It's Time to Outlaw Hedge Funds

Do we really need any more evidence that hedge funds should be regulated or even outlawed altogether? How many blowups does it take for us to realize that unregulated greed in the name of “free market” demagoguery does not work for working people and the broader economy?

The U.S. economy is failing for three main reasons. First, the increasing reliance on the use of leverage was a ticking time bomb that finally went off and decimated the balance sheets of banks and financial institutions, not just in the U.S. but around the world. Second, the invention of exotic securities, derivatives and other financial shenanigans by financial wizards at investment banks which bear zero correlation to economic value creation or worker productivity. And third, excessive influence of corporations and their lobbyists in the regulatory process.

In all three cases, hedge funds have been the biggest culprits of these practices which not only put their investors at risk - like retiree savings and philanthropic foundations - but also taxpayers, since it is they who end off having to foot the bill for the economic calamity that lies in the wake of the destruction.

Sure, the SEC may have missed the mark - perhaps on more than one occasion - in catching Bernard Madoff’s $50 billion ponzi scheme, but let’s not vilify the policeman for a crime committed by a criminal. For years, the SEC has been an underfunded agency devoid of real leadership (before Cox, there was the equally worthless Donaldson and Pitt) which has been unwilling to fully protect investors and instead ceded authority over and over again to the business community. It’s time to put a stop to these disastrous investment vehicles. Hedge funds are equal opportunity abusers; they hurt wealthy people, institutional investors, retirees and taxpayers and drain valuable resources from the government. Let’s take a stand and say enough is enough.

Solving this economic calamity will require efforts on many fronts. For starters, the Obama administration can help empower shareholders, the SEC and the DOJ to hold corporations and money managers accountable to society. Less regulation is not the solution; it’s the problem. I hope Summers, Rubin and other leftovers from the Clinton years who are now part of Obama’s inner circle have come to see the failure of their past aversion to responsible regulation of Wall Street. These luminaries can start on their road to redemption by cutting out the most cancerous tumor in our financial system. We will all be better for it.

Comments

[john s. gordon:]

above market returns require above average risk. don't do hedge funds unless you understand this.
> jack

2008 Dec 18 08:03 AM

[Lok Sang Ho:]

Rob has a point. Although investors should be responsible for their risky investments, only the regulatory authorities have the authority and capability to look into the books of financial managers to make sure that investments are indeed investments or at least honest bets.

Regulators have to ensure (i) no excessive leveraging; (ii) no dishonest deals, (iii) no conflict of interest, (iv) dealings and records are transparent and accurate. If these conditions are met, investors should be responsible for their own fate.

2008 Dec 18 08:19 AM

[Lok Sang Ho:]

Let me add that the no excessive leveraging requirement is necessary not just to protect investors but to ward against systemic risk. The Basel capital ratio requirement is just one example of such regulation. A minimum down-payment on home purchases is another.

2008 Dec 18 08:21 AM

[thatswhatit...:]

Madoff was NOT a hedge fund. Get your facts straight before making outlandish comments.

2008 Dec 18 09:38 AM

[carter bick:]

He was a money manager, not set-up as a hedge fund. Get the facts straight before you write.

2008 Dec 18 10:08 AM

[Global Inve...:]

Virtually every major news outlet covering this story has described Madoff's business as a "hedge fund" (or operating a hedge fund business) - he in fact marketed himself as one to potential clients. The point is that his investment scheme had at least three problematic elements to it (at least based on what we know at the moment): 1) utter lack of transparency; 2) targeted non-industry high net worth individuals; 3) use of excessive leverage. The distinction you are making here between whether he was technically a "hedge fund" or a "money manager" is an artificial one that misses the point. But the fact we're having this exchange emphasizes the important of tighter regulation for these types of investment vehicles, doesn't it?


On Dec 18 10:08 AM carter bick wrote:

> He was a money manager, not set-up as a hedge fund. Get the facts
> straight before you write.

2008 Dec 18 11:05 AM

[Global Inve...:]

20%???? Consider Soros' recent testimony to Congress that hedge funds will be "decimated" by this crisis. Predictions are that the number of players in the industry could shrink by 50%. GS just released its 2009 outlook and said we are about half-way through the "asset compression" cycle. Obviously, the bubble was fueled by MBS at investment banks but we shall see how many hedge funds are holding this toxic debt. Since they are further down the food chain it will take time to shake out.


On Dec 18 06:14 AM guest2 wrote:

> Yes you are absolutely right. Madoff-a registered company with the
> SEC blew lots of people's money. Hedge funds are down around 20%
> this year on average and generally markets are down anywhere from
> 40-70%. An dthe US govt has had to bail out all these hedge funds.
> Oh I'm sorry, I meant to say that no hedge fund has been bailed out.
> Only the big investment banks and commefcial banks. Who is responsible?
> endless rollcall, but start with Greenspan's easy money, then with
> Cox removing the limits on investment bank leverage in 2003. Madoff
> got away with it because he was one of the club-just as GS and MS.
> Please get your facts right before posting such utter rubbuish. Do
> you get paid for this?

2008 Dec 18 11:23 AM

[Global Inve...:]

non industry studies (academic) consistently show that on a risk adjusted/net fee basis hedge funds historically underperform the broader market. funds which qualify for institutional money (i.e. can meet their due diligence standards - which Madoff didn't) tend to do better but not by much.

On Dec 18 08:03 AM john s. gordon wrote:

> above market returns require above average risk. don't do hedge funds
> unless you understand this.

2008 Dec 18 11:29 AM

[waf76:]

at this current rate the stock market will only consist of government and insider money. we will have red chip stocks just like china....everyone will park their money somewhere else if confidence cannot be restored...

2008 Dec 18 11:32 AM

[happysoul77777:]

All large financial institutions including hedge funds need to be regulated to provide further transparency, protection of investors confidence, and control over systemic risks.

2008 Dec 18 11:56 AM

[Chancer:]

Before outlawing hedge funds, i would do the following:

Reinstitute the uptick rule.

Outlaw all short selling on stock exhanges, which restricts shorting to commodity and currency exchanges.

Outlaw program trading.

Such changes are needed to protect small retail investors from the big guys.

SEC investigations are a "paper shuffling" joke. Cox needs to resign if failures to investigate Madouf happened on his watch. He is responsible for the direction and failure of subordinates.

For the financial, banking, mortgage problems:

Set all existing and new mortgages at 3% for 5-10 years, probably at least 7 years.

Stop all mortgages adjustment resets for the same length of time (5-10 years).

The Feds do not have enough money to bail out the continuing mortgage and housing problem that is coming with Atl-A and Option Arms.

2008 Dec 18 12:30 PM

[ain't no fo...:]

Many, many hedge funds were spawned by the big money center and investment banks. They are the "dirty tricks" squads that can operate in the dark and do the slimey stuff like (just one example) breaking good small companies with naked shorting campaigns that take a healthy company's stock to ridiculous lows and drive out the small investor. Then once he is chased out, the hedge fund comes in buying with both grubby fists and runs it back up.

And since the slime balls running those MCB and IB sponsored funds were the greasiest (and therefore most successful) traders on their sponsors' trading desks, they have the former colleagues on those desks who will put through their naked short trades with no questions asked. Failure to deliver? Who, ME?

That's just one small example of the games they run.

The hedge fund industry is unregulated and living in a shadow world for a reason - they're cockaroaches who don't like the light. And everyone in power over the years has made sure things stay that way because until a year ago, they contributed a huge chunk of Wall Street's profits.

I say let 'em all burn.

2008 Dec 18 01:34 PM

[irondoor91:]

May I present the other side of the "outlaw hedge funds" argument?

I am the sole manager of a registered limited partnership (call it a hedge fund if you want). I work out of the basement office in my home in a small two-traffic-light town in the western US. I have no employees. I use an attorney in DC. My attorney registered the partnership in DE and the other states in which I have investors. My accountants are in Atlanta. The fund's assets are custodied with GS. I have direct electronic access to their trading systems.

My accountants access the partnership account monthly and download all trades and transactions. They independently prepare detailed monthly performance statements and email them to investors. Investors also receive a daily (pre-market opening) email with daily, monthly, quarterly and YTD performance, positions and previous day's trades. These reports are prepared by another independent third party. I do not furnish any investor reports from my office. Investors have access to dozens of reports at their demand at any time from a third party source or from the GS system if desired.

YTD performance thru 11/30/08 was 28.98% (Gross). Leverage runs from 0 to 100%. Liquid US larger cap stocks and ETF's only. I charge 2 and 20.

The management company is a Registered Investment Advisor (since 1984). It is routinely subject to regulatory audit.

All investors are "Qualified", "Sophisticated", High Net Worth. All are personal friends of the mine. I have a significant portion of my liquid net worth in the fund.

What's the problem with this setup?

2008 Dec 18 10:49 PM

[john s. gordon:]

chancer - your points are well taken but will interfere with the income of a lot of wall st. executives.
> jack

2008 Dec 19 11:22 AM

[auto44:]

Come on your not in accounting who you kidding


On Dec 18 05:46 AM Vienna wrote:

> Fully right, in Europe have have in many occasions tried this, but
> where told by US that we don not understand big business.
>
> NEVER EVER trust any US statistic, even Chinese resemble the truth
> better.
>
> I have been doing audits in US factories, and I know what I am talking
> about here, it is bullshit. Former communist countries have better
> systems in place.
>
> SO don't only get read of the hedge fond, introduce higher tax, and
> get back to quality.

2008 Dec 20 12:36 AM

[auto44:]

How do you do due diligence on something as opaque as a hedge fund?


On Dec 18 07:16 AM OracleofMN wrote:

> Are you a socialist? It is not up to the government to baby-sit investors.
> If you invest money you are also risking your money. You are responsible
> for your own due diligence. When Madoff didnt let you into the offices
> I would think a red flag would go up. If the government starts to
> tell shareholders where to invest and what to invest in they will
> be far worse than they are now.

2008 Dec 20 12:38 AM

[auto44:]

good job


On Dec 18 11:05 AM Global Investor wrote:

> Virtually every major news outlet covering this story has described
> Madoff's business as a "hedge fund" (or operating a hedge fund business)
> - he in fact marketed himself as one to potential clients. The point
> is that his investment scheme had at least three problematic elements
> to it (at least based on what we know at the moment): 1) utter lack
> of transparency; 2) targeted non-industry high net worth individuals;
> 3) use of excessive leverage. The distinction you are making here
> between whether he was technically a "hedge fund" or a "money manager"
> is an artificial one that misses the point. But the fact we're having
> this exchange emphasizes the important of tighter regulation for
> these types of investment vehicles, doesn't it?

2008 Dec 20 12:41 AM

[auto44:]

Why reinstitute the uptick rule if you are going to outlaw short selling?


On Dec 18 12:30 PM Chancer wrote:

> Before outlawing hedge funds, i would do the following:
>
> Reinstitute the uptick rule.
>
> Outlaw all short selling on stock exhanges, which restricts shorting
> to commodity and currency exchanges.
>
> Outlaw program trading.
>
> Such changes are needed to protect small retail investors from the
> big guys.
>
> SEC investigations are a "paper shuffling" joke. Cox needs to resign
> if failures to investigate Madouf happened on his watch. He is responsible
> for the direction and failure of subordinates.
>
> For the financial, banking, mortgage problems:
>
> Set all existing and new mortgages at 3% for 5-10 years, probably
> at least 7 years.
>
> Stop all mortgages adjustment resets for the same length of time
> (5-10 years).
>
> The Feds do not have enough money to bail out the continuing mortgage
> and housing problem that is coming with Atl-A and Option Arms.

2008 Dec 20 12:45 AM

[auto44:]

It's not a hedge fund,it is far to transparent. Nothing is wrong with it.....


On Dec 18 10:49 PM irondoor91 wrote:

> May I present the other side of the "outlaw hedge funds" argument?
>
>
> I am the sole manager of a registered limited partnership (call it
> a hedge fund if you want). I work out of the basement office in my
> home in a small two-traffic-light town in the western US. I have
> no employees. I use an attorney in DC. My attorney registered the
> partnership in DE and the other states in which I have investors.
> My accountants are in Atlanta. The fund's assets are custodied with
> GS. I have direct electronic access to their trading systems. <br/>
>
> My accountants access the partnership account monthly and download
> all trades and transactions. They independently prepare detailed
> monthly performance statements and email them to investors. Investors
> also receive a daily (pre-market opening) email with daily, monthly,
> quarterly and YTD performance, positions and previous day's trades.
> These reports are prepared by another independent third party. I
> do not furnish any investor reports from my office. Investors have
> access to dozens of reports at their demand at any time from a third
> party source or from the GS system if desired.
>
> YTD performance thru 11/30/08 was 28.98% (Gross). Leverage runs from
> 0 to 100%. Liquid US larger cap stocks and ETF's only. I charge 2
> and 20.
>
> The management company is a Registered Investment Advisor (since
> 1984). It is routinely subject to regulatory audit.
>
> All investors are "Qualified", "Sophisticated&amp... High Net
> Worth. All are personal friends of the mine. I have a significant
> portion of my liquid net worth in the fund.
>
> What's the problem with this setup?

2008 Dec 20 12:49 AM

[auto44:]

I don't understand how short selling drives down the price of a stock,I do see how it drives it upwhen the short has to be covered. Can anyone explain it tome i really don't get it.


On Dec 18 01:34 PM wpdragon wrote:

> Many, many hedge funds were spawned by the big money center and investment
> banks. They are the "dirty tricks" squads that can operate in the
> dark and do the slimey stuff like (just one example) breaking good
> small companies with naked shorting campaigns that take a healthy
> company's stock to ridiculous lows and drive out the small investor.
> Then once he is chased out, the hedge fund comes in buying with both
> grubby fists and runs it back up.
>
> And since the slime balls running those MCB and IB sponsored funds
> were the greasiest (and therefore most successful) traders on their
> sponsors' trading desks, they have the former colleagues on those
> desks who will put through their naked short trades with no questions
> asked. Failure to deliver? Who, ME?
>
> That's just one small example of the games they run.
>
> The hedge fund industry is unregulated and living in a shadow world
> for a reason - they're cockaroaches who don't like the light. And
> everyone in power over the years has made sure things stay that way
> because until a year ago, they contributed a huge chunk of Wall Street's
> profits.
>
> I say let 'em all burn.

2008 Dec 20 12:54 AM