CSI Wall Street: Leverage Killed the Bear

Looking for a little beach reading heading into the beginning of a long break?  Pack the beach bag and unplug the crackberry, you deserve it.

I normally don’t recommend reading autopsy’s on holiday, but this one is so engrossing, and so spot on accurate, I wish I had written it. It has the three classic elements of a true Wall Street debacle : greed, fear, and hubris.  And if you want blood, you’ve got it:

“Come Grow with Us”

Bear Stearns told potential investors in a now-stricken hedge fund that it could cope with even higher leverage because it put money into “high quality” assets – many of them hard-to-value structured products based on sub-prime mortgage bonds.

However, Bear also warned investors that taking on higher leverage could increase its volatility and brings with it “an additional risk element”. FT

I have mentioned in past posts that Bear clearly articulated the risks inherent in the strategy. No whining please. You want 15 to 1? You got it.

Ralph Cioffi, manager of the two Bear funds, invited investors last year to switch to the new Enhanced Leverage fund, saying in a letter: “Additional leverage brings with it additional risk, however we feel the form of leverage we are utilising will complement our current strategy.”

I have long admired rocket scientists. The kind that work at NASA:

All of the long positions were in bonds and bank loans with AAA or AA credit ratings, which have first call on assets and are supposedly safe. But increased scrutiny by markets of the assets underlying CDOs led to a fall in the value of top-rated CDO bonds this year, hurting both the Bear funds in February.

The credit default swaps, a form of hedge, should have partially protected both funds against a fall in credit quality and so in the value of the bonds they had bought. However, in a note to investors Bear revealed the funds had been caught out in March when both the bonds and hedges worsened.

You can’t walk around midtown these days without running into Black Swans. They must be part Gypsy, as they will pick your pockets clean:

“The widening in [credit] spreads we experienced in February and March was the result of fear of an unprecedented increase in the cumulative losses these portfolios will suffer over time, not of an actual deterioration in credit on the underlying bonds in our portfolio,” Bear wrote in May.

The Bear funds are dead. Long live the Bear.

Bear Stearns assured investors on leverage
Financial Times
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The content contained represent the opinions of 1440 Wall Street. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author. No position in securities mentioned

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