Subprime Contagion: Credit Bubble or Credit Babble?
By Emma Trincal - June 29, 2007

NEW YORK (HedgeWorld.com)— How does the subprime meltdown influence the credit market?

We know from the Bear Stearns case how a combination of leverage and illiquid assets can put fatal pressure on the valuation of a hedge fund invested in mortgage-backed securities. Janet Tavakoli, president of Chicago-based Tavakoli Structured Finance, explained it clearly in a recent contributed piece to HedgeWorld Previous HedgeWorld Story. Funds, such as the Bear fund, that see the price of their subprime collateral drop will be under redemption pressure from their investors. The more leveraged those funds are, the more difficult it will be for managers to satisfy those redemption requests, forcing firms in some cases to impose lock-ups. Meanwhile the investment banks that provide leverage worry about the declining price of the fund's assets and will ask for more collateral, adding more pressure on the hedge fund. And that's the vicious cycle.


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