Lenders Pull Assets as Hedge Funds Near Collapse

Investors in the bond market are nervously watching developments at Bear Stearns. Two of the firm's hedge funds are experiencing heavy losses as problems in the sub-prime mortgage market worsen. Merrill Lynch has apparently decided to pull the plug on its investments in the two funds, which is forcing Bear Stearns to scramble to find additional financing.

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Two giant hedge funds managed by Bear Stearns are near collapse today. They racked up big losses because they invested in risky mortgage-backed securities, and their lenders have reportedly started seizing some of their assets and selling them off.

The problems at the funds are one more result of the meltdown in the sub-prime mortgage market. And the question a lot of people are asking today is whether the troubles will spread.

NPR's Jim Zarroli has the story.

JIM ZARROLI: The hedge fund world can be murky and mysterious. And so when a particular fund gets into trouble, it can be hard for outsiders to know what's behind it. In this case, the funds were said to be big purchasers of mortgage-backed securities. Those are investments whose value is tied to mortgages, sometimes very risky ones.

And to pay for those mortgages, the fund is borrowed heavily. Together, they owed $9 billion to various lenders.

Stephen Brown, professor of finance at New York University says this kind of leverage is pretty common among hedge funds.

Professor STEPHEN BROWN (Finance, New York University): It's basically a magnification device. If they're confident that they can make money, then the amount of money they can make can be quite substantial.

ZARROLI: But Brown says when their investments begin to tank.

Prof. BROWN: They lose with the same speed.

ZARROLI: That's what happened here. The funds were doing pretty well last year, but then in March, they began to lose value. By the end of April, the bigger fund - which has the bulky name of the High-Grade Structured Credit Strategies Enhanced Leverage Fund - was down 23 percent. And it's suspended redemptions, which meant investors couldn't get their money out.

Bear Stearns try to work out a restructuring plan, but the effort failed, and one of the lenders, Merrill Lynch, has taken steps to seize some of the fund's assets. This is not the first time that a hedge fund has been KO'd by troubles in the sub-prime market.

Just last month, UBS shut down its Dillon Read Capital Management Fund after similar losses. But financial consultant Janet Tavakoli says it's surprising that these troubles are cropping up at Bear Stearns.

Ms. JANET TAVAKOLI (Chicago Financial Consultant): The reason everyone is so interested in what's going on at Bear Stearns is that Bear Stearns is particularly expert in mortgage-backed securities. So for Bear Stearns now to be having liquidity issues is a bit of a surprise.

ZARROLI: Tavakoli says there's a lesson in there for investors.

Ms. TAVAKOLI: So if it can happen to Bear Stearns, it can happen to many other funds who have invested in these securities.

ZARROLI: Tavakoli says one of the big problems with the kind of securities that Bear Stearns was investing in is they can be hard to value, they're complex and their value shifts with the strength of the mortgage market, so it can be difficult for an investor to judge how well a fund is doing until it's too late.

That raises questions about the underlying strength of other funds. NYU Stephen Brown says he's not too worried about the problem's widening.

Prof. BROWN: There's a huge diversity of hedge funds and a huge diversity both in terms of the scale of the funds and in terms of the strategies they employ.

ZARROLI: And Brown says the number of hedge funds that invests in these risky mortgage-backed securities is actually relatively small. Brown also says no one should waste any tears on the individual investors who lose money in the Bear Stearns funds. They tend to be very rich people who can absorb their losses.

Jim Zarroli, NPR News, New York.

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