Thursday, 23 April 2009

Lefties vs hedge funds

I was watching Will Hutton's Dispatches programme on bank failures last night, and it really (unintentionally) emphasised the point that it is impossible to generalise about hedge funds, much as many of us lefties like to. Bear Stearns was floored by its hedge funds' exposure to CDOs, as part of a big punt on subprime. Yet at the same time (and subsequently) there were hedge funds profiting from a wholly negative take on subprime.

I don't see how we can criticise 'hedge funds' as a group for their role in the crisis, given that there were diametrically opposed strategies out there (unless you consider all trading in relation to subprime to be inherently bad). It's simply too much of a generalisation to say what 'hedge funds' were up to since there was such a wide variety of activity across many different types of funds.

It's an old joke that hedge funds are a fee structure in search of an asset class, but it's got a lot of truth in it. The cartoony version that many lefties have of hedge funds (and I'm a recovering cartoonist myself here) is that they are inherently speculative and/or short-termist, and a threat to financial stability. But hasn't the crisis demonstrated somewhat that this view of hedge funds is overblown? It was the banks that really caused the problems in the end. Despite some hedge fund wipe-outs, did they really create the structural havoc that was expected by some?

Therefore in any reform response surely we've got to focus on strategies and behaviours that are problematic, rather than gunning for an asset class that is so broad as to make the definition almost meaningless.

6 comments:

zedman said...

Hi Tom,
I don't know if you saw my email, but if you are interested in speaking at a conference I am putting together for May. Let me know.

CharlieMcMenamin said...

It's taken me a while to get my head round what I didn't quite 'get' about this post.

Hedge funds hedge, don't they? That is to say they insure themselves against potentially catastrophic one way punts by taking (partially) balancing positions betting the other way. So, pretty obviously, some will have into sub prime mortgages big-time and some will have minimized their exposure. Surely it all depends on what you're hedging against?

Now I'm very conscious of my own lack of technical knoweldge here- I'm being guided by Donald McKenzie's LRB article here(http://tinyurl.com/bdofdw - but aren't banks and hedge funds usually pretty much hand in glove? McKenzie certainly suggests most hedge funds have a international bank as 'prime broker',which might even do some of its trades for it. He says this is likely to stop/ have stopped.

But hedge funds can be de-stabilising,according to McKenzie, whatever their relationship to the banks:
"No single hedge fund seems currently to be in as pivotal a situation as LTCM was in 1998, but if the sector continues to shrink as fast as recent reports suggest it will, then the liquidation of trading positions is likely to lead to further violent price movements and market disruption, particularly where there are consensus trades."

So lefties' 'cartoon' prejudice against hedge fund may not be about their investment strategies per se, but their unregulated nature and potentially system destabilizing capacity.

Mind you, I did see the bloody Hutton programme in the first place so I may just have made a huge fool of myself:)

Tom P said...

Charlie

not my best post to be honest, but my point ws basically that I don't think there is much unique to hedge funds in this crisis. I don't know to what extent hedge funds actually hedge, but it's not an intrinsic characteristic anymore IMO, despite the label. so the term has become a category for all kinds of funds that basically just don't fit anywhere else. that's why I think we have concentrate on the strategies rather than the asset class.

PS. I'm halfway through that Monthly REview book you reviewed recently - interesting stuff.



Zedman

can't see an email? my work address is the better one to use.

zedman said...

Tom's comment regarding hedge funds being "a fee structure in search of an asset class" is apt. If I am not mistaken, a similar comment was made in US Congress in the mid 1990's where a hedge fund manager said the only thing he could find in common was the fee structure. From an investment point of view, it is a mistake to group the many different trading strategies into a single "hedge fund" description as there is little that is germane to all funds.
Hedge funds in fact don't always hedge. Some are directional (unhedged), others hedge but to varying degrees, and still others attempt to be more or less market neutral.
I have yet to see any evidence that hedge funds were a significant factor in the credit/liquidity crisis. They can accelerate existing momentum and so in that sense could be considered destabilising to an extent, but also act as the counterbalance to momentum being driven by others. They act as the buyers when long sellers have driven the prices beyond reasonable values.
If you look at UK bank shares, the amount of short selling by hedge funds decreased as the bank shares dropped lower. The primary driver for the share price drops were long investors dumping the stocks and buyers only at ever-reducing prices. The best evidence of this is the continued price falls after the short selling ban.
Hedge fund leverage is at its lowest level in my long memory. Even if they were interested, it is unlikely hedge funds could get substantially more credit from their prime brokers. The redemptions referred to McKenzie's excellent article have had a major impact on the funds themselves, but that has caused both selling of long positions and buying to cover short positions. It has inevitably resulted in thinner markets than might have otherwise been the case. In a proper outcome for unsuccessful businesses, many hedgies have shut down, rather than be bailed out a la some of the "regulated" banking entities that have sucked up public capital.
IMHO the various proposed regulations are another example of politicians wanting to appear to be doing something to control hedge funds, a diversionary tactic.
Tom, send me an email, as I have lost your work address and want to see if you are interested in speaking at a conference next month. roy@stocklendingtoday.com

Howard Thorp said...

Hi Tom

don't know what sort of 'leftie' you are/were but you are completely deluded if you think hedge funds are OK and capitalism can be reformed so that it becomes 'nice'.



Howard

capitalism-creates-poverty@blogspot.com

Tom P said...

Hi Howard

I'm a 'weedy social democrat with leftish tendencies' sort of lefty.

The point of my post wasn't that hedge funds are 'ok'. Arguably the failure of the Bear Stearns funds crystallised the underlying problems in the financial system, for example. Also I regularly moan about shorting - a tactic some hedge funds use (as do other investors).

My point was that the label 'hedge funds' is a pretty rubbish one, since it captures all kinds of funds, some of which are very boring and less problematic (from a systemic risk POV) than other institutions. Therefore if the Left is serious about financial reform, we need to focus on the details, not take potshots at an asset class that is pretty meaningless.

Capitalism isn't great but a) it comes in different varieties and we have a choice about what shape it takes b) I don't see a viable alternative.