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Cashing in on the Crash

Distressed-debt investors--a.k.a. vulture fund--are poised to feast during the credit crunch.
Economist Staff, The Economist
August 24, 2007

The past few years have been lean ones for those who feed off corporate carrion. Now, as credit markets creak, distressed-debt investors—known less kindly as vulture funds—are confident that their time has come at last.

Many can claim to have seen the rout coming. Private Equity Intelligence, a research firm, calculates that vulture funds raised $15.6 billion in the first seven months of this year, more than the $13.9 billion they garnered in all of 2006, itself a record. A further $30 billion is in the works, including a giant $20 billion fund being pieced together by Goldman Sachs.

Nothing gets vultures squawking louder with delight than a wave of forced selling. This week Thornburg, a property firm facing funding difficulties, sold an array of top-notch securities worth over $20 billion at a 5-10 percent discount. Highly leveraged, computer-driven "quant" funds are having to liquidate shares, bonds and anything else they can sell in order to meet margin calls from their prime brokers. As markets tighten, creditors will also be less willing to refinance wobbling companies. That could mean an imminent end to the bankruptcy drought.

While some hedge funds suffer, others are poised to snaffle up bargains. Citadel, Ellington and Marathon Asset Management, among others, have both the ready cash and the inclination. Citadel traditionally keeps more than a third of its assets in cash or liquid securities, allowing it to pounce when opportunities arise. It recently took over a chunk of Sowood Capital, a rival that buckled under bad bets.

If the past is any guide, spectacular returns beckon for some. John Mauldin, publisher of an investment newsletter, points out that during America's 1980s savings-and-loan crisis, bottom-fishers could net perfectly good mortgages for 15 cents on the dollar.

Two skills will be particularly useful: spotting the gems in the rubble, and timing. An investor who pays 90 cents on the dollar for debt that is almost certain to be repaid can make mouth-watering returns with minimal leverage. But after WorldCom's collapse, many would-be vultures swooped too early, tearing into the discounted bonds of cable and telecoms firms, only to see them tumble further.

Ironically, the very firms that helped to inflate the credit bubble are now among the keenest to profit from its bursting. Blackstone and TPG, two of the biggest sponsors of leveraged buy-outs, both have distressed-debt funds, and Blackstone has expanded its already big restructuring unit. Private-equity firms are even looking to buy debt in each other's deals at a discount, says Martin Fridson, an independent credit analyst.

Experience counts for more in busts than in booms. So no one was surprised when Wilbur Ross, who earned a fortune buying up failed steelmakers, made an "initial foray" into subprime mortgages this month, offering $50m to a bust lender. Warren Buffett is also sniffing around, armed with a cash pile approaching $50 billion. When the price is right, he told the Wall Street Journal this week, "I can spend money faster than Imelda Marcos." Unlike the Philippines' former first lady, however, he will be looking for weather-beaten shoes in need of a shine.




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