Back in March, when the whole subprime mortgage mess was beginning to hit the headlines, derivatives consultant Janet Tavokoli said something that both interested and alarmed me. Some of the big Wall Street firms appeared to have started betting against the subprime market at the beginning of the year and successfully protected themselves from the meltdown. But who had lost money then? I asked.
“That’s the $300 billion question, because no one is fessing up to being on the other side of this trade,” Tavokoli told me.
No one had to fess up immediately because the bonds and derivatives that make up the subprime market aren’t traded on an organized exchange or priced in any kind of consistent and public way. If you owned subprime debt, that meant you had a lot of leeway to keep pretending that it had maintained its value.
This appears to be what happened with Bear Stearns’ High Grade Structured Credit Strategies Enhanced Leverage Fund and its High Grade Structured Credit Strategies Fund. Both owned securities at the top of the subprime heap, which haven’t yet been hit by defaults. But the willingness of others to buy those securities has dropped dramatically over the past few months, and the managers of the Bear funds were slow to acknowledge these changed market conditions. To quote from yesterday’s W$J:
Last month, Enhanced Leverage reported that its value fell 6.75% in April after the fund’s bets on the mortgage market went wrong. Two weeks later, it put the loss at 18%, spooking already-nervous investors and creditors and sending many of them running for the exits.
The huge revision at least in part reflected conversations Bear Stearns hedge-fund managers had with bond dealers, three of which told them in late April that some of the funds’ assets were worth less than the values stated on the funds’ books, according to a person familiar with the matter.
The Bear Stearns funds owned mortgage securities that used to be valued at about $20 billion. Which I guess means the rest of the market is still struggling with a $280 billion question.