The firm is, meanwhile, negotiating with banks to rescue the second, larger fund started last August, which has more than $6 billion in loans and reportedly holds far riskier investments. Those negotiations were continuing yesterday, and it was unclear whether they would be successful.  “We don’t think it is over,” said Girish V. Reddy, managing director of Prisma Capital Partners, which invests in other hedge funds. “More funds will feel the pain, but not many are as leveraged as the Bear fund.”  Nervousness about the souring subprime loans and rising oil prices sent the stock market plummeting. Already down almost 60 points, the Dow Jones industrial average fell sharply after the announcement of the bailout and closed down 185.58 points.  Shares of Bear Stearns closed down $2.06, to $143.75; the stock was down more than 4 percent for the week.  For Bear Stearns, the drama surrounding its two troubled hedge funds has given it and its prestigious mortgage business a black eye. The bailout was a major departure for the firm, which has long resisted putting too much of its own capital at risk.  But in this case, the stakes were too high. If lenders had seized the assets of the funds and tried to sell billions of dollars in mortgage-related securities at fire-sale prices, it could have exposed Bear Stearns and the market to substantial losses.  While the board of Bear Stearns never met over the funds, all of its top executives, including the chief executive, James E. Cayne; its presidents, Alan D. Schwartz and Warren J. Spector; and the chief financial officer, Samuel L. Molinaro Jr., huddled in meetings over the last few days looking to find a way to contain the crisis, according to people briefed on the discussions who could not speak for attribution.  Even Alan C. Greenberg, the 79-year-old former chairman, who spends less time these days on the firm’s matters but remains an active board member, became involved.  Yet, as Bear Stearns worked to manage the crisis, many on Wall Street speculated about how the firm could let the funds get in such a precarious position.  In fact, executives at Bear Stearns Asset Management had debated last summer whether to start the second hedge fund.  The first fund, the Bear Stearns High-Grade Structured Credit Fund — the one bailed out yesterday — was started in 2004 and had done well, posting 41 months of positive returns of about 1 percent to 1.5 percent a month. But investors were clamoring for even higher yields, which would require more aggressive bets on riskier mortgage-related securities and significantly higher levels of borrowed money, or leverage, to bolster returns.  The firm clearly had the expertise — it was a leader in underwriting and trading bonds and esoteric securities backed by mortgages. In addition, Ralph R. Cioffi, who ran the funds, had played a major role in building the Bear Stearns mortgage business.  So, in August, the Bear Stearns High-Grade Structured Credit Enhanced Leveraged Fund — the second fund that eventually had huge losses — was started with $600 million in investments, mostly from wealthy individual clients of Bear Stearns, and at least $6 billion in money borrowed from banks and brokerage firms. Bear Stearns and a handful of its top executives invested a mere $40 million in both funds.  The timing could not have been worse.  By the end of last year, housing prices in many areas were cresting and beginning to fall. The decline began to expose lax lending standards in the subprime market. Soon borrowers started falling behind on payments just months after they closed on their loans, forcing several large lenders into bankruptcy protection.  The Bear Stearns funds, like so many others, had invested in collateralized debt obligations, or CDOs, which invest in bonds backed by hundreds of loans and other financial instruments. Wall Street sells CDOs in slices to investors. Some of those pieces have low yields but they are easily traded and carry less risk; others are more susceptible to defaults and trade infrequently, which makes them difficult to value.  Last year, $316.4 billion in mortgage-related CDOs were issued, about 77 percent more than the year before, the Securities Industry and Financial Markets Association said.  At first, the Bear Stearns hedge funds appeared to weather the storm. But in March, the older fund registered its first loss. One investor, who asked not to be identified because he was trying to recover his investment, said that when he moved to get his money out, he was told investors had tried to redeem 10 percent of the fund.  By April, the older fund was down by 5 percent for the year, and the newer fund had fallen 10 percent.  Managers tried to protect the fund by hedging potential losses in lower-rated securities they held, but did not do so for higher-rated bonds, which also fell in value.  “They didn’t realize this was Katrina,” the investor said. “They thought it was just another storm.”  In May, however, more significant problems began to emerge. The Swiss investment bank UBS shut its hedge fund arm, Dillon Read Capital Management, after bad subprime bets led to a $124 million loss.  Also that month, Bear Stearns Asset Management filed plans to start a public offering of a financial services firm called Everquest Financial, which, to some, appeared to be little more than a place to park the riskiest securities Bear Stearns had invested in. (The firm has no plans for now to move forward with the offering, according to a person briefed on the firm’s plans.)  Perhaps the most startling development was a sharp restatement in April of the second fund. The firm revalued some securities and told investors that the fund was down 23 percent, not 10 percent as it had said earlier.  Shocked investors began contacting Bear Stearns, demanding to pull their money out. In May, the firm froze all redemption requests. This month, at least three Wall Street firms — JPMorgan Chase, Citigroup and Merrill Lynch — began demanding more cash as collateral for the loans they had made.  Fighting to save the funds, Bear Stearns sold $3.6 billion in high-grade securities. Meanwhile, its adviser, Blackstone, scrambled to line up a deal in which Bear Stearns would put up $1.5 billion in new loans and a consortium of banks led by Citigroup and Barclays would put in $500 million.  In return, the lenders would have their exposure to the funds reduced but could not make further margin calls for 12 months.  Some lenders, including Merrill Lynch and Deutsche Bank, balked and moved to sell assets. At one point Wednesday, nearly $2 billion in securities were listed for sale, although some banks, including JPMorgan, eventually canceled scheduled auctions.  By the end of the day, out of the $850 million in securities that Merrill had put up for sale, only a small portion actually sold.  In the wake of the weak auctions, several other lenders, including JPMorgan, Citigroup, Goldman Sachs and Bank of America, reached deals with Bear Stearns. At least some of the deals involved the lenders selling the securities back to Bear Stearns for cash, although the prices were not disclosed.  Bear Stearns is bailing one of the funds out because it is worried about the damage to its reputation if it stuck investors and lenders with big losses, said Dick Bove, an analyst with Punk Ziegel & Company.  “If they walked away from it, investors would have lost all their money and lenders would have lost all of the money,” Mr. Bove said. But “if they did that to everyone in the financial community, the financial community would have shut them down.”  Gretchen Morgenson and Landon Thomas contributed reporting.  A version of this article appears in print on , on Page A1 of the New York edition with the headline: $3.2 Billion Move By Bear Stearns To Rescue Fund. Order Reprints| Today's Paper|Subscribe
A hedge fund’s near collapse stems directly from bad bets on subprime mortgages and is the biggest such bailout since 1998.