Two Bear Stearns hedge funds hid subprime exposure — and $1.8B of it vanished

Bear Stearns Asset Management ran two hedge funds, the High-Grade Structured Credit Strategies Fund and a higher-leverage sibling, the Enhanced Leverage Fund, that bet heavily on collateralized debt obligations built from subprime mortgage-backed securities. Portfolio managers Ralph Cioffi and Matthew Tannin told investors in monthly summaries that direct subprime exposure ran about 6-8% of each portfolio. The SEC later found that once the funds had collapsed, Bear's own sales force was told the true combined direct and indirect exposure was roughly 60%.

As the funds took losses through early 2007 and redemption requests mounted, Cioffi released preliminary April results projecting essentially flat returns; the final numbers weeks later showed an actual loss of 5.09% for the High-Grade fund and 18.97% for the Enhanced Leverage fund. Tannin told investors he was personally adding to his own stake as a buying opportunity and mocked one investor who wanted to redeem instead — while Cioffi was privately pulling $2 million, over a third of his own investment, into a different fund he knew was betting against subprime.

By late July 2007, the Enhanced Leverage fund's value had been effectively wiped out and the High-Grade fund could not meet a margin call on a $1.3 billion credit facility; Bear Stearns seized the fund's collateral and began an orderly liquidation. Both funds filed for bankruptcy protection at the end of July, with the SEC later putting total investor losses at approximately $1.8 billion. Cioffi and Tannin were indicted on fraud charges in 2008. The collapse was an early tremor of the subprime crisis that forced Bear Stearns itself into a sale to JPMorgan Chase eight months later.