Unanswered Questions at Bear Stearns

Does anybody really understand what happened at the two Bear Stearns hedge funds which have now imploded? There are a lot of unanswered questions, and Bear Stearns itself seems to be trying as hard as possible not to answer them. Naturally, the combination of large financial losses and extreme opacity is almost certain to result in lots of litigation. But even those of us without any direct financial interest in the Bear funds have many reasons to want to understand exactly how the whole fiasco happened.

The biggest question in my mind is how investors in the two different funds could end up losing pretty much exactly the same amount of money. The first fund was more conservative, and it got a $1.6 billion bailout from Bear Stearns – and yet nearly all of the money of its investors has disappeared. Meanwhile, the second fund was more highly levered, and got no bailout at all – and yet it seems that all of its borrowers have been repaid in full, and that its investors might actually get a tiny amount of their money back.

Steve Waldman has lots more questions, especially regarding the manner in which creditors were repaid.

As an investor in one of the funds, I'd want to know how much debt was extinguished for each of the assets surrendered, that is, what sort of valuations were implicit in the workout, and how they were arrived at. If the assets were not in fact auctioned, perhaps creditors paid less in terms of debt forgiven than the assets were in fact worth. Perhaps Bear's interest in putting an embarrassing incident behind it without causing turmoil in a fragile market led it to drive less-than-a-hard bargain with creditors, who were after all in an exploitably poor bargaining position. Were fund managers gentlemanly among Wall Street colleagues, or fierce on behalf of their investors? I'd want to know.

Chief among the askers of such questions would seem to be Barclays, which has lost as much as $400 million of its own and its clients' money. All of Barclays' loans to the funds have been repaid; the losses are on investments in the funds. But because Barclays was a big lender to the funds, it had the ability to limit the investments those funds were making. And there seems to be a good chance that Bear Stearns ended up, essentially, breaking loan covenants:

Barclays imposed certain investment restrictions on Bear. The restrictions ranged from limiting the number of noninvestment grade holdings that the fund could buy, to curbing the fund's exposure to collateralized debt obligations, securities backed by pools of mortgage loans, and asset-backed securities. But according to people familiar with the situation, some of those restrictions were breached by the Bear fund.

If this is true, then Bear Stearns could yet be on the hook for some big legal liabilities – especially since all the funds' other investors are likely to start suing Bear as well.