Banks need to be bold and show hedge funds the money

As banks withdraw from risk-taking to repair their tattered balance sheets, providing hedge funds with leverage is low on the priority list, even if those funds are the very buyers that banks need to take distressed structured credit assets off their hands.

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The most levered funds are now borrowing no more than five times their asset base, compared with 10 times their asset base just six months ago, according to fund of hedge fund managers.

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Steve Gross, principal at Penso Capital Markets, a fund of hedge funds, says that if the prospects for obtaining leverage were to get significantly worse, the large established hedge funds, some of whom have access to the public debt markets and alternative leverage options, will survive while smaller funds will struggle. "Investors need to take a long-term view on how bank business models are likely to change, and to what extent providing hedge fund leverage is going to fit in those new models," he says.

There is a chance, he says, that banks will not return to providing leverage any time soon.

But this means that in the structured credit markets, asset prices could fall further still before enough buyers emerge to restore stability.