18 01:05. Section: Daily Dispatches
By Joey Bel Bruno
Associated Press
Tuesday, July 17, 2007
NEW YORK — Bear Stearns Cos. told clients Tuesday that a meltdown in the subprime mortgage market has made the assets from two of its flagship hedge funds almost worthless.
Both funds were squeezed after Bear Stearns made wrong-way bets on the home mortgage market and was caught as loans to risky investors began to default. The assets in one of the funds are essentially worthless, while another is worth 9 percent of its value at the end of April, according to a document obtained by The Associated Press.
Bear Stearns, the nation’s fifth-largest investment bank, began disclosing in March that the two hedge funds had sustained heavy losses tied to subprime loans extended to risky borrowers. At the time, its High-Grade Structured Credit Enhanced Leveraged Fund was worth about $638 million — and now has no value.
Meanwhile, the larger and less-leveraged High-Grade Structured Credit Fund lost 91 percent of its value. It was worth about $925 million before taking on losses in March.
“In light of these returns, we will seek an orderly wind-down of the funds over time,” Bear Stearns said in a letter that will be sent to clients who might have questions about the funds. “This is a difficult development for investors in these funds, and it is certainly uncharacteristic of Bear Stearns Asset Management overall strong record of performance.”
A spokeswoman for Bear Stearns didn’t return calls seeking comment.
In June, Bear Stearns said it would spend $1.6 billion to bail out the High-Grade Structured Credit fund. About $1.4 billion of that remains outstanding, Bear Stearns said in the letter.
James Cayne, Bear’s longtime chief executive, has said the bailout would not have “any material adverse effect” on the company’s business.
The problems began when the funds’ assets — mostly securities backed by risky mortgages to investors with poor credit, known as subprime loans — lost value amid rising defaults in a persistent housing slump.
Defaults have been rising quickly, and a large volume of subprime loans with variable interest rates are slated to reset at higher levels in the next two years.
Meanwhile, securities regulators have started a dozen inquiries related to how hedge funds place a value on the complex securities called collateralized debt obligations, many of which are underpinned by subprime loans.
CDOs- collateralized debt obligations (CDOs) are a type of asset-backed security and structured credit product. CDOs are constructed from a portfolio of fixed-income assets. These assets are divided into different tranches: senior tranches (rated AAA), mezzanine tranches (AA to BB), and equity tranches (unrated). Losses are applied in reverse order of seniority and so junior tranches offer higher coupons (interest rates) to compensate for the added default risk. CDOs serve as an important funding vehicle for fixed-income assets.
Bear Stearns shares fell $5.41, or 3.9 percent, to $134.50 in after-hours trading. The shares had closed down 40 cents at $139.91.
So the issue here is FUD. Fear, uncertainty and doubt. When the banks took some sub-prime loans and combined them with other CDOs and then sold them to everyone, everywhere the buyers now have no know way of knowing if they are holding good loans, bad loans or more likely what is the mix of good to bad in the brown bag of payments they bought. So the uncertainly increases risk and risk is expensive. Others just take their money elsewhere and so the music stops and somebody gets left with out a chair.
Because the holder of the loans doesn’t know whose loan they are holding the assumption is that many US home loans are now ticking time bombs. You can’t call up the homebuyer and ask him if he still has his job and if things are going okay. Therefore when CDOs are priced marked to market they can quickly evaporate due to the mere EXPECTATIONS of default.
Ironically it seems that the sub-prime defaults are bad but the CDOs sold spread the risk well enough that the high interest rates paid by many sub-prime borrowers are more than offsetting the losses.
