How to win friends and influence people – not. Bear Stearns’ handling of its hedge fund debacle has come in for a lot of criticism and rightly so. It made a number of tactical mistakes.
The first was hoping Wall Street creditors to its highly geared fund would cut it some slack and hold off making margin calls, as part of a rescue package. It was naive of Bear to expect Wall Street to contemplate such a drastic move, especially once the big investment banks were able to discount fears of systemic risk. It is hard to imagine Bear itself agreeing to this, had the shoe been on the other foot.
The second mistake was not to have moved faster to offer some sort of limited backing to the less-troubled fund. The $3.2bn secured financing that it finally came up with – already whittled down to $1.6bn – does not expose Bear to that much economic risk since the loans that Bear is buying out are over-collateralised. Of course, the valuation of the collateral could tank but, in this fund especially, the issue seems to be mainly one of liquidity. The financing buys Bear some time to stabilise the fund. Admittedly, Bear’s intervention sets an important precedent, so it is understandable that Bear took its time. Furthermore, Bear could not offer blanket guarantees. Still, Bear could have been more sensitive, earlier, to the expectation that since its name was on the funds’ door it would play a key role in limiting the fall-out.
The third mistake was more technical: a mismatch between the exotic, potentially illiquid assets in the hedge funds and the short-term nature of their funding sources. The latter included equity investors who could redeem fairly quickly and short-term borrowing via re-purchase agreements. All told, this episode has been a black eye for one of Wall Street’s cannier players.