How Hedge Funds Saved the Galaxy
It seems like whenever the government or its apologists want to distract attention from government’s responsibility for the financial crisis they start talking about hedge funds. Thus Bloomberg’s headline today about Volcker’s testimony: “Volcker Says Hedge Funds Should be Allowed to Fail”
Well, when weren’t they? The only hedge fund that ever moved the U.S. government into too-big-to-fail mode was Long Term Capital Management in 1998. The government intervened to save not the fund, which was wiped out, but the highly regulated banks that put themselves and the entire financial system at risk by giving hundreds of billions of other people’s money to the Nobel Prize winning geniuses who ran LTCM.
The government loves to talk about the dangers of hedge funds because they are supposedly “lightly regulated.” The more responsibility the government can lay off on hedge funds the more it can avoid the question “how did the government supervised banking sector mess up so badly, while the vast majority of hedge funds, if they were involved with mortgage finance at all, were on the other side of the trade, being smart and virtuous rather than stupid and corrupt?”
The pols answer? Just as it was wicked for the banks to go long on junk mortgages it was equally wicked for the hedge funds to short them. The bankers who lost trillions of the nation’s capital were wicked and the hedge fund managers who preserved their client’s capital were wicked too. Only the government was good; too bad it is so shy and unassuming.
Well try this on for size. If it weren’t for the nation’s hedge funds, instead of the mortgage-backed securities market beginning to crack in early 2007 it might have held on for months more, even another year, while more and more bad mortgages were made. The data on foreclosures are perfectly clear: with every year that passed mortgages got worse. Defaults on mortgages originated in 2005 are much worse than those written in 2004, and those written in 2006 and early 2007 were worse still.
And junk volume was huge in 2005 and 2006. It is fair to say that if the mortgage backed market had been cut off at the knees in late 2004, which it would have been if more people had followed the shorts, the crisis would have been much less severe, perhaps avoiding the need for bank bailouts altogether. On the other hand, if the mortgage market had not been exposed by the shorts when it was, we would have had another year of the worst loans ever, written in huge volume, and the bailout might have been twice as costly.
So next time you see a hedge fund manager who helped uncover the most destructive financial scandal in U.S. history, shake his hand, and just say “thanks.”
AR & RV
Tags: Andrew Redleaf, bankers, banking crisis, banking deregulation, capitalism, economy, government agents, Hedge Funds, Mortgage Crisis, Paul Volcker, Richard Vigilante, Whitebox
