Bear Stearns' Billion Dollar Hedge Fund Bailout

The news that two Bear Stearns hedge funds were being forced to liquidate is a big sign of trouble in the bond markets. My previous post showed how the market for the types of securities held by the Bear Stearns funds was tanking. Had the forced liquidations gone through, they likely would have been a serious strain on the market.

Bailing out the fund by taking over the creditor role from Merrill and others saves the bond market from more forced sales and saves Bear from the negative publicity. As the mortgaged backed bonds continue to deteriorate the losses will go back to being slow and steady, rather than dramatic and eye catching. Meanwhile, high risk MBSs continue to tank. Bear will probably pull the plug somewhere down the line so that hedge fund investors are the big losers and Bear as creditor will be largely protected.

For now, Bear's response falls in line with what everyone in the industry seems to be doing - Pretend on your books that your asset backed securities or real estate owned is still worth far more than the market will actually bear. If you don't try to sell and continue to expand your borrowing you can keep up the charade for a long time. Eventually, losses will overwhelm the securities holders, but that doesn't have to be anytime soon if firms like Bear keep stepping up with more financing.