. bank holding companies, the federal reserve continues to pay keen attention to hedge fund exposures and is working to ensure stronger risk - management practices. in addition, through the federal reserve bank of new york, the federal reserve is actively facilitating collaboration and coordination among domestic and international supervisors of the global banks that are key counterparties and creditors of hedge funds. this area of significant focus – targeting management of exposures to hedge funds – is part of a broader, comprehensive set of supervisory initiatives that seeks to ensure that banks'risk - management practices and market infrastructures are www. ustreas. gov / press / releases / hp272. htm a collateralized debt obligation ( cdo ) is a security that entitles the purchaser to some portion of the cash flows from a portfolio of assets, which may include bonds, loans, mortgage - backed securities, or other cdos. for a given pool, cdos designated as senior debt, mezzanine debt, subordinated debt, and equity often are issued. sufficiently robust to cope with stresses that may accompany a deterioration of market conditions. to that end, the federal reserve has been focusing on five key supervisory initiatives : comprehensive reviews of firms'stress - testing practices ; ( 2 ) a multilateral supervisory assessment of the leading global banks'current practices for managing their exposures to hedge funds ; ( 3 ) a review of the risks associated with the rapid growth of " leveraged lending " ; ( 4 ) a new assessment of practices to manage liquidity risk ; and ( 5 ) continued efforts to reduce risks associated with weaknesses in the clearing and settlement of credit derivatives and other over - the - counter ( otc ) derivatives. indeed, this committee should be assured that the federal reserve has taken on these initiatives with great purpose and resolve. these initiatives are fully consistent with the founding purpose assigned to the federal reserve by congress : to help mitigate the risks to the financial system and the broader economy caused by periodic bouts of instability and financial stress. hedge funds although there is no precise legal definition, the term " hedge fund " generally refers to a pooled investment vehicle that is privately organized, administered by a professional investment manager, and not widely available to the public. the assets, investment strategies, and risk profiles of funds that meet this broad definition are quite diverse. in no sense are hedge funds an " asset class, " like stocks, bonds, commodities, or real estate. while some hedge funds pursue investment strategies similar to those pursued by

and other insured depositories. in those earlier periods, declines in asset prices created considerable financial and economic stress – the losses produced failures of many depositories and severely impaired the capital and lending capacity of others. at the same time, the growth of hedge funds clearly presents risk - management challenges to participants in financial markets. if those risk - management challenges are not addressed successfully, problems in the hedge fund sector could pose risks to the broader financial system. for example, when the hedge fund long - term capital management ( ltcm ) nearly failed in september 1998, market participants were concerned that ltcm's losses would force liquidation of its very large positions in a wide range of financial markets, which could amplify price movements and erode market liquidity. indeed, the primary factor that induced ltcm's counterparties and creditors to recapitalize the institution was their fear that liquidation of ltcm's positions would adversely affect the value of their own trading positions and their exposures to other counterparties. in recent months, many market participants have expressed concern that a widening of credit spreads from relatively narrow levels could lead to hedge fund losses that would make funds unwilling or unable to maintain their existing positions, thus potentially eroding market liquidity. such circumstances could pose significant challenges to hedge funds'counterparties and creditors and perhaps to other market participants. thus far, however, the repricing of credit risk does not appear to have imposed significant strains on the financial system. limiting potential systemic risks from hedge funds since the ltcm episode, policymakers have continued to discuss the best approach to limiting potential systemic risks from the activities of hedge funds. in the immediate aftermath of the episode, the pwg studied the implications for financial stability and published its conclusions in april 1999 in a report entitled " hedge funds, leverage, and the lessons of long - term capital management. " 6 the report concluded that the episode had posed a threat to financial stability as a result of a breakdown in market discipline by its creditors and counterparties, which allowed ltcm to become leveraged excessively. the report concluded that the most effective means of limiting systemic risk from hedge funds was to reinvigorate market discipline. to that end, the pwg made various recommendations, which were directed primarily at enhancing credit risk management by hedge funds'creditors and counterparties. late last year, the pwg reassessed how best to address the challenges posed by the continued growth of the hedge fund sector. the