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Bear Stearns to Bail Out Hedge Fund, Says Problem 'Contained'

Bear Stearns confirmed it will bail out one of its troubled hedge funds with $3.2 billion in secured loans, but the Wall Street firm sought to convince the broader market its troubles are "relatively contained."

Worries about the Bear Stearns funds and further fallout from the subprime mortgage meltdown rattled financial markets on Friday, sending stocks sharply lower.

Bear said it stepped in to save the Bear Stearns High-Grade Structured Credit Fund because market uncertainty made it "difficult" to unwind the fund's assets--mostly securities backed by risky mortgage loans.

That unit and its sister fund, The Bear Stearns High Grade Structured Credit Enhanced Leveraged Fund, have come under pressure as the value of the assets underlying the bonds they hold fell sharply in recent months.

Broker-Dealer Closes

Separately, Brookstreet, an Irvine, Calif., broker-deal, closed its doors Friday after heavy losses in the collaterialized mortgage obligation market. The firm was forced to shut down after it faced heavy markdowns over the last two weeks in its CMO investments held in margin accounts. The firm had a value of about $17 million at the end of May, which has evaporated.

Combined, the two funds had assets of more than $10 billion as of a week ago, the company said. Bear's commitment was less than $35 million, according to Chief Financial Officer Sam Molinaro.

Bear prevented the fund's dissolution "because there continues to be significant value in it," Molinaro said in a conference call Friday.

He said the $3.2 billion loan is backed by assets that "have been beaten down dramatically" in the past two weeks, but that the collateral is worth more than the amount of the loan, making it relatively low-risk.

No Effect on Ratings

Molinaro said the company's mortgage business, recognized as the most experienced on Wall Street, would not be affected by the funds' performance. Separately, ratings agency Standard & Poor's said Friday that the problems with the funds have no effect on the company's overall credit ratings.

By injecting money into the High-Grade fund itself, Bear buys time to make trades to generate income, so that it can repay investors who want to get out.

While the loans will go to the Structured Credit fund, Bear Stearns said it is still working on a solution for the Enhanced Leveraged fund's problems.

Bear had worked the past week to sell the funds' assets to generate money to repay investors, which primarily include other Wall Street firms such as Merrill Lynch and JPMorgan Chase . Bear itself had no material exposure to the fund, Molinaro said.

Merrill seized collateral reported to be worth $850 million and auctioned the assets earlier this week. Other firms flirted with demanding collateral, but backed off after talking with Bear Stearns.

Others Exposed

People familiar with the matter have told CNBC's Charles Gasparino that Barclay's Bank and Cantor Fitzgerald are among the investors with exposure to the the Enhanced Leveraged fund.

These people have told Gasparino that Barclay's could stand to lose as much as $500 million of unsecured debt within the fund. However, Gasparino said Cantor had sold off its exposure without losing money.

"Earlier Friday, traders were speculating that [Cantor] was losing money," Gasparino said. "But Cantor denied that, and said, 'We sold the bonds in a successful auction. We have not lost a penny.' ”

It still seems likely that the Enhanced Fund will be unwound, with the only question being how dramatically that occurs.

"There will continue to be asset dispositions, but we hope to do it without forcing massive liquidations in the market," Molinaro said. He said it could take several months to do that.

The concern for the broader market is that other investors will get jittery about holding these types of securities. If the banks were to demand collateral for their loans and sell them on the market at fire-sale prices, that necessarily would lower the value of the entire class of securities.

But Molinaro said the broader market was not in danger. "From our perspective, (the troubles) appear to be relatively contained."

He said Bear does not have any other funds exposed in the same way to the market for mortgaged-backed securities. But he added that the two funds' high-profile struggles seem to be increasing risk premiums, or the additional cost of borrowing money for risky investments.

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