Hedge Funds Make a Political Mistake

By Simon Johnson

The political flavor of the month is to push back against even the Obama adminstration’s mildly reformist inclinations on finance (e.g., Peter Weinberg in today’s FT is a nice example). And, of course, once you hire a lobbyist, he or she tells you that “winning” means stirring up Congress in favor of the status quo. Measured in these terms, the hedge fund industry has had a string of notable recent victories effectively preventing tighter regulation.

Advocates have a point, of course, when they argue that big banks rather than hedge funds were primarily responsible for crisis. But this misses where we are in the long-cycle of regulation/deregulation. Look at this picture (source: WSJ; more on Ariell Reshef’s webpage).

If we’re at the top of the long deregulation wave and likely headed for tighter control of the financial sector – if not this year, then soon – where do you want to be in the political equation?

You can resist change, but this is just asking for trouble. You know that individual (lightly regulated) funds – whether or not these are officially “hedge funds” is irrelevant - will have high profile trouble. The latest alleged tunneling details in the case of Danny Pang are a precursor to broader social fascination with this phenomenon – you know that a dozen screenwriters are already at work. Sooner or later, there will be a more focused backlash against specific practices revealed or implied in this kind of case.

At the same time, the broader Treasury attempt to respond with only milder controls over big banks will likely also run into trouble (see my latest Economix column), so more social pressure will appear from that direction also. Big banks repeatedly get into serious scrapes, but their political clout consistently allows them to deflect attention onto others. The idea that big banks and hedge funds have some natural congruence of political interests in this space is simply wrong.

In fact, if hedge funds dig in too deeply with “the crisis was not our fault” position, that is just asking for trouble – and to be scapegoated – down the road. It would be much smarter to get out ahead of the political dynamic, and to propose ways to measure, control, and regulate risk.

Voluntarily keeping hedge funds “small enough to fail,” without endangering the system, would also make sense – particularly if accompanied by a complementary political strategy that emphasizes that it is big banks that have done almost all the damage.

Comments

[Neil459:]

This article, while logical, totally misses the point. This crisis was caused by and is currently being driven by political greed. When the democrats took control in 2006 the crisis was well known. The Democrats choose to do nothing so they could grab power now. The Republicans were too afraid to show any leadership in exposing this greed and corruption and now are simply a stain on woodwork. The only thing worse is the media that is putting their own ideology ahead of what's good for America.

Every one will be a scapegoat target because the politicians are not interested in solving the problem. They are only interested in reaping the rewards of an ignorant public.

Jun 26 09:02 AM

[john s. gordon:]

distortions in an orderly market are made by both hedge funds & corporate greed. a pox on both their houses.
> jack

Jun 27 09:57 AM

[BRUCE E. W.:]

This is a very diplomatic handling of what is otherwise shere duplicitous double talk and transference. The desparate selling of predator loans may have amplified a greed, but those loans were sliced and diced into derivitives to be more or less passed along to the final losers. The frenzy of derivitive profits were leveraged into even greater sums far beyond the imagination of the little brick layer bankers who did the dirty work. The short selling and machinations by Hedge Funds on Wall Street have been gaining bad publicity and ill will for some time, and claims of corporate bankruptcies have been part and parcel of the hedge fund profit planning strategies. Of course Hedge Funds "create" wealth; and they certainly protect it as well with well placed offshore planning. I have been trying to remember where I might have heard that the entire economy would fail if the hedge funds were to be endangered;...but I can't exactly remember actually hearing it put that way. I am sure it was some very well funded think tank or some great big fellow from Stanford who might have said something sort of like that,...but : well the point is that the hedge funds really can't separate themselves from the big banks in any real way. Insurance, investments...etc.; it is all very public minded. I'm sure the Hedge Fund risk manage-mentality would agree that it is better them than us. So let's just say from that basic premise that the banking CEOs should get all the money they can grab. But it should be placed in public escrow until they return the banks to health and prosperity. Perhaps we could up the stakes just a little if, in the meantime, we let those value engineers over at the hedge fund invest your entitlements from the escrow account by trading shares...in your own bank.

Jun 29 02:29 AM

[Moon Kil Woong:]

Which was worse Goldman Sacs bundling and selling bad mortgage loans and asking AIG to write fraudulent AAA coverage to back them so they can sell the m to Fannie Mae and Freddie Mac while they shorted them or Paulson's hedge funds that didn't write the fraudulent bonds but just bought the derivatives raw to short the bad morgage bonds? To me to argue one or the other is at fault is missing the point. They both are integral to the overall problem (fraud and conflict of interest) and need to be reformed.

Jun 29 03:43 AM

[Between The...:]

The only political mistake that hedge funds could make would be to stop filling the coffers of politicians with buckets of cash. Even in a down market, I'm sure they can scrape together the required influence to minimize any real reform.

Jun 30 10:35 PM

[Between The...:]

The only political mistake that hedge funds could make would be to stop filling the coffers of politicians with buckets of cash. Even in a down market, I'm sure they can scrape together the required influence to minimize any real reform.

Jun 30 10:35 PM