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Banks' demands threaten hedge funds

Bloomberg News

The hedge fund industry is reeling from its worst crisis in a decade as banks are now demanding more money pledged to support outstanding loans even when the investment is backed by the full faith and credit of the United States.

Since Feb. 15, at least six hedge funds, totalling more than $5.4-billion (U.S.), have been forced to liquidate or sell holdings because their lenders - staggered by almost $190-billion of asset writedowns and credit losses caused by the collapse of the subprime-mortgage market - raised borrowing rates by as much as tenfold with new claims for extra collateral.

While lenders are most unsettled by credit consisting of real estate and consumer debt, bankers are now attempting to raise the rates they charge on Treasuries, considered the world's safest securities, because of the price fluctuations in the bond market.

"If you have leverage, you're stuffed," said Alex Allen, chief investment officer of London-based Eddington Capital Management Ltd., which has $195-million invested in hedge funds for clients. He likens the crisis to a bank panic turned upside down with bankers, not depositors, concerned they won't get their money back.

The lending crackdown is the worst to hit the $1.9-trillion hedge fund industry since Russia's debt default in 1998 roiled global credit markets and required the U.S. Federal Reserve to pressure the securities industry to arrange a $3.6-billion bailout of Greenwich, Conn.-based Long-Term Capital Management LP. Today, hedge funds are being forced to sell assets to meet banks' margin calls, resulting in the dissolution of the funds.

"There has to be more in the next weeks," Mr. Allen said. "There are people who have been hanging on by their fingernails who can't hold on much, much longer."

Ivan Ross, founder of Westport, Conn.-based hedge fund Tequesta Capital Advisors, received a call from his bankers on Feb. 22 demanding he put up more money or risk losing his loans.

Ross was unable to meet the margin call as the market for mortgage-backed debt seized up, preventing him from selling securities to raise the necessary cash. Four days later, lenders liquidated his $150-million fund.

"Because it's impossible in this environment to move among dealers, you're at the mercy of counterparties," said the 45-year-old Mr. Ross, who has managed hedge funds for 13 years, including a stint handling mortgage-backed debt for billionaire George Soros.

The demise of Tequesta revealed the deathtrap for hedge funds caught in the credit maelstrom of banks selling mortgage-backed bonds as fast as they can while demanding more collateral.

Some managers set themselves up for a stumble by taking on too much leverage, said Christopher Cruden, CEO of Lugano, Switzerland-based Insch Capital Management, which oversees $150-million for clients.

"If you're going to dance with the devil, there comes a time when your toes are going to be stepped on," Mr. Cruden said. "Prime brokers are there to do business, not be your friend."

On Feb. 24, London-based Peloton Partners LLP gave up a "night and day" effort to stave off demands from banks, including Goldman Sachs Group Inc. and UBS AG, for as much as 25 per cent collateral for securities that once required 10 per cent, according to investors in the fund. Peloton, run by former Goldman partners Ron Beller and Geoff Grant, liquidated the $1.8-billion ABS Fund, its largest.

© 2007 The Globe and Mail. All rights reserved.

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