Merrill Lynch Seizes $400 Million of Assets from a Bear Stearns Managed ‘Subprime’ Hedge Fund for Failing to Meet Margin Calls

A hedge fund managed by Bear Stearns that takes both bullish and bearish positions in subprime loans has been hit heavily by conditions in that market. Some of the fund’s assets were held at Merrill Lynch, on margin. When the equity in the fund dropped, Merrill issued margin calls.

The hedge fund reportedly began with about $600 million in investor capital, $40 million of that from Bear Stearns and its executives, then borrowed $6 billion from Wall Street lenders, including Merrill, Goldman Sachs, Bank of America and Deutsche Bank.

As the fund’s assets lost market value, the Bear Stearns managers scrambled to sell hundreds of millions of dollars in assets to satisfy demands for cash and assets from creditors to stave off liquidation of the fund. The managers auctioned almost $4 billion in mortgage bonds, and attempted to present a 30-day plan to sell more assets, but was unable to persuade Merrill to refrain from seizing assets.

An auction was then held by Merrill to liquidate these assets and the fund’s fate remains in peril. It the hedge fund is dissolved it would become the second blowup of hedge funds dealing in the high risk home loans, known as “subprime” mortgages. UBS AG shut down Dillon Read Capital Management after bad trades in subprime-mortgage loans led to a $124 million loss.

Wall Street is concerned that the asset liquidations could cause values on other subprime pools to spiral downward causing additional pressure to liquidate other simliar portfolios. Sub-prime mortgages react to market conditions different than high-quality and liquid mortgage-backed bonds, and are more akin to “junk” corporate bonds in fluctuation and liquidity.

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