Last night, I had a conversation with my wife’s family (all of whom are liberals or moderates with liberal leanings). Her aunt asserted that the main reason that led to the current market collapse was hedge funds -- that instead of investing into developing businesses, people were basically allowed to gamble their money with a hope of becoming rich. And more and more banks (she used Leeman Brothers as an example) used this method.
I am not really sure how her argument worked, and when I pressed her to explain, the conversation moved elsewhere. But since I don’t know almost anything about hedge funds, I asked my cousin (who is a Republican and an invester himself), who said that because hedge funds were one part of the problem; the government’s encouragement of sub-prime mortgages was another.
I didn’t really have time to understand what he meant either.
So, can anyone explain what role hedge funds had to play in the market collapse and also how libertarians would argue against the claim that we need more regulation of entities like hedge funds? (Using as simple terms as possible. As I said, I have almost no background in this area.)
Links to good explanations are also welcome.
We Call Upon the Hedge Funds
What's Behind the Financial Market Crisis?
The Myth that Laissez Faire Is Responsible for Our Present Crisis
We are the soldiers for righteousnessAnd we are not sent here by the politicians you drink with - L. Dube, rip
Hedge funds are partnerships. The General Partner (the management firm) is the decision maker as to how the partner's assets (property) would be allocated (invested) across the markets globally. They can bet (risk their assets) on any direction (up/down) on any market (futures, stocks, bonds, currencies). I fail to see how partnerships of individuals pursuing their self-interest in the global markets could be responsible for the ever larger credit-indiuced bubbles and busts.
The more ignorant people are about subjects the stronger opinions they seem to have about them.
I fail to see how partnerships of individuals pursuing their self-interest in the global markets could be responsible for the ever larger credit-indiuced bubbles and busts.
Umm... government is also "partnerships of individuals pursuing their self-interest". Yet it caused it. So....
Wheylous: Umm... government is also "partnerships of individuals pursuing their self-interest". Yet it caused it. So....
The type (size) of the entity (an individual or a partnership of more than one individual) is irrelevant. It's the actions of those entities that matter. The entities that I am talking about exclusively participate in voluntary exchanges (markets). The ones you're mentioning don't.
The markets (market participants and prices) are only messengers, never culprits. It wasn't the "markets" (hedge funds, speculators, traders) that caused subprime US mortgages to trade at 90% under par and Greek govt bonds to trade at 70% under par.
When bond investors start dumping bonds of a government which is clearly making bad fiscal decisions, the media terms them "bond vigilantes" and if the government in question goes bankrupt, they will argue that the bond vigilantes contributed to or even caused the crisis. But this reasoning is ludicrous. It's like saying that depositors who ran down to the bank when they heard it might collapse caused the bank to collapse. If a business or bank or government is bankrupt, the pull-out of resources before they become unavailable as a result of the collapse is not the cause of the collapse, it is a symptom of the imminent collapse.
Hedge funds provide a major headwind to government fiscal insanity because hedge funds can move their often substantial assets out of paper and into commodities in a heartbeat. That means that when the hedge funds smell inflation, they begin shorting the inflating currency and buying commodities and commodity futures. This huge outflow from paper causes a decrease in the demand for paper concomitant with the government's attempt to print itself more money while pushing the devaluation off onto the public. The hedge funds force the government to eat some of its own devaluation which means to get the desired effect the government must print more money than it would otherwise have had to, which increases the risk of inflationary bubbles and even hyper-inflation.
Plus, some of the best hedge-fund managers tend to be the antithesis of the Establishment golden boys.
Clayton -
Ah, so the argument is that hedge funds reacted to the underlying rottenness of the system, exposing it, but not causing it? Makes sense. It's not like they said "hey, let's just crash this system!"
Pretty much. Markets -- to the extent that they are not manipulated by governments and central banks as they increasingly are these days -- reflect the supply/demand for (or the participants' subjective valuation of) each global asset through prices. When prices get "out of hand" (i.e. out of the bureaucrats' control) then bureaucrats blame market participants (speculators, vigilantes, hedge funds, etc.) for pushing them there. The most important price in the world -- the price of money (interest rates) -- has been manipulated for so long now (decades!) that the accumulated imbalances are becoming too big for the bureacrats to control. It literally becomes a battle of bureaucrats vs. markets -- the former trying to maintain the imbalances through making them larger, the latter trying to resolve them.
The typical economically ignorant person sees (1) someone suffering (laid off, lost house) and sees (2) some rich guy becoming richer by "pushing prices" where they seem to have hurt (1) and automatically concludes (2) is to blame. (2) must have stolen something from (1). Ask them to explain how exactly hedge funds are responsible for the market collapse and they have no idea. Ask them for an example, they have none. As I said, the more ignorant people are on a subject the stronger opinions they seem to have on it.
z1235 wrote: "... the price of money (interest rates) -- has been manipulated for so long now (decades!) that the accumulated imbalances are becoming too big for the bureacrats to control. ..."
Which, in many ways, is analogous to this.
bbnet, yes, like a tank-slapper.
Or more like a loaded spring or a streched out rubber band. Bureaucrats keep stretching the rubber (pushing markets out of balance), then use the media to brainwash the masses into thinking it's the rubber's (markets, hedge funds) fault for attempting to snap itself back into balance.
Self-exciting oscillations are a logical consequence of systems which are described by a closed loop of time-lagged differential equations, i.e. where a change in variable N is driven by a change in variable N+1 but only after a time delay, a change in variable N+1 is driven by a change in variable N+2 but only after a time delay, … a change in variable N is driven by a change in variable N+x but only after a time delay.
Ask them to explain how exactly hedge funds are responsible for the market collapse and they have no idea. Ask them for an example, they have none.
Well, so, the person whom I was speaking to said that participating in a hedge fund is basically like playing poker. The problem is: people this time were playing poker not with their money, but with someone else's. She gave Lehman Brothers as an example.
A hedge fund is a private capital pool with particularly stringent requirements to participate. Hedge fund managers "play poker with someone else's money" in the same way that Joe Nobody's mutual fund manager "plays poker with someone else's money". Investments have risk. If that means you're playing poker, then everyone is playing poker pretty much all the time when they do anything.
Hedge funds and investment banks and stock exchanges and other types of financial investment and market trading organisations are too blame for the financial problems. But if they were engaged in activity that was high risk and a scam from the start and they failed, then they would reap the consequences of their actions. This is a type of market regulation that is far more effective than any government mandate or inspectors or regulatory authorities. But this does not negate the need for compliance regulating organisations. From what i understand, which is very limited in this regard, hedge funds, out of the different types of financial organisations, will generally have a larger portion of their business in investment in actual business.
Which type of financial organisation is too blame is probably not the best way to distinguish the culprit. It is better to say what individual organisations were involved? if they were involved, if they received bailout from the corrupt fed, then they are responsible for the financial problem. At the least complicit with the FED in a fraudulent activity.
FlyingAxe: Well, so, the person whom I was speaking to said that participating in a hedge fund is basically like playing poker. The problem is: people this time were playing poker not with their money, but with someone else's. She gave Lehman Brothers as an example.
Sorry but this makes no sense. Hedge fund "investors" are voluntary partners pooling their capital in partnerships. They "play" with their own (partners') money and are aware of the risks involved.
Lehman Brothers was not a hedge fund. It was an investment bank and a primary dealer for US Treasuries with special government privileges. The people that lost money with Lehman's collapse were its shareholders, creditors (lenders, holders of Lehman bonds), and contract counterparties. The public's (taxpayer's) risk exposure to Lehman existed only through the central banking system explained below.
Market participants (speculating and risking their own money in voluntary exchanges) are not the problem. The problem your dinner guest should be concerned about is fractional reserve banking (fracRB) supported via a lender of last resort (central bank, i.e. the Fed) with the mandate and ability to print money out of thin air in order to bail out said over-leveraged fracR banks. Without the Fed, fracR banks whose assets (mortgages, loans) lose value become insolvent and are unable to perpetuate the Ponzi scheme (the lie) that their depositors actually have money in their accounts. Hence, a CRISIS (!!) is announced and the public is convinced that the Fed must come in and lend money (out of thin air!) to said fracR banks lest ATM's stop giving out cash within hours.
THIS is the reason why these banks were bailed out and were not allowed to go bust (as they should have in a free market). THIS is the mechanism by which bank profits are privatized and their losses socialized. THIS is the mechanism by which banks "play poker" with everyone else's money (not only their shareholders', bondholders', and depositors' but yours and mine too, via the Fed's destruction of the currency in which we save and earn our wages). It's the Federal Reserve System. Not hedge funds.
Give your dinner guest a copy of Ron Paul's "End the Fed" or Murray Rothbard's "The Case Against The Fed".