You, within the hedge-fund community, are amongst the few in American society who remain relatively free from the shackles of government. This is your gift. We are not asking you to share your earnings, but merely to use your talent, capital, and influence in order to protect your own industry and help strive towards a more free-market, capitalist system. FULL ARTICLE by Dan O’Connor
Source link: http://archive.mises.org/10740/we-call-upon-the-hedge-funds/
{ 18 comments }
Your comments regarding the Fed and short selling are spot on. However, to claim hedge funds did not recieve bailouts is false.
Your article fails to recognize the counter party risk that was averted by the Wall Street bailouts. The bailout of Bear, AIG, etc were all back door bailouts of hedge funds. Many of the hedge fund managers that made millions would have been sunk had AIG gone under. This is a fact and a lesson learned by letting Lehman fail. Constellation had to sell part of themselves to the French to save themselves. The ripple through effects of multiple Street failures is unknown, but would have been disasterous. The Lehman liquidation was anything but orderly. And remember, this mess started with the collapse of a Bear hedge fund.
To be clear I’m not defending the bail outs. The involvent banks and overleveraged investment banks should have been nationalized, shareholders and bondholders wiped out, and the derivative books should have been orderly wound down.
Mr. O’Connor says, “Leveraging capital, although it has backfired on many firms in recent years, is part of what allows investors to expand their resources; hedge funds have only two main resources, people and capital.”
“Leveraging” is another word for borrowing. The “investors” Mr. O’Connor is talking about make “investments” by taking out large loans (at artificially low interest rates) and using them to purchase securities, commodities, etc…
This is not an entirely free market phenomenon.
The other commenters here seem to get it as well. If Austrian economics ruled the day and bank credit was 100% backed by gold, where exactly would the hedge funds get all this cheap capital to leverage up their investments? Hedge funds are a creature of the system, just as are the bloated banks.
Dear sb101,
You say:
The Lehman liquidation was anything but orderly
I do not where you have that information from but I can assure you that it is not true.
At my company’s blog we have written about the bankruptcy at Lehman Brothers.
http://blog.upsido.com/2009/07/07/indblik-i-hvordan-frie-finansmarkeder-handterer-konkurser/
Unfortunately the blog is in Danish so would not get much out it but let me briefly explain the main conclusions in our post “A view into how free markets handle bankruptcies”.
Lehman Brothers went bankrupt September 15, 2008. The bank had liabilities for around USD 613bn and there was USD 72bn in CDS contracts on the bond debt. The USD 72bn contracts was divided between 350 counter parties in the financial community. Two days after the bankruptcy on September 17 the 350 counter parties signed ISDA’s UNIFORM CDS SETTLEMENT AGREEMENT (http://upsido.files.wordpress.com/2009/07/uniform-cds-settlement-agreement.pdf). This document describes how the counter parties should carry out the contracts. Remember ISDA is a private organisation with 830 members within the derivates market. All members have voluntarily agreed upon the ISDA Master Agreement which the CDS Settlement Agreement is built upon. That is all participants in the global CDS market know exactly how to carry out counter party contract when a bankruptcy hits. The October 21, DTCC (The Depository Trust & Clearing Corporation) declares that all CDS contracts worth around USD 72bn have been cleared. The bankruptcy insofar the CDS liabilities was handled very quickly – actually with 46 days. We talking about one of the largest bankruptcies in the history. How other liabilities were precisely handled I do not know but from my intel, the whole bankruptcy was handled smoothly and is now an example to follow.
As a lifelong corn and wheat grower, I’ve understood the necessity of short selling, hedges, etc. to keep markets liquid and efficient. This includes the necessity of having “outsiders” (not just farmers and cattle feeders) participate in the market. This, of course, includes hedge funds.
But a question I have is how can free markets avoid the gross distortions that occurred last year? In 2008 (2007, too), corn producers took advantage of the “insanely” high prices by hedging or forward contracting. When corn hit 8.00 per bushel (with an historical range of maybe 2.50 – 4.00) no producers were complaining.
It is clear, at least in my mind, that the vast resources at the hedge finds’ disposal, combined with the secrecy of who was holding all those long positions, allowed actual manipulation of the markets.
Being a farmer and free market libertarian (but not an economist), I’d be very interested in the Austrian response to how true manipulation of markets can be avoided without interference by the Black Hand of government. Or is manipulation just part of the system that true producers and consumers must live with to be part of a free society?
Fred,
I concur. Whenever hear a story about “attack of the shorts” I immediately think a hedge fund is behind it.
A free market in money (sound money, no FED) would not have all of this excess cheap credit available to lever the crap out of things. There are plenty of hedge funds that are exactly that, hedged (with short positions) and plenty of funds that operate without the use of leverage. In a free market with a true market rate of interest the borrowing of money to invest would come at a much higher price.
The author is correct that the hedge fund world is a terrific example of capitalism and a terrific example of a free market that regulates itself… you suck, investors pull capital, you make them money, you make money. Let’s not forget who also benefits when these guys make money – who are their investors? Teachers retirement funds, university endowments, etc… the left likes teachers, but not hedge fund investors that generate returns for them?
PS – to Fred… the ABCT explains the massive commodities boom we saw in the timeframe you are describing. Without the rate manipulation and the subsequent credit creation that follows i would doubt you would see such a crazy shift in pricing that could put you guys into a position where you hedge the wrong way and get destroyed by the collapse of the artificial boom.
I am not clear on how exactly the market was manipulated – interested to hear more – pls explain.
I think Mr. O’Conner is playing too loose with his terms. He talks of hedge funds having capital. In the context of his essay, he really needs to be talking about them having “net assets”. Further, there’s nothing particularly capitalistic about the subject of his essay. Hedge funds could exist in a socialistic environment just as easily. All hedge funds have brought to the party is the ability to increase (or diminish) net assets regardless of which direction the market is going. He is, however, thoroughly correct in that government can bring no safety to the practice. What government tries to do is remove caviat emptor. What it ends up doing is rewarding the losers at the expense of the winners.
JD,
Don’t forget that hedge fund managers income tax liablity has protected status by their politicans. This itself creates an imbalance.
http://www.epi.org/publications/entry/pm120/
We should suffer no illusions that the money being injected into the system is being funneled toward that which is most profitable for the recipients.
As usual, context is important.
Christopher,
That articles main points are quite fallacious. Just because they do not tax hedge funds as much as everybody that doesn’t mean it’s a net loss to the Treasury. The Treasury should learn to spend less. The more money that they would get would probably go to fund more wars, porkbarrel projects, the welfare state, the federal bureaucracy, etc. What that article should conclude is that everybody should be taxed at an equal rate. It’s obviously more politically pleasurable to tax billionares more so the beneficiaries can get the money, but how about we tax everybody less? Why the hell would we want to fund SCHIP? It is public options like those and Medicare that help contribute to this skyrocketing cost. Free up capital for investment, not political welfare.
this is one of the worse articles i have seen in this site.
there is absolutely nothing “free market” in hedge funds except that they, their controllers, are the main beneficiaries of the inflation tax created by the fed.
they converted the “fractional reserve” banking system into a “no reserve banking system” as most hedge funds funds function as “triangulation schemes” for bank credit and bank directors.
read peter schiff for more on this.
this is one of the worse articles i have seen in this site.
there is absolutely nothing “free market” in hedge funds except that they, their controllers, are the main beneficiaries of the inflation tax created by the fed.
they converted the “fractional reserve” banking system into a “no reserve banking system” as most hedge funds funds function as “triangulation schemes” for bank credit and bank directors.
read peter schiff for more on this.
The AIG bailout was all about bailing out hedge funds and Goldman Sachs especially who traded in subprime security insurance contracts.
The “bad” hedge funds didn’t get bailed out – but the connected ones did.
JD & Christopher:
First, I apologize for not recognizing ABCT (JD). Brief description, please.
Next, there is no smoking gun re manipulation that I can see, but the shadowy signs are there. Maybe this is naive. Don’t know.
But when Goldman Sachs (or any single entity) holds historically overwhelming positions (in this case long) of a commodity and can do so with massive leveraging, it is logical that they can intentionally drive markets up (2007 – 2008) and then bail out ahead of everyone else (summer 2008).
The institutional losses that occur are deceptive. If the managers and traders escape with their individual bonuses before the system catches up with them, those individuals do not suffer any consequences.
The easy credit and too-big-to-fail factors are real in this latest crash. So is the coziness of Goldman with the Federal government. (Some consider Goldman Sachs to be a branch of government or the Fed.)
But this still doesn’t answer the fundamental question of how can we have a free market that includes highly leveraged hedge funds, yet still gives the “true marketplace” (producers and consumers of a commodity) a reasonable pricing/marketing system within which to work. Inherent in this is how do you prevent/minimize actual manipulation? Would full transparency be a solution?
This article is terrible – it’s patently false, and should be taken down.
All in all, I liked the spirit of this article, but it covered a lot of ground, so there are a few things to pick on.
First, the hedge funds did not perform as advertised. Even before the short ban, the main strategy in the crisis for most of the hedge funds was to park in cash. Why pay someone 2% to remain in cash? The whole pitch was to make gobs of money in a down market as well as an up market.
The 2% should go away too. It guarantees them money for failure. They can scrape up start up capital like every other business has to.
Short selling has more benefits than hastening a terminal outcome. The vast majority of shorts are not traded with intent of damaging a company. Most are traded because they feel a stock is overbought. This has the very beneficial effect of cooling a frenzy, and adds liquidity to the stock. It’s good stuff.
Granted, premiums were getting outrageous, but options were a very good way of making money during the ban. I know that for a fact. The problem hedges had with options, is they couldn’t go naked with them. Naked shorting is not the same as shorting – one is beneficial.
The bad on short selling was the government’s way of preventing price discovery of the toxic assets. Any company under attack from shorts can simply purchase blocks of their own stock and send the shorts scampering to lick their wounds. The problem with that is you need money to buy the shares. A bank has maybe a full day to complete this, so they would have to sell the most liquid assets to raise cash fast. Paulson had visions of some bank selling toxic assets for 10 cents on the dollar, and that would have exposed everyone to a little bit of the reality that they have been working so hard to cover up.
The spirit of what you say is true, but it is a proven fact that the financial system is not to be trusted on its own. It is incapable of moderation in anything other than a short period of time, usually after being humbled. They always slowly forget, and slowly screw up bad, and hurt many in the process. The government helps them along with the process, but they would be more than capable even without the government.
It all comes down to stopping it at the root. You need a free market in money before many of these problems can be solved. Our financial system is wonderful for banks… free money that you collect interest on is a tremendous business model. The rate manipulation by the FED and the credit that is created through fractional reserve banking guarantees magnified speculative bubbles. Not to say that bubbles wouldn’t form or exist if you had sound money et al, but the bubbles would be smaller and less harmful. If you make super cheap credit available then these guys will borrow and make these levered bets…
To say all HFs are “good” or “bad” or to criticize their fee structure is silliness. These institutional investors enter into these contracts with fund managers with their eyes open… and i sure as heck would pay a 2% management fee to be all cash in a year where the market tanked. If you don’t think that those in funds that were flat in 2008 aren’t happy as pigs in shit, then you need to pass me some of whatever it is you are smoking. There are other forms of principal investing (large-cap LBO) where the management fee and transaction fees exist where there is incentive to put money to work, but they can be pretty wealthy without generating returns… that is something that the market will fix and is already being addressed by those who are in the drivers seat, those providing these funds with capital. Again, the financial engineering of returns and massively levering up of companies was made possible by the cheap debt.
I agree the tax treatment is different on deferred comp and in the case of PE funds (carried interest) than other investors receive which is wrong, but i sure as heck wouldn’t advocate increasing taxes on investment. There shouldn’t be different tax treatments for anyone – heck we shouldn’t have an income tax, a capital gains tax period.
And to follow up on the financial system being left to it’s own designs not being sustainable… yes, in it’s current form when we subsidize risk taking and failure and do not allow losers to lose, then yes we have a problem… the answer is not more regulation. The answer is actually addressing the root of the problem… see all the articles today talking ab granting the FED more regulatory authority over the mess they create… AY DIOS MIO!!!
Comments on this entry are closed.