July 23 (Bloomberg) -- When Bear Stearns Cos. Chief Executive Officer James E. ``Jimmy'' Cayne told the New York Times the failure of the firm's hedge funds was a ``body blow of massive proportion,'' he may have been using a tactic honed in three decades of championship bridge.

To win the card game, a player sometimes will misstate the number of tricks he can win to dupe opponents into underestimating his hand. So far, Bear Stearns shareholders aren't showing much anxiety. The stock has outperformed its peers since Cayne's remarks were published on June 29, even after Bear Stearns told investors in the High-Grade Structured Credit Strategies and High-Grade Structured Credit Strategies Enhanced Leverage funds that almost all of their money was wiped out.

While Bear Stearns fended off creditors and investors who demanded their money back, Cayne, 73, remained silent. On June 22, the day New York-based Bear Stearns offered to put up $3.2 billion to keep one of the funds solvent, Cayne flew by helicopter to the Hollywood Golf Club in Ocean Township, New Jersey, where his 97 score would have been celebrated by duffers half his age.

``This was a game where the other team was playing out the hand because things went beyond Bear's control,'' said Andrew Corn, a bridge player and money manager at New York-based Clear Asset Management LLC, which holds Bear Stearns shares. ``But Cayne knew how to capture that extra trick to win the day.''

Bear Stearns, the biggest U.S. broker to hedge funds, doesn't expect to lose even a dime on the bailout, according to a July 17 statement to clients. Most analysts say the debacle is unlikely to have anything but a negligible impact on profit and book value. Only two of 16 have cut their estimates for Bear Stearns earnings in the past four weeks.

Cayne declined to comment.

Committed Capital

If anything, Cayne's decision to provide the loan to the $925 million High-Grade Structured Credit Strategies Fund may have helped burnish the firm's reputation and minimized the collateral damage. Because the funds were managed at arm's length by a subsidiary, Bear Stearns had no obligation to lend the money. Cayne eventually committed $1.6 billion of capital, half as much as initially forecast.

``If the market is already putting a discount on your valuation because they fear the worst, you might as well set the expectations fairly low,'' said Roger Freeman, an analyst at Lehman Brothers Holdings Inc., who has an ``overweight'' rating on Bear Stearns shares and raised his 2007 earnings estimate last month. ``When all this is said and done, when the funds are unwound, there won't be losses and they'll have moved quickly to take care of the reputational issues.''

Management Shakeup

The same day Cayne's comments appeared in the Times, Bear Stearns dumped the motorcycle-riding head of its asset-management unit, Richard Marin, 53, who posted movie reviews on his blog as hedge fund losses accelerated in mid-June. Cayne replaced Marin with Lehman Vice Chairman Jeffrey Lane, 65, a Wall Street veteran with four decades of experience.

The firm also moved over its top mortgage trader, 45-year- old Tom Marano, to ensure the funds get the best prices for their remaining assets.

While shares of Bear Stearns dropped 3.8 percent since Cayne made his remarks, Lehman's stock tumbled 8.4 percent, Goldman Sachs Group Inc. shares fell 5 percent and Merrill Lynch & Co.'s stock declined 4.2 percent. Of the firm's largest rivals, only Morgan Stanley has performed better.

Founded in 1923, Bear Stearns belongs to a select group of securities firms that survived as independents while more than 450 rivals were acquired or shut down. Still, it's the smallest of Wall Street's big five, with less than a third as much shareholders' equity as New York-based Goldman, the world's biggest securities firm by market value.

Earnings History

Cayne's reluctance to take long-term risks has constrained growth. It also insulates the firm from market turmoil. In 2001, as the bubble in Internet stocks burst, Bear Stearns's profit fell 20 percent, the smallest drop on Wall Street. The following year, earnings surged 42 percent, while they declined at New York-based Lehman, Morgan Stanley and Goldman.

``During bear markets, Bear doesn't do too bad,'' said Justin Fuller, an analyst at Morningstar Inc. in Chicago. ``That's partly because they're more focused than others at serving clients and don't make huge bets with their own money. Even the hedge fund fiasco, that was clients' money.''

Lehman, which ranks ahead of Bear Stearns as the fourth- largest securities firm, beat back similar pressure in 1998. Battered by Russia's debt default and the meltdown of hedge fund Long-Term Capital Management LP, Lehman shares fell 63 percent from June through September and money market traders doubted that the firm could finance its overnight loans.

Two quarters later, Lehman reported record profit, and the firm has since increased net income five-fold.

Estimate Reductions

Bear Stearns will lose some money from the hedge fund debacle. The firm invested $34 million of its own capital in the funds and has $43 million of unsecured loans outstanding. It would also collect about $30 million in management fees annually, at the typical 2 percent rate for hedge funds.

``If they hadn't stepped in and put up their own money, the reputational risk would be severe,'' said Tom Jalics, an analyst at National City Bank in Cleveland, Ohio, who helps manage $32 billion, including Bear Stearns shares.

The analysts who reduced their estimates for Bear Stearns profit, Sanford C. Bernstein & Co.'s Brad Hintz and Punk, Ziegel & Co.'s Richard Bove, say the shakeout in the market for subprime mortgage bonds and related securities will do more damage.

`Same Headwinds'

Hintz expects the slowdown in mortgage-bond sales to reduce trading revenue and predicts that Bear Stearns will restrict lending to hedge funds, one of its most lucrative businesses. Last week, he trimmed his estimate for 2007 earnings by 30 cents a share to $14.10. Hintz figures Bear Stearns will make $15.10 a share in 2008, down from his earlier forecast of $15.35.

The average estimates in the Bloomberg survey of 16 analysts are for profit of $14.53 a share this year and $15.66 in 2008. Bear Stearns earned $14.27 a share in 2006.

``Most of the earnings impact will come from the market conditions,'' said Hintz, who's based in New York. ``Everyone in its peer group faces the same headwinds.''

Bove of Punk Ziegel in Lutz, Florida, downgraded all five of the largest U.S. securities firms on July 18, saying the industry isn't facing a ``Bear Stearns problem but a systemic one.''

Ralph Cioffi, 51, who managed the High-Grade Structured Credit Strategies Fund and the High-Grade Structured Credit Strategies Enhanced Leverage Fund, invested in collateralized debt obligations, or CDOs, that held mortgage bonds. As homeowners defaulted on payments at the highest rate in 10 years, the value of those bonds began to slide. Some now fetch as little as 50 cents on the dollar.

Bernanke's Forecast

Cioffi also lost money as an offsetting bet on mortgage- backed debt unraveled, further squeezing the funds. Clients began withdrawing money and creditors demanded more collateral, forcing the funds to liquidate at least $4 billion of securities.

JPMorgan Chase & Co. analysts said last week that ``the worst is not over in the subprime mortgage market'' and U.S. Federal Reserve Chairman Ben S. Bernanke said there will be ``significant financial losses,'' citing estimates as high as $100 billion. Credit Suisse Group forecasts losses on CDOs alone of $52 billion.

Bear Stearns Chief Financial Officer Sam Molinaro said in March that subprime home lending and related securitizations make up only about 3 percent of the mortgage business, which itself provides a fraction of the firm's $4 billon in annual fixed- income revenue. Asset management, the unit that ran the hedge funds, contributed $112 million of revenue last year.

Relative Risks

About 15 percent of the hedge fund managers to whom Bear Stearns provides brokerage services is invested in the fixed- income markets. Hedge funds are mostly private and unregulated pools of capital where managers can buy or sell any assets, participating substantially in the profits of the money invested.

``Bear's business is more diverse than realized,'' Bank of America Corp. analyst Michael Hecht said in a July 18 report.

The firm also has taken on comparatively little credit risk in the CDO market. Creditsights Inc. analyst David Hendler said on July 10, after scrutinizing the firms' quarterly filings with the U.S. Securities and Exchange Commission, that Bear Stearns's potential loss on CDOs in off-balance-sheet entities would be $128 million at most, compared with $15.8 billion for Goldman.

Cayne's real Achilles heel is outside the U.S., where Bear Stearns generates 20 percent of its revenue -- a smaller share than any of its larger rivals. Goldman, by contrast, gets more than 50 percent in overseas markets.

``They're more exposed than peers because they're more U.S.- centric and more fixed income,'' said Peter Goldman, who helps manage $600 million at Chicago Asset Management and holds shares of Bear Stearns. ``But like all the brokers, Bear is a cyclical story. Shares might drop when business slows, but when markets turn around, they'll be making a lot of money.''

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

Last Updated: July 22, 2007 20:27 EDT