Fear of Hedge Funds is 'Overblown'

Date: Thursday, December 21, 2006
Author: Dailyii.com

Fears that hedge funds will rock the financial boat are greatly "overblown," and are based "more on ignorance or simplistic caricatures than on actual knowledge." That's the assessment of Washington Post columnist Sebastian Mallaby. Writing in Foreign Affairs magazine, Mallaby states that "popular resentment" stems from the fact that hedgies "earn too much," rather than the much-ballyhooed concern that they pose a systemic risk to financial markets, which some say could be controlled with proper regulation. Mallaby points out that such risk is "neither limited to the hedge fund sector nor best addressed through regulation of it," noting that most proposals are "so vague as to be impossible to evaluate or are poorly suited to addressed the supposed problems." The author explains that those larger-than-life earnings "reflect the workings of a daunting star system" in an industry that each year attracts smart analysts "just as thousands of aspiring movies stars arrive in Hollywood." Mallaby takes issue with the assessment that hedge funds are concerned only with profits "without regard to any costs or consequences that might follow." In fact, he says, hedge funds "do not so much create risk as absorb it," viewing them as "quasi insurers" that shoulder "risks that others wish to avoid." In other words, hedge funds should be seen not as "locusts" as one German so famously labeled them, but "benevolent firefighters." He admits that hedge funds can pose a serious risk if they become too large - picture the fallout from Amaranth Advisors debacle had the losses mounted to $26 billion rather than $6 billion. But, he notes, "imposing some arbitrary regulatory cap on the size of hedge fund would unjustly penalize successful firms." He concludes, "The best safeguard against the risk posed by large funds is the presence of other large funds."