Several months ago, as a stunned subprime MBS market was still reeling from crumbling fundamentals, selloffs and wide spreads, the capital markets thought that the hedge fund industry - despite its conflicted history with the subprime MBS market - might be able to supply the necessary liquidity to keep the sector afloat until conditions improved. It seemed like a reasonable role for hedge funds to play, underscored by Fortress Investment Group's purchased of about $4 billion of loans from Fremont Mortgage.

Last week however, two major hedge funds managed by Bear Stearns were on the brink of collapse - hit by what market sources described as a lethal combination of credit, leverage and liquidity problems. The High Grade Structured Credit Strategies Enhanced Leveraged Fund and the High Grade Structured Credit Strategies Fund held about $20 billion in MBS, mainly via high-grade AAA' and high-grade AA' CDOs, according to market sources and press reports.

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