Living on the H’edge

Nor is the question before us whether the market is a force for good or ill. Its power to generate wealth and expand freedom is unmatched, but this crisis has reminded us that without a watchful eye, the market can spin out of control — and that a nation cannot prosper long when it favors only the prosperous. … What is required of us now is a new era of responsibility — a recognition, on the part of every American, that we have duties to ourselves, our nation, and the world, duties that we do not grudgingly accept but rather seize gladly, firm in the knowledge that there is nothing so satisfying to the spirit, so defining of our character, than giving our all to a difficult task. From President Obama’s Inauguration Speech

We really don’t need to rely simply on Bernie Madoff’s Ponzi scheme to show a system gone wrong. Awhile ago, I blogged about that relatively unregulated financial market – the hedge fund – a structure which raises money from higher-net worth investors to deploy capital based on the fund’s senior management’s track record and analytical philosophy (I call it their claim to financial “magic”). Like the “sister” financial institutional structure, “private equity” (equally unregulated funds which buy or take control of what they see as undervalued companies – with lots of debt placed on to the acquired companies’ books – fix them and then sell the “revived” company back into the marketplace), hedge funds have become a very large fixture in the money world. Financial overseers tremble at the thought of how these now-damaged structures will impact or prolong our “managed depression.”

Hedgefunds.net estimates that the average loss to these entities last year was 29%, with many funds reaching more than double that loss number. Where investors have been able to pull money out of these funds, they most certainly have. In those structures where the commitment to the fund does not permit an easy escape, investors steam as they watch their declining investment where managers still charge an annual fee on the remaining invested capital

The January 17^th New York Times: “Assets held by hedge funds surged to nearly $2 trillion as of the start of last year, from $375 billion in 1998, according to estimates from Hedge Fund Research, a Chicago firm. Along the way, hedge funds — once so few in number that they represented a boutique industry populated by a rarefied group of specialists — sprang up like kudzu… Few funds have actually shut their doors. The number of funds peaked early last year at 10,233 [compared with around 3,000 a decade ago and just a few hundred two decades ago], according to Hedge Fund Research, and fell just 4 percent during the year. And they still manage $1.6 trillion…

“Orin Kramer, [a] hedge fund manager, who also helps oversee the New Jersey pension fund, says that what bothers him most is that managers who are freezing their funds are still charging 2 percent management fees on money they have trapped… Skip to next paragraph‘It’s like telling someone at a hotel that they can’t check out and then charging them for the privilege of staying,’ Mr. Kramer says.”

The fourth quarter of 2008 shows hedge fund investors running for the hills – when they can. The January 21^st theDeal.com: “Hedge funds have seen the best of times and the worst of times in the fourth quarter. In the last quarter of 2007, the industry attracted a record $194 billion from investors. But it's been all downhill from there as the financial crisis handed hedge funds their worst returns in nearly 20 years, according to Hedge Fund Research, prompting a crippling $152 billion in withdrawals in the fourth-quarter 2008.”

The horrible is less that the investors have incurred serious losses – they are big institutions and rich individuals – it is what this era of non-regulation has done to the rest of the economy. The disproven mantra that deregulation of the rich is a reflection of a free market is now seemingly reaching an end. The Times: “ ‘I believe there’s been a near-consensus that hedge funds can cause systemic risk,’ said Representative Carolyn B. Maloney, a Democrat from New York and a member of the House Financial Services Committee.” Mary L. Schapiro, Barack Obama’s nominee to head the Securities and Exchange Commission had made it clear that this regulatory void will now be filled. Free markets have just reprioritized “accountability.” Why did it take so long?!

I’m Peter Dekom, and I approve this message.