Aug. 14 (Bloomberg) -- The widening gap between the stocks and bonds of Bear Stearns Cos. and Goldman Sachs Group Inc. shows just how fast investors are losing confidence in James E. Cayne.

Not even an emergency conference call with analysts or letters of assurance to clients have alleviated pressure on Bear Stearns. The failure of two of its hedge funds and the sudden ouster of Co-President Warren Spector on Aug. 5 left shareholders so unsure of the firm's finances that New York- based Bear Stearns is trading as if it were headed for liquidation. Bond buyers are treating the debt, which has an A+ rating, like it's scarcely better than junk.

Cayne, Bear Stearns's chief executive officer for the past 14 years, is being punished for leaving his firm dependent on U.S. mortgages, as rivals expanded abroad and into equities and commodities. While the surge in yield premiums for corporate and asset-backed debt has driven Wall Street stocks to the lowest valuations in more than three years, Bear Stearns is the cheapest at 1.2 times book value.

``The stock is the ultimate arbiter of how well management has responded, and the stock is saying they have not responded well,'' said Michael Holland, who helps manage $4 billion for Holland & Co. in New York. ``This most recent episode was so out of character with respect to the firm's history that the penalty is 1.2 times book.''

Shares of Goldman are trading at an industry-leading multiple of 2.2 times book value, reflecting the appeal of the firm's diverse sources of revenue and giving CEO Lloyd Blankfein the biggest advantage over Cayne with investors since 2001. In the debt market, the risk premium on Goldman bonds is 35 percent less than Bear Stearns, the fifth-biggest U.S. securities firm.

Steering Clear

Some investors are steering clear of investment banks altogether until the shakeout is over. The average price-to-book ratio for the five largest Wall Street firms -- Goldman, Morgan Stanley, Merrill Lynch & Co., Lehman Brothers Holdings Inc. and Bear Stearns -- has dropped to about 1.6 from 2.1 a month ago.

Jon Fisher, who helps oversee $22 billion at Fifth Third Asset Management in Minneapolis, said he considers the securities industry overvalued because analysts haven't cut earnings estimates enough to reflect the loss of business from structured credit products such as collateralized debt obligations and leveraged buyouts. He sold shares of Goldman and Merrill at the end of last year and holds only Morgan Stanley now.

``Bear, just from a business mix standpoint, is going to trade at a discount to Goldman,'' Fisher said. ``I'd say that gap probably has to close because I think Goldman has to come down more than Bear does.''

Hedge Funds Decline

Nothing illustrates the divide between the firms like the way each handled its own hedge fund crisis.

When Bear Stearns's two funds, High-Grade Structured Credit Strategies and High-Grade Structured Credit Strategies Enhanced Leverage, nosedived in June, the company tried to forestall a total collapse by halting withdrawals and unloading securities to meet lenders' demand for more collateral. That strategy failed, and Bear Stearns was forced to bail out one of the funds with a $1.6 billion loan. Investors in the other fund were wiped out.

Goldman took a different course of action. When assets in the firm's Global Equity Opportunities hedge fund dropped by 28 percent this month, Goldman yesterday pumped in $2 billion of fresh capital and raised $1 billion more from investors including Maurice ``Hank'' Greenberg, the former American International Group Inc. chairman, and billionaire Eli Broad.

Goldman `Confident'

Bear Stearns Chief Financial Officer Sam Molinaro, speaking on a June 22 conference call with analysts, called the loan an effort to ``improve liquidity and facilitate an orderly de- leveraging of the fund.'' Goldman stepped in as an investor because ``we're pretty confident in the future success of the fund,'' CFO David Viniar said on a conference call yesterday. ``Let me clarify, this is not a rescue,'' he said.

Goldman's $7.25 billion Global Alpha hedge fund has lost 27 percent this year and North American Equity Opportunities, a $500 million pool, was down 15 percent as of July 27.

The past eight weeks have been the toughest on Bear Stearns since 1998, the last time the 84-year-old firm was caught in such a credit crunch. In addition to bailing out the one hedge fund, Cayne, 73, had to take over the investments when buyers couldn't be found. He removed Richard Marin as head of Bear Stearns Asset Management, then dismissed Spector, who oversaw trading and at 49 was considered the leading contender to succeed Cayne as CEO.

The 33 percent slide in Bear Stearns shares through Aug. 13 would be the steepest drop for a Wall Street stock since 1987, when they fell 34 percent and Merrill Lynch tumbled by even more. Goldman, the biggest U.S. securities firm by market value, has dropped 11 percent this year.

`Poorest Light'

``Bear is probably being looked at in the poorest light in 10 years and Goldman's still the star of the group,'' said Peter Goldman, who helps oversee $500 million at Chicago Asset Management and owns shares of Bear Stearns and Morgan Stanley. ``Bear was the least diversified away from what right now is the core problem in the market.''

After Standard & Poor's threatened to cut Bear Stearns's debt rating on Aug. 3, Cayne and Molinaro held another conference call to address the ``uncertainty in the marketplace.'' Cayne said he wanted to assure investors that ``we are taking the situation seriously.'' While Molinaro said conditions in the fixed-income markets were ``about as bad as I've seen it,'' he added that Bear Stearns's ``balance sheet, capital base and liquidity remain strong.''

Bear Stearns sent letters last week telling clients to ``rest assured,'' that the firm has survived ``challenging markets'' in the past.

Prospecting in China

Now Cayne is prospecting for investors in China and may sell a minority stake to Citic Group, Forbes magazine reported on Aug. 9, citing an unidentified person close to the Beijing- based company. Some investors even consider the firm a possible takeover target.

``It depends on how bad are some of the assets that they've had,'' said David Dreman, who oversees $22 billion as chief investment officer at Dreman Value Management LLC in Jersey City, New Jersey. ``If they really don't have major other problems, they could be taken over if they decided to go that way.''

Bear Stearns spokesman Russell Sherman said Cayne declined to comment beyond his remarks on the Aug. 3 call.

Not everyone's spooked. James Barrow, president of Dallas- based Barrow Hanley Mewhinney & Strauss, said he has been adding to the 3.65 million Bear Stearns shares held at the end of June. Barrow, who oversees $70 billion, said he's confident in Cayne and Alan ``Ace'' Greenberg, Cayne's 79-year-old predecessor and chairman of the firm's executive committee.

Confidence in Cayne

``We've gone through the book value in great detail, and we don't find anything to have questions about,'' Barrow said. ``In terms of Jimmy Cayne, he's been there his entire life, and the guy that ran it before him is still there.''

Peter Kovalski, who helps manage $22 billion, including shares of Goldman, Morgan Stanley, Merrill and Lehman, at Alpine Woods Investments in Purchase, New York, said he's avoiding Bear Stearns shares even at the current discount.

```We may not have heard the full extent of the problems,'' he said. ``I'm not as comfortable with them as with maybe Merrill Lynch.''

At least eight analysts have reduced their profit estimates for Bear Stearns in the past four weeks. UBS AG's Glenn Schorr, rated No. 2 in Institutional Investor's annual survey, made the deepest cuts. He expects Bear Stearns to earn $12.46 a share this year instead of $14.70 because the firm is losing fixed- income revenue.

Investors are shunning mortgage-backed bonds, Bear Stearns's specialty, and structured products. Next year, profit will drop to $12 a share, Schorr estimates.

Rival Firms

While the outlook has dimmed for New York-based Goldman, Morgan Stanley, Merrill and Lehman, Schorr still expects them to report higher net income.

``Bear's in a tough spot because of the storm brought on from both their exposures to mortgage and credit businesses and of course the hedge funds blowing up,'' he said in an Aug. 7 interview. ``Partly, it's a loss of confidence, and the concern is that some of their business could be pulled.''

Richard Bove, an analyst at Punk Ziegel & Co. in Lutz, Florida, who recommends selling shares of Bear Stearns and Goldman, has an even stronger opinion.

``What he's doing is all wrong, everything he's done to this point has been incorrect,'' Bove said of Cayne. ``I don't think the guy has any credibility with people outside the firm.''

Investors say Goldman can withstand the market turmoil best because it makes more than half its revenue overseas and can lean on markets such as commodities and equities. Bear Stearns has only a nascent business in commodities and got 42 percent of its revenue in the first half from fixed-income trading, the most on Wall Street, compared with 35 percent for Goldman.

Overseas Retreat

Bear Stearns has a record of making overseas investments just as the markets peak, only to pull back in the following years. A European expansion culminated with the May 2000 hiring of 11 telecommunications merger bankers, just as the industry swooned. Bear Stearns also downscaled in Asia in the wake of the region's financial crisis a decade ago. In 1987, the firm was about to sell a 20 percent stake to Hong Kong's Jardine Matheson Holdings Ltd. when the stock market crashed, scuttling the deal.

Craig Overlander, Bear Stearns's co-head of global fixed- income, said earlier this month that the firm plans to double the number of employees in Europe and Hong Kong. ``Our major competitors are larger on their international slice than we are, so we still have some way to go,'' he said.

Bond House Label

Lehman, the fourth-largest U.S. securities firm, used to be derided like Bear Stearns for being a bond house. Since 2002, Lehman has increased its equity-trading revenue by about sixfold while Bear Stearns's has doubled. Goldman's has grown by more than eight times, and the firm now has the world's largest equities business.

Goldman also enhanced its ability to lend money to investment-banking clients by investing $1.3 billion in Japan's Sumitomo Mitsui Financial Group Inc. in 2003. In turn, SMFG agreed to cover at least $1 billion of losses on loans that Goldman makes to investment-grade customers, giving the firm a competitive edge against the biggest commercial banks, such as New York-based Citigroup Inc. and JPMorgan Chase & Co.

While Goldman remains the world's No. 1 adviser on mergers and acquisitions, Bear Stearns has slipped to 23rd this year from 12th in 2002, according to data compiled by Bloomberg.

``Bear has earned a ton of money by not spending money diversifying overseas,'' said James Ellman, who manages about $200 million at SeaCliff Capital in San Francisco. ``Today I'm sure they wish they'd taken some of those earnings from mortgages and built more non-U.S. businesses.''

Profit Differential

Under Blankfein, 52, Goldman has improved its industry- leading productivity and effectiveness at deploying capital for maximum return. Goldman's 28,013 employees generated $5.53 billion of earnings in the first half, or $197,415 apiece. Bear's 15,120 workers produced $915 million in first-half profit, for a per-person average of $60,546.

Goldman trades at 8 times the average estimate for 2008 earnings per share, compared with 7.5 times for Bear Stearns.

Profit at Wall Street's biggest firms will decline as much as 40 percent from the peak in the first quarter of 2007, according to estimates by Charles Peabody, an analyst at Portales Partners in New York who has recommended selling shares of all five Wall Street firms since at least November 2005. He expects the rising defaults in mortgages to spread to corporate loans and bonds and to emerging markets debt, which could damp revenue from equities and mergers.

``Bear has such a large mortgage exposure that even if they get through this, what's the growth opportunity? It's been dented,'' said Steve Roukis, who helps manage $1.8 billion at New York-based Matrix Asset Advisors Inc. Goldman ``qualitatively is the best franchise out there.''

To contact the reporter on this story: Christine Harper in New York at charper@bloomberg.net

Last Updated: August 14, 2007 00:13 EDT