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EARLY : SPREADING SUBPRIME WORRIES
were sold as commercial paper to short-term investors such as money market mutual
funds.
Critically, Bank of America guaranteed those deals with a liquidity put—for a fee.
Later, commercial paper investors would refuse to roll over this particular paper;
Bank of America ultimately lost more than billion on this arrangement.
“ is doomsday”
Nearly all hedge funds provide their investors with market value reports, at least
monthly, based on computed mark-to-market prices for the fund’s various invest-
ments. Industry standards generally called for valuing readily traded assets, such as
stocks, at the current trading price, while assets in very slow markets were marked by
surveying price quotes from other dealers, factoring in other pricing information,
and then arriving at a final net asset value. For mortgage-backed investments, mark-
ing assets was an extremely important exercise, because the market values were used
to inform investors and to calculate the hedge fund’s total fund value for internal risk
management purposes, and because these assets were held as collateral for repo and
other lenders. Crucially, if the value of a hedge fund’s portfolio declined, repo and
other lenders might require more collateral. In April, JP Morgan told Alan Schwartz,
Bear Stearns’s co-president, that the bank would be asking the BSAM hedge funds to
post additional collateral to support its repo borrowing.
Dealer marks were slow to keep up with movements in the ABX indices. Even as
the ABX BBB- index recovered some in March, rebounding , marks by broker-
dealers finally started to reflect the lower values. On April , , Goldman sent
BSAM marks ranging from cents to cents on the dollar—meaning that some
securities were worth as little as of their initial value. On Thursday, April ,
in preparation for an investor call the following week, BSAM analysts informed
Cioffi and Tannin that in their view, the value of the funds’ portfolios had declined
sharply. On Sunday, Tannin sent an email from his personal account to Cioffi’s per-
sonal account arguing that both hedge funds should be closed and liquidated:
“Looks pretty damn ugly. . . . If we believe the runs [the analyst] has been doing are
ANYWHERE CLOSE to accurate, I think we should close the Funds now. . . . If [the
runs] are correct then the entire sub-prime market is toast.” But by the following
Wednesday, Cioffi and Tannin were back on the same upbeat page. At the beginning
of the conference call, Tannin told investors, “The key sort of big picture point for us
at this point is our confidence that the structured credit market and the sub-prime
market in particular, has not systemically broken down; . . . we’re very comfortable
with exactly where we are.” Cioffi also assured investors that the funds would likely
finish the year with positive returns. On May , , the two hedge funds had at-
tracted more than million in new funds, but more than million was re-
deemed by investors.
That same day, Goldman sent BSAM marks ranging from cents to cents on
the dollar. Cioffi disputed Goldman’s marks as well as marks from Lehman, Citigroup,
