If a hedge fund went bankrupt, the cash will go to investors who may be risk averse.

If the hedge fund survives it will have significant losses and probably be cagey about deploying a lot of capital again too quickly because it just stared into the face of death.

In the case of individual investors selling off everything, they might be scared because everything is crashing.

There's no rule that says the money will come back to the market quickly. It depends on investor sentiment. Often things have a V-shaped recovery and things are more or less "fine". We had a few of those over the past few years.

But put it to you this way, if this statement of yours:

It has to go somewhere, and so it will come back into securities in probably a few weeks or max, months. The value represented isn’t exactly disappearing it’s still in the ‘system’.

...was correct, then we wouldn't have crashes. But we do. When fear takes over the money doesn't just come back into the market quickly. And then even if it could, it doesn't because second order effects take over. Small businesses close en masse, etc, which magnifies the downturn until it snowballs into a legitimate recession.

I'm not saying a crash will happen because of this. I'm saying it very realistically can happen.