Bear Stearns Offers $3.2 Billion Hedge Fund Bailout

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Bear Stearns Cos. Inc. (BSC) Friday said it would provide up to $3.2 billion in financing for a struggling hedge fund it manages, but sources said a second fund is still working out a restructuring plan with creditors.

The bailout sent financial markets into a tizzy, spurring investors to sell shares, particularly of investment and commercial banks, and buy safer Treasuries.

"People are extremely nervous about this issue, so it's sell first, ask questions later," said Stephen Massocca, co-chief executive of San Francisco-based investment bank Pacific Growth Equities. "People are concerned that this is a contagion that could spread elsewhere."

Bear's shares fell 1.1 percent to $144.16 in early afternoon trading on the New York Stock Exchange.

Bear Stearns, the fifth-largest U.S. investment bank, has held tense negotiations with creditors for more than a week after two funds suffered big losses from bad investments in securities linked to subprime mortgages and other forms of debt.

Creditors had threatened to seize assets from the funds and sell them off, even after Bear Stearns said it would add $1.5 billion of its own capital, sources said. Merrill Lynch (MER) went so far as to sell $100 million of assets from the funds, after seizing some $850 million of securities.

Bear said it provided secured financing to the High Grade Structured Credit Strategies Fund, which, according to a source familiar with the matter, was down about 5 percent through the end of April.

Bear believes it has more than enough collateral in that loan to cover its exposure, Chief Financial Officer Sam Molinaro said in a conference call.

The financing will eliminate exposure that banks including Citigroup and Barclays Plc had to the fund, sources said.

But many banks still have exposure to a sister fund, High Grade Structured Credit Strategies Enhanced Leverage Fund. That fund was down 23 percent for the year by the end of April. Bear Stearns is still trying to negotiate a recapitalization for that fund, sources said.

At their peak, the two funds controlled more than $20 billion of assets.

At issue for financial markets is the hedge funds' holdings of collateralized debt obligation sector.

Collateralized debt obligations, or CDOs, are essentially bonds that are portfolios of other bonds or loans, and have provided crucial financing to areas including subprime lending and leveraged buyouts.

If the prices of those securities broadly fall, Wall Street firms, hedge funds and other investors could have to take losses on their portfolios of CDOs, cutting into profits. Meanwhile, leveraged buyout funds that depend on the CDO market to help provide financing for takeovers could have more trouble completing deals.