Hedge Funds, An Impression

I try to read four newspapers before the day really starts, and also look through a couple of on-line sites.  I skim the lead economic stories and randomly dig all the way through the paper to the end of some business/financial stories.

Sometimes the news jumps off the page, and sometimes it seeps through.  Now, about two hours after looking at today’s weekend papers, I realize that something is stuck in my mind, rather like a tune that you can’t get rid of.

I read, in at least two places, various versions of the following proposition.

1. Hedge Funds, if they get into trouble, will not be rescued by the government

2. Big Hedge Funds are not in trouble

Statement #1 is presumably false.  There is no way that any responsible government could let a large Hedge Fund fail at this point.  The system is too fragile and the risks too obvious.  In fact, the Europeans ratcheted up the pressure in this regard during the week, with their increasingly undiplomatic condemnations of the US for not saving Lehman. (Just wait until they figure out what really happened in the “rescue” of AIG.)

Statement #2 is interesting.  I’m not taking a view either way on this; I much prefer to be agnostic and see what the data bring in.  But I did note a story that mentioned that the US government had been asking financial institutions about their exposure to particular (named in the story) Hedge Funds.

Now, I don’t know about you, but when a representative of the federal government comes to my house, shows me identification and asks questions about a neighbor (yes, it has happened), I start to wonder – what exactly is this neighbor doing to attract the attention of the government (a notoriously distracted organization, except when it is very focused)?

I worry about the US crisis managers, particularly at the Treasury, who used to like to catch dominoes, until they found out how dangerous that could be – because you tend to knock over other dominoes.  Then they switched to broader, more systemic and systematic approaches, which we have called for and applauded here (most recently, on Friday, they adopted the recommendation – from us and others – to recapitalize insurance companies).  I really hope these crisis managers are not going back to their old ways.

6 thoughts on “Hedge Funds, An Impression

  1. I am starting to hear references to the Bretton Woods system in the past few days. Is this a basic “redo” of the global economic system?

  2. Just curious… what papers do you read (I guess NYT, WSJ, FT, and… WaPo)? In paper, or online?

  3. Since Simon hasn’t responded to this yet … Having been to his house, I can tell you that he gets all four of the newspapers you listed, on old-fashioned, messy, heavy newsprint. (I’m a Google Reader fan, myself.)

  4. To prevent a reoccurence of the current financial crisis, the US should limit leverage. I personally think that the over 30-to-1 leverage ratios at Lehman and Bear before bankruptcy, and possibly similar ratios at Morgan and Goldman are the reason why we’re in this mess to begin with.

    My personal suggestion is an “excess leverage tax” for all non-bank financial institions, taxing both the loan provider and the loan receiver, applying to any loans greater than $5 million originated anywhere (not limited to the US) and used to purchase US-dollar denominated financial instruments.

    The general idea is similar to margin accounts for individual investors, but applying the same restriction to hedge funds, investment banks, etc.
    And, if you (e.g. hedge fund) exceed the margin requirement, which is lets say a 10-to-1 leverage ratio, then both the loan provider (probably an investment bank) and the hedge fund, should pay additional taxes. I strongly suspect that a 2% tax on the loan amount for both the originator and borrower should easily discourage excess leverage.

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