Aug. 1 (Bloomberg) -- Bear Stearns Cos., the manager of two hedge funds that collapsed last month, blocked investors from pulling money out of a third fund as losses in the credit markets expand beyond securities related to subprime mortgages.

The Bear Stearns Asset-Backed Securities Fund had less than 0.5 percent of its $900 million of assets in securities linked to subprime loans, spokesman Russell Sherman said in an interview yesterday. Even so, investors concerned about losses sought to withdraw their money, he said.

Shares of New York-based Bear Stearns fell as much as 6 percent, pushing some brokerage stocks lower on concern about shrinking profits from debt underwriting and trading. Bear Stearns triggered a decline in credit markets in June, when funds it managed faltered after defaults on home-loans to people with poor credit rose to a 10-year high.

``There will be more pain,'' said Felix Stephen, a strategist who helps oversee the equivalent of $7.5 billion at Advance Asset Management Ltd. in Sydney. ``I'm giving it a couple of months at least. It's not the subprime issue that really matters, it is the first card to fall in the tower of cards in this situation.''

Bear Stearns's shares recouped most of their losses by the end of trading at the New York Stock Exchange, closing at $118.30, down 2.4 percent. They're down 27 percent this year, more than any of the other four biggest U.S. securities firms. The Standard & Poor's 500 Index, which fell as much as 1.1 percent earlier today, recovered to close 0.7 percent higher.

Brokerage Stocks Down

Some rival brokers' shares also fell, on concern credit troubles will hurt earnings. Merrill Lynch & Co. dropped 1.1 percent to $73.05, and Lehman Brothers Holdings Inc. fell 1.9 percent to $60.82. Goldman Sachs Group Inc., the largest brokerage, rose 0.4 percent to $189 while No. 2 Morgan Stanley gained 0.8 percent to $64.38.

Investors are overreacting to speculation about subprime ``contagion'' in the credit markets, said CIBC World Markets Corp. analyst Meredith Whitney.

``Brokers are off at least 20 percent from their highs, and most of their business lines are doing great,'' Whitney said in a report today. ``This group offers the best upside potential in financials.''

Other hedge funds have announced losses. Macquarie Bank Ltd., Australia's largest securities firm, said today that investors in two hedge funds may lose 25 percent of their money and Boston-based hedge fund manager Sowood Capital Management LP said yesterday that it lost $1.5 billion in July after declines in the corporate debt markets.

`Having Problems'

The latest developments signal that the slump in the subprime mortgage market may not be ``contained,'' as officials including Treasury Secretary Henry Paulson have said.

``You don't necessarily have to be a subprime fund now to be having problems,'' said Bryan Whalen, a money manager in Los Angeles at Metropolitan West Asset Management, which oversees more than $21 billion in fixed-income assets.

Banks and insurers ranging from UBS AG in Zurich to CNA Financial Corp. in Chicago have reported losses related to subprime mortgage debt. UBS, the world's biggest money manager, replaced Peter Wuffli as chief executive officer in July after three quarters of declining earnings and losses at one of its hedge funds that invested in securities linked to subprime loans.

The risk of owning European corporate bonds increased. Credit-default swaps based on 10 million euros ($13.7 million) of debt included in the iTraxx Crossover Series 7 Index of 50 companies rose 20,000 euros to 420,000 euros, according to JPMorgan Chase & Co. An increase indicates a decline in the perception of credit quality.

Waiting it Out

Bear Stearns doesn't plan to close the Asset-Backed Securities Fund, which has $50 million in cash and gets about $13 million in principal and interest monthly, Sherman said. The fund, which probably lost money in July, can afford to wait until the slump in the mortgage market is over because it doesn't have any debt, he said.

``We don't believe it's prudent or in the interests of our investors to sell assets in this current environment,'' Sherman said. ``The fund portfolio is well positioned to wait out the market uncertainty.''

The fund invested in asset-backed securities, which can be based on car loans, credit card payments and other consumer debt as well as mortgages. Sherman declined to say how many of the assets were mortgage-related. The Wall Street Journal reported that most of the investments were mortgage-backed.

ABS Prices Fall

The ABS fund was up for the year by the end of June and had annual returns averaging 25 percent since its establishment in 2000.

Non-mortgage ABS prices have also declined in the last three months, pushing their yields up. The extra yield investors demand to own asset-backed securities made up of both prime and subprime auto loans, equipment leases, and credit- card receivables rose above their 12-month averages in the week ended yesterday, according to Wachovia Corp.

Even though investors demand an extra 4.19 percentage points in yield to own high-yield, high-risk company debt, the most since May 2005, defaults are near record lows. Merrill Lynch & Co. index data show the spread narrowed to 2.41 percentage points on June 5, the lowest since at least 1997, when the index was created, and is below the peak of more than 10 percentage points in 2002.

Debt rated below Baa3 by Moody's Investors Service and BBB-by Standard & Poor's is considered high-yield, or junk.

Investors Retreat

The collapse in July of Bear Stearns's High-Grade Structured Credit Strategies Fund and its High-Grade Structured Credit Strategies Enhanced Leverage Fund fueled concerns about subprime securities. As investors retreated from risky credit, more than 45 companies were forced to cancel or rework bond and loan sales, according to data compiled by Bloomberg.

The two funds, managed by 22-year Bear Stearns veteran Ralph Cioffi, 51, invested almost all of their assets in subprime mortgage-related securities. They failed when creditors demanded more collateral after the value of those securities dropped. Bear Stearns extended $1.6 billion in credit to one of the funds before seizing its assets last week.

Both funds filed for bankruptcy protection yesterday, two weeks after Bear Stearns told investors they would get little if any money back. Bear Stearns in June assigned its top mortgage trader, 45-year-old Tom Marano, to get the best prices for the funds' remaining assets.

`Weeks to Resolve'

``It's uncertain when we will see the full impact'' from the subprime fallout, Craig Overlander, co-head of global fixed-income at Bear Stearns, said in an interview today in Hong Kong. ``We can stress test, we can come up with possible scenarios but really we won't know until we see what's coming in the mortgage pipeline, the forms they are coming and the environment in which they will reset.''

Investors became more skittish last month as delinquencies on subprime mortgages grew. Blackstone Group LP stepped in to help Sydney-based Basis Capital Fund Management Ltd. avoid a fire sale of assets. Absolute Capital Group Ltd., partly owned by ABN Amro Holding NV, froze investor accounts.

``These are all continuing issues that don't go away in one day or in one week,'' said Ira Jersey, strategist at Credit Suisse Group in New York. The Bear Stearns announcement ``won't be good'' for credit markets, he said. ``It will take a number of weeks to resolve.''

Late payments on subprime home loans, those made to the riskiest borrowers with lower credit scores, rose in the first quarter to the highest level since 2002, the Mortgage Bankers Association has reported. At least 60 mortgage companies have halted operations, gone bankrupt or sought buyers since the start of 2006, according to Bloomberg data.

On the Brink

American Home Mortgage Investment Corp., which lends to homeowners with higher credit scores than subprime borrowers, said yesterday that it doesn't have cash to fund new loans, stranding thousands of home buyers and putting the company on the brink of failure.

Shares of MGIC Investment Corp. had their biggest one-day loss and Radian Group Inc. tumbled the most in eight years yesterday after the home-loan insurers said their stakes in a subprime mortgage company once valued $1 billion may now be worthless because of ``unprecedented'' disruptions in mortgage markets.

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

Last Updated: August 1, 2007 16:42 EDT