All the Devils Are Here [181]
And so, the Bear hedge fund managers made two final, desperate efforts to raise cash. In the fall of 2006, they had started working on a deal to sell off the equity—the riskiest part—of ten CDOs to a new company called Everquest. Now, in the spring of 2007, they tried one last push to have Everquest itself sell shares to retail investors in an IPO. “The deal appears to be an unprecedented attempt by a Wall Street house to dump its mortgage bets,” wrote Matthew Goldstein in a May 11 article in BusinessWeek. The Everquest deal would have allowed Bear to raise cash and pay down a $200 million line of credit from Citigroup. But the deal seemed so obviously self-serving that a furor erupted, and it became impossible to complete.
The Bear Stearns team also began rushing to complete another deal that had been in the works: a CDO squared made out of the funds’ holdings of CDOs. The idea was, as Cioffi put it in an e-mail, to “get as much of our assets off our books... as possible.” He was hoping it would result in more stable financing for a lot of the funds’ assets, instead of using increasingly fractious repo lenders. This deal did close, on May 24, 2007. Bank of America, the underwriter, wrote a liquidity put requiring the bank to buy the $3.2 billion of commercial paper that was issued by the new CDO in the event of problems. Money market funds bought most of the commercial paper.
Later, Bank of America sued Bear Stearns, Cioffi, Tannin, and McGarrigal for allegedly hiding the funds’ true condition. As part of the lawsuit, the bank also claimed that it had gotten a verbal agreement from Cioffi that he wouldn’t put certain “high-risk” assets into the new CDO, but that Cioffi ignored that agreement. There was one asset in particular that Bank of America singled out in its complaint, an asset that quickly lost all its value: Goldman’s Timberwolf deal. (This lawsuit was also ongoing as of the fall of 2010.)
By the time the Bank of America deal closed, the funds were in serious trouble. Investors had demanded half their money back from Enhanced Leverage, leaving Cioffi and Tannin with little choice but to wind it down. Tannin, at least, seemed to finally recognize that the jig was up. In late May, a Bear salesman announced good news: Tokio Marine wanted to invest $10 million in the High Grade fund. When Tannin heard the news, he asked for a meeting with Greg Quental, who was the head of Bear Stearns Asset Management’s hedge fund business. After the meeting, Quental announced that the Bear funds wouldn’t be taking any new investments.
At the end of May, Cioffi e-mailed Spector, his longtime supporter at Bear. “Warren, I’m almost too embarrassed to call you,” he wrote. “I feel especially badly because you have been a big supporter of mine for so long... I know apologies are meaningless at this stage but I am sorry... Emotionally, I am obviously keeping a business as usual persona at work and on the job 24-7. I assure you of that. But it is very stressful and strange when it looks like one’s business is collapsing around him... we are running out of options.”
More bad news was coming. A few weeks earlier, Bear had told investors in the Enhanced Leverage fund that it had lost 6.5 percent in April. But at a meeting on May 31, Bear Stearns’s pricing committee, which determined the funds’ returns by surveying how its counterparties were marking the securities, decided the fund had actually lost 18.97 percent in April. One key reason for the stunning change was Goldman’s low marks.
According to the SEC, Cioffi tried to argue that his original marks were right. When he gave up, he wrote an e-mail to a member of the pricing committee: “There is no market... its [sic] all academic anyway −19 percent is doomsday.”
Which, in fact,