Resisting Corporate Corruption, 3rd Edition

Case 4Subprime Heading South at Bear Stearns Asset Management

What am I going to tell Barclays Bank? They won’t be expecting a down month so soon after committing $400 M to our Enhanced Leverage Fund (ELF). Only half of the facility has been disbursed. Do I give them the facts knowing that doing so risks Barclays’ freezing the credit line? Releasing a full story also could send our investors running for the exits. Or, do I say what I need to say to buy time to turn performance around?

MATTHEW TANNIN, A FUND MANAGER for Bear Stearns Asset Management (BASM), sighed as he looked at the preliminary results for February 2007. A key threshold was being crossed. For the first time one of the two Funds managed by Tannin and his boss, Ralph Cioffi, was going to show a loss. Tannin was deeply concerned about how Barclays, the major source of liquidity for that Fund, would react. If Barclays froze its credit line, the resulting crisis could topple the Funds.

Tannin felt constrained by their prior disclosure to investors. Information Memoranda for their Funds described them as “only slightly riskier than a money market fund.”¹ The stated aim was to invest in highly rated long-term asset-backed bonds. Most investors assumed these to be auto loan and credit card-backed securities. Yet, Tannin knew that most Fund investments were actually backed by subprime mortgages. These “collateralized mortgage obligations” (CMOs) had interest rates that had allowed the Funds to generate enviable returns ...