June 22 (Bloomberg) -- Bear Stearns Cos. offered $3.2 billion in loans to bail out one of its failing hedge funds, the biggest rescue since 1998, after creditors started seizing assets and investors demanded their money back.

The High-Grade Structured Credit Strategies Fund would be provided a credit line, the New York-based firm said in a statement today. Bear Stearns is seeking to replace loans extended by banks including Citigroup Inc. and Lehman Brothers Holdings Inc.

Bear Stearns offered to salvage the fund, one of two that made bad bets on collateralized-debt obligations, after creditors including Merrill Lynch & Co. took the funds' CDOs as collateral and started selling them in auctions. An agreement with creditors would prevent a fire sale of the collateral, and help stem a plunge in prices, while potentially increasing the risk to Bear Stearns, the second-biggest underwriter of mortgage bonds.

``Bear needs to put this behind it as soon as possible,'' said Peter Goldman, who helps manage $600 million at Chicago Asset Management, including shares of Bear Stearns. ``The firm might take on some of the risk of the fund they didn't have before, but they're a bond shop and they wouldn't take on risk they shouldn't.''

The Bear Stearns fund lost about 10 percent of its value this year, while the related fund, the 10-month old High-Grade Structured Credit Strategies Enhanced Leverage Fund, lost about 20 percent, according to people familiar with the matter. Both funds are run by Ralph Cioffi, 51, a senior managing director.

Enhanced Leverage fund was more leveraged, meaning it had borrowed more relative to its assets. Talks with creditors to that fund are also underway, Bear Stearns said.

Margin Calls

The funds received ``high levels'' of margin calls from creditors in the past few weeks and had trouble selling enough assets to keep running, Bear Stearns said in the statement.

``The uncertainty in the marketplace surrounding these funds has made an orderly deleveraging difficult,'' James Cayne, chief executive officer of Bear Stearns, said in the statement. ``By providing the facility we believe we will stabilize financing, reduce uncertainty in the marketplace and allow for an orderly process.''

Creditors extended $9 billion to the funds which made bets of more than $11 billion, a person familiar with the situation said. Lenders include Merrill, Lehman, JPMorgan Chase & Co., Goldman Sachs Group Inc., Citigroup and Cantor Fitzgerald LP, all in New York. Bank of America Corp., based in Charlotte, North Carolina, Barclays Plc in London and Frankfurt-based Deutsche Bank AG were the other lenders.

Taking Collateral

The funds speculated in highly rated CDOs -- securities backed by bonds, loans, derivatives and other CDOs -- that were hurt in March and April as defaults on subprime mortgages to people with poor or limited credit histories increased. The fund also lost on opposite bets against home-loan bonds, which backed many of its CDOs.

As the funds faltered, Merrill sought to protect itself by seizing the assets that were used as collateral for its loans.

Cantor Fitzgerald also took collateral from its credit lines and sold the remaining securities in an auction yesterday, spokesman Robert Hubbell said in a telephone interview.

JPMorgan offered some securities for sale before withdrawing its plan. Lehman also put some securities up for sale, according to a person with knowledge of the situation.

Lehman spokesman Randy Whitestone declined to comment as did Adam Castellani, a spokesman for JPMorgan.

Fastest-Growing

Bear Stearns Chief Financial Officer Sam Molinaro, said the firm's line of credit, known as a repurchase agreement, is ``adequately secured.'' On a conference call, Molinaro declined to comment on the market value of the assets that are backing the credit line.

``The numbers are so fluid,'' he said. ``I'd prefer not to do that.'' Prices for the CDOs the funds held have fallen on concern that they assets will still be dumped on the market, Molinaro said on the call.

``Clearly when we have a situation like this, it puts a lot of pressure on asset values and spreads in the market place,'' Molinaro said. ``That's obviously happening.''

Investors from hedge funds to pension funds and foreign banks have snapped up CDOs as a new way to invest in debt, making it the fastest-growing market and pushing the amount outstanding to more than $1 trillion.

`What You Don't See'

CDOs trade infrequently and holders rarely have comparable sales to use when valuing the securities on their books. Forced sales may have required investors to write down those values, potentially causing billions of dollars of losses.

``The problem is not what we see happening, but what we don't see,'' said Joseph Mason, associate professor of finance at Drexel University in Philadelphia and co-author of an 84-page study this year on the CDO market. ``We don't know the price of these assets. We don't know which banks are exposed to this sector. These conditions are the classic conditions for financial crises across history.''

The bailout of the fund would be the largest since Long-Term Capital Management LP, which received $3.5 billion from 14 lenders in 1998. The Greenwich, Connecticut-based fund, run by John Meriwether, lost $4.6 billion.

In the case of Long-Term Capital, lenders agreed to take equity stakes in the fund after New York Federal Reserve President William McDonough called the heads of the firms together. They then sold assets over time to limit the impact of its collapse.

Bear Stearns's proposal doesn't involve taking equity. Instead, the firm would become a lender to the fund, its loan secured by the assets of the fund.

Drexel Burnham

Bankers and money managers bundle securities into a CDO, dividing it into pieces with credit ratings as high as AAA. The riskiest parts have no rating because they are first in line for any losses. Investors in this so-called equity portion expect to generate returns of more than 10 percent.

The first CDOs were created at now-defunct Drexel Burnham Lambert Inc. in 1987. Sales reached $503 billion in 2006, a fivefold increase in three years. More than half of those issued last year contained mortgages made to people with poor credit, little loan history, or high debt, according to Moody's Investors Service.

CDOs may have lost as much as $25 billion because of subprime defaults, Lehman Brothers analysts estimated in April.

Fitch Ratings warned today for the first time that it probably will downgrade some securities from CDOs containing bonds from 2006 of subprime second mortgages, the class of home loans that have been ``experiencing the greatest stress.'' Standard & Poor's cut ratings on 45 bonds backed by subprime second mortgages.

Perceived Risk

Bear Stearns shares dropped $2.06, or 1.4 percent, to $143.75 in New York Stock Exchange composite trading. The stock has fallen 12 percent this year.

The perceived risk of owning corporate bonds approached the nine-month high reached yesterday. Contracts based on $10 million of debt in the CDX North America Crossover Index jumped $9,000 to $178,000, according to Deutsche Bank AG. It touched $179,000 yesterday, the highest since September.

The risk of owning Bear Stearns's corporate bonds also rose today. Five-year credit-default swaps based on $10 million of the bonds rose $2,200 to $48,000, according to composite prices from CMA Datavision. They touched a three-month high yesterday, trading at $49,000. An increase in the contracts, used to speculate on the company's ability to repay its debt, signals deterioration in the perception of credit quality.

S&P today affirmed its A+ rating on Bear Stearns's unsecured debt and said the firm's exposure to the funds is ``manageable.'' Moody's Investors Service affirmed its A1 rating, though said Bear Stearns will ``need to maintain a delicate balance'' between protecting its reputation and protecting itself from losses.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net; Yalman Onaran in New York at yonaran@bloomberg.net.

Last Updated: June 22, 2007 17:17 EDT