The Law Planet Blog

Bear Stearns announced bankruptcy petitions for two of its hedge funds. The term "hedge fund" has been used to describe a variety of investment vehicles. Generally, these funds are designed for high net worth investors with significant investable assets. The investors in these funds have virtually no say in how the funds are invested and, generally, they pay significant management fees to the fund manager. They are usually organized as partnerships.

According to this article in Forbes magazine, these funds invested heavily in subprime mortgage instruments. This is the domestic equivalent of Third World debt. These are instruments backed by loans made to borrowers with low quality credit.

To make matters worse, at least one of these funds appears to have been using leverage to purchase these instruments. Leverage is a buzzword for borrowing money. So the leveraged fund is borrowing money to buy investments that loaned money to people with bad credit. When it is explained this way, instead of buried in some dense disclosure document, would anyone place any significant amount of money in this investment?

Subprime lending survived because of the real estate boom in most parts of the country. Now that the gloss is off of the real estate market, the subprime market has come crashing down, taking those that were profiting from the higher interest rates of subprime loans with it. Bear Stearns, as manager of the funds, had no monetary risk unless it had some of its own money in the funds, which I doubt.

The hedge fund "industry" is an area that desperately needs regulation. I'm guessing that some of the "high net worth" investors in these funds are going to be people who had no business being in the investment. Only time will tell -- and the sob stories on 60 Minutes

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