The Boston Globe reports on how Sowood Capital, a $3 billion hedge fund founded by a former manager of Harvard's endowment, collapsed this week -- costing Harvard $350 million.

Sowood, which has lost $1.6 billion dollars over the last several weeks, borrowed lots of money to bet on what it believed were low risk investments and backed them up with a hedging strategy intended to act as insurance in case anything went wrong. But markets reacted much differently than Sowood expected, driving down the price of its securities and rendering its hedges ineffective.

When Sowood went to sell its assets, it found no buyers. So it arranged for a Chicago-based hedge fund, Citadel Investments, to bail it out -- selling its securities at a deep discount. According to its founder Jeff Larson, Sowood did this "in order to avoid what we believed was the very real possibility of counterparties -- [e.g., lenders] -- seizing our collateral and liquidating or auctioning our positions. In such an uncontrolled process, we believe there was a high likelihood that little to no net asset value would remain for our investors."

Although i don't find Sowood's explanation all that enlightening -- since it did not provide an example of a specific position that went bad -- I think it's helpful in explaining generally what's going on: Sowood borrowed a lot of money to make what it thought were safe bets. The safe bets turned out to be risky, money-losers. And when the lenders who backed the bad bets demanded their money back, Sowood could not come up with enough cash to pay back its lenders.

If you're wondering why the market is gyrating so much, just imagine this process taking place around the world as some undisclosed subset of the highly leveraged $3 trillion hedge fund market tries to scramble out of its mistakes when unpredicted events happen just at the moment of maximum peril.

Unfortunately, the best thing for individual investors to do is sit tight and wait it out. But there will be stomach churning days ahead as hedge funds try to salvage their funds and reputations.

Peter Cohan is president of Peter S. Cohan & Associates, a management consulting and venture capital firm. He also teaches management at Babson College and edits The Cohan Letter.