Profs: Hedge Funds Didnt Cause Economic Crisis

Date: Friday, November 14, 2008
Author: HFN Daily Report

Professors of finance who study the hedge fund industry told Congress Thursday that hedge fund firms weren't at the root of the current economic crisis.

The House Committee on Oversight and Government Reform, chaired by Henry Waxman (D.-Calif.), held hearings to examine systemic risks to the financial markets posed by hedge funds and proposals for regulatory and tax reforms.

"Hedge funds were never the major purchasers of mortgage-related securities," Houman Shadab, a senior research fellow at George Mason University's Mercatus Center, told the Committee on Oversight and Government Reform.

Banks, insurance companies and mutual funds were the major purchasers, Shadab said.

Mortgage-backed assets such as collateralized debt obligations became virtually worthless as the housing market went into a downturn. Banks were forced to take billions of writedowns for those assets.

Andrew Lo, a professor at the Massachusetts Institute of Technology, said "hedge fund ubiquity, size, leverage and lack of transparency," can have an impact on systemic risk, citing the 19998 blowup of Long Term Capital Management.

Although Lo and his fellow academics stopped short of recommending specific regulations for hedge fund firms, most did believe that registration and transparency were important.

Not surprisingly, David Ruder, a former chairman of the Securities and Exchange Commission and now a professor of law at Northwestern University, said that the SEC was the proper agency to gather that information.

Ruder also said that SEC registration should be required of the industry.

Lo, on the other hand, said if the issue was one of liquidity or a question of a hedge fund that was "too big to fail," the Federal Reserve should be involved. He also proposed that a new agency be created to investigate hedge fund blowups, not unlike the National Transportation Safety Board.

Ruder said that there was validity to the proposal that the "accredited investor" limit – those investors who can invest in hedge funds – be raised to $5 million (it is currently $1 million for individuals.) He acknowledged that there were other issues raised when pension funds invested in riskier vehicles.

"But we can't proceed by bright line dollar numbers," Ruder said. "We have to put responsibility on the stewards of other people's money."

Lo pointed out that pension funds usually had less than 10% of their assets invested in alternatives. He also said, while hedge funds had sustained losses, the broader equity markets were down even further this year.

While the HFN Hedge Fund Aggregate Average is down 13.06% year-to-date, the S&P 500 was down 41.96% at the same time.

As to the much-maligned short sellers among the hedge fund class, Lo had a simple prescription: "Don't kill the messenger."

"Short sellers are trying to get the message across that a hedge fund is overvalued," Lo said.