Investors, and others, burned by the 2008 credit crisis, have a sense of foreboding that we are at the end of another business cycle. While some dismiss this as an alarmist concern that ignores fundamentals, we see contemporary indicators that led to the great credit crisis, hedge fund collapse and Madoff blow-up: mounting inflationary pressures, rising debt yields, volatility in equity markets and so-called ‘dumb’ money flowing into little understood alternative asset classes.

The silver lining to the 2008 crisis – if there is any to be found – is that it provided a case study on risk management and asset recovery for funds and their investors. While it is unlikely we will face anything approaching the magnitude of the 2008 meltdown in the near future, fund managers, liquidators, institutional investors and high-net-worth individuals should study the lessons learned from the past to react to any future crisis

The first ripple in a wave of financial institution failures (and near-failures), including Bear Stearns and IndyMac Bank, came in 2007 when mortgage giant Freddie Mac announced it would no longer buy the riskiest subprime loans. The situation escalated with the failure of Lehman Brothers which presaged numerous private fund collapses. These fallen dominoes led to the worst global financial collapse since the Great Depression.

Many funds faced net asset value concerns, as investors lost confidence in funds whose documents had given broad discretion to managers to invest in hard to value assets. In many cases, this broad discretion had led to abuse and limited the scope of investor audits. Exasperating liquidity concerns, cash and liquid assets were depleted, in many cases, to pay the standard 2/20 fund management fee: 2 percent of assets under management and 20 percent of any increase over the high-water mark.

Apr-Jun 2019 issue

Nixon Peabody LLP