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Distressed Hedge Funds Amidst the Credit Crunch

By Jeff J. Marwil

As we begin a new year, many beleaguered hedge funds will reflect on 2007 and how the credit crunch affected Wall Street, corporate borrowers and hedge funds in the long run. Although nobody knows if the end of troubled times is near, we do know that a sustained recovery will take lots of know-how, cooperation and willingness to be more transparent in our dealings with one another and, perhaps, some old-fashioned work.

As many of us know, until mid-August 2007, Wall Street was awash in cash and derivative securities; selling the latter for mounting sums of the former. The derivative products, collateralized loan (or debt) obligations (CLOs or CDOs), were bond-like securities (comprised of hundreds or thousands of securitized bonds or mortgages) sold to investors directly or through massive pooling vehicles called Structured Investment Vehicles (SIVs). The SIVs bought the CLOs or CDOs en masse, and sold interests in the SIVs to investors. The inherently complicated structure and hedging of these various investments securities were to provide relative safety to investors (including hedge funds) by virtue of the diversification of risk among the underlying borrowers. Investors could, in effect, buy more or less risk, based on which tranche of a particular CDO or CLO issuance they purchased, and SIV investor could limit downside risk because the SIV investments were themselves so diversified ' or so they thought.

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