It was April 2007, and two Bear Stearns hedge funds run by Ralph Cioffi and Matthew Tannin were piling up losses in the subprime-mortgage...

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NEW YORK — It was April 2007, and two Bear Stearns hedge funds run by Ralph Cioffi and Matthew Tannin were piling up losses in the subprime-mortgage market. The men were panicking over an internal report showing their funds were tanking.

“The subprime market looks pretty damn ugly,” Tannin wrote in an e-mail to Cioffi. “If we believe the [report] is ANYWHERE CLOSE to accurate I think we should close the funds now. The reason for this is that if [the report] is correct then the entire subprime market is toast.”

The slide only worsened in the ensuing weeks. On June 9, Cioffi wrote that if he couldn’t miraculously turn the funds around, “I’ve effectively washed a 30-year career down the drain,” prosecutors said.

On Thursday, Cioffi and Tannin were in handcuffs — arrested on charges of conspiracy and securities and wire fraud for allegedly lying to investors in the hedge funds.

They were the first criminal charges to arise on Wall Street from the subprime-mortgage debacle, and legal experts said they could signal a wave of prosecutions to come.

The implosion of Tannin and Cioffi’s hedge funds cost investors $1.8 billion and foreshadowed Bear Stearns’ own historic demise: On the verge of bankruptcy, the bank was bought by JPMorgan Chase earlier this year.

Prosecutors say the men painted a rosy picture to investors about the funds’ health when they were clearly aware that the funds were in trouble because of the subprime-mortgage market. The two funds were heavily invested in subprime mortgages.

Both defendants pleaded not guilty, were released on bond and left court without speaking to reporters. Each faces up to 20 years in prison.

Tannin, 46, “is innocent,” said his attorney, Susan Brune. “He is being made a scapegoat for a widespread market crisis. He looks forward to his acquittal.”

The mortgage-market crisis “took the whole financial world by surprise,” said Cioffi’s attorney, Edward Little. “So our question is, why is Ralph Cioffi being charged in this case?”

The arrests came as the Justice Department announced the indictments of more than 400 players in the real-estate industry since March in a crackdown on mortgage fraud. Sixty were arrested on Wednesday alone.

That alleged fraud includes misstatement of income or assets, forged documents, inflated appraisals and misrepresentation of a buyer’s intent to occupy a property as a primary residence.

Legal experts said more Wall Street figures would probably be charged in the credit crisis, the latest front for white-collar prosecutors who brought — and in most cases won — high-profile cases earlier this decade after the fall of Enron.

“There is no doubt the government is always looking to go as high as they can,” said Bill Leone, a former U.S. Attorney in Colorado. “Any time you get losses into the billions, the likelihood that higher-level executives participated in decisions increases.”

Subprime mortgages were sold to people with less-than-ideal credit. Many of them began defaulting on their loans when the housing market fell and their introductory “teaser” interest rates shot up, making their payments unaffordable.

Because many of those mortgages were sliced and repackaged as securities that could be bought and sold, the mass defaults caused widespread pain among large U.S. banks.

The collapse of the two Bear Stearns funds is just a small part of the subprime crisis, which is still rippling through the economy.

Amid the fallout for banks, prominent CEOs have lost their jobs, including Citigroup’s Charles Prince, Merrill Lynch’s Stanley O’Neal and Bear Stearns’ own James Cayne, who was stripped of his CEO title.

Hedge funds cater to large investors and the very wealthy and use complex, speculative investing methods in hopes of winning enormous gains. They operate with little government supervision and have lately come under fire from regulators.

In the Bear case, the internal e-mails provide a window into the trouble that began to engulf the hedge funds in 2007.

The indictment describes a meeting of Cioffi, Tannin and two unnamed colleagues in which Cioffi confided the hedge funds had narrowly “averted disaster” in February 2007 — news that “led to a vodka toast to celebrate surviving the month.”

The situation became so dire that Cioffi pulled $2 million of his own cash from the fund, but the pair still told investors that they should stay in and that the outlook was good, prosecutors said.

The complaint says Tannin expressed doubt about Cioffi’s management in an one e-mail last March to a third fund manager with only question marks in the subject line. The e-mail said, “Is Ralph doing what he should be doing right now?”

Around the same time, Cioffi wrote to a Bear Stearns economist: “I’m fearful of these markets. … As we discussed it may not be a meltdown for the general economy but in our world it will be. Wall Street will be hammered with lawsuits.”

Tannin and Cioffi were repeatedly telling investors and Bear Stearns brokers responsible for selling funds that the outlook was good.

In once instance, prosecutors said, Tannin encouraged an investor to add money to the fund and said he would do the same, but never did.

At the same time, prosecutors say, Cioffi pulled $2 million of his own money out of the fund, about a third of his stake, and put it into a separate fund without telling investors. He was charged with insider trading in addition to fraud.

“This is not about mismanagement of a hedge fund,” said Mark Mershon, head of the New York FBI office. “It is about premeditated lies to investors and lenders.” The Bear Stearns hedge funds had more than $20 billion in assets before collapsing in June 2007.

The case demonstrates yet again how e-mail can trip up Wall Street executives.

Prosecutors used e-mail exchanges against former Credit Suisse Group banker Frank Quattrone and famed stock analysts Jack Grubman and Henry Blodget. But prosecutors struggled to win and maintain convictions in all of those cases.

Cioffi and Tannin have already been named in lawsuits brought last year by hedge-fund investors who allege they were purposely misled.

The fortunes of Bear Stearns began to crumble around the same time that the fund collapsed, getting so bad that the Federal Reserve and JPMorgan had to intervene to save the once-mighty institution from bankruptcy.