Hedge-fund bailout may cost firm less

Brokerage Bear Stearns may put up $1.6 billion to rescue another one of its money-losing hedge funds, half as much as it offered last week, according to two people with knowledge of the situation.

The size of the bailout dropped after the Bear Stearns High-Grade Structured Credit Fund found buyers for some assets and creditors sold others, said the sources, who declined to be identified because they aren't authorized to comment for the firm.

Bear Stearns, the biggest U.S. broker to hedge funds, said Friday it would assume $3.2 billion of loans to prevent lenders from liquidating assets.

The reduction means Bear Stearns won't have to tie up as much capital to salvage the fund from bad bets on subprime mortgage bonds and collateralized debt obligations. Shares of Bear Stearns fell as much as 3.2 percent Monday as investors speculated that the funds' tailspin and risks the firm faces in the mortgage market would reduce earnings.

"It's certainly a plus for them that the amount they have to put up is much less than they thought earlier," said Marshall Front, who helps manage about $800 million at Front Barnett Associates. "But the question remains about whether there are other assets that need to be valued differently, and that question goes for the whole financial-services community."

That concern spread to shares of other securities firms and commercial banks Monday. Goldman Sachs, one of the world's largest hedge-fund managers, fell 2.5 percent. Lehman Brothers dropped 2.1 percent and Citigroup declined 1.4 percent.

Elizabeth Ventura, a Bear Stearns spokeswoman, declined to comment.

Together, the two Bear Stearns funds had borrowed about $10 billion as of two weeks ago, Bear Stearns Chief Financial Officer Samuel Molinaro said during a Friday conference call with analysts. At the time, he said it was possible that bailing out the first fund would require less than $3.2 billion.

The second pool, the Bear Stearns High-Grade Structured Credit Enhanced Leveraged Fund, also reduced its loans and now owes about $1 billion, the people said.

Merrill Lynch analyst Guy Moszkowski said in a report to clients Monday that the $3.2 billion loan would represent about 15 percent of Bear Stearns' after-tax equity. He also estimated that the so-called enhanced fund owed $7 billion to creditors. He said he based his estimate on Molinaro's comments.

"You're going to see, in all likelihood in the next 30 to 60 days, another fund blow up and it could be a significant one," said Tim Mungovan, a partner at law firm Nixon Peabody in New York and co-head of the alternative-investments litigation practice.

One collapse is often a "harbinger" of more, Mungovan said. Amaranth Advisors, the hedge fund that lost $6.6 billion because of wrong-way bets on natural gas, failed about six weeks after fellow energy hedge fund MotherRock.

Ralph Cioffi, the funds' manager at Bear Stearns, was among the biggest buyers of CDOs — short for collateralized debt obligations — backed by subprime mortgages, home loans to people with poor credit ratings or heavy debt loads.

Sales of CDOs skyrocketed to $503 billion in 2006, according to estimates from Morgan Stanley.

CDOs are investment-grade securities backed by a pool of bonds, loans and other assets.

Cioffi also helped create Everquest Financial, a company that invested in CDOs and which filed in May to raise as much as $100 million in an initial public offering (IPO).

The two funds transferred investments to Everquest and ended up with a 67 percent stake. Everquest withdrew its IPO Monday.