Hedge Funds: Just Misunderstood?

Meme of the day is whether all the current calls for hedge-fund regulation come not because these funds pose some enormous systemic risk, but rather because they're simply not understood.

Alphaville today has a report from Crestmont Research devoted to "dispelling myths" about hedge funds – and astonishingly, most of those myths seem to be negative.

Meanwhile, here in LA, the panel on hedge fund regulation spent very little time indeed on the question of whether hedge funds did, indeed, need to be regulated. Of course not, was the consensus: hedge funds are much less risky than any individual stock, and anybody can buy stocks. Besides, hedge funds aren't as leveraged as they used to be back in the bad old days of LTCM, and in any case those prime brokers (Bear Stearns was mentioned by name) are keeping a very close eye on their hedge-fund clients and are effectively performing the oversight function themselves.

It was also noted, fairly enough, that the huge number of hedge funds which do equity investing pose little if any systemic risk – it's really only the credit funds which the likes of Tim Geithner and Jean-Claude Trichet are worried about.

And the US government seems to be on board with this conclusion – Christopher Cox, Hank Paulson, and Ben Bernanke seem to have come to the same conclusion that Bob Rubin, Alan Greenspan, and Art Levitt came to back in 1999 – that not regulating hedge funds is OK. Of course, no one knows what the 50 state attorneys general think about such things.

The real problem, according to Mark Lasry of Avenue Capital Group (assets under management: $13 billion), is that he makes too much money, and that no one really understands how he does so. Because hedge funds are barred from advertising, they're necessarily secretive, and therefore people assume the worst: when Lasry first set up his fund 10 years ago and told his father how much money he made that year, his father headed straight to his local synagogue, on the grounds that anybody making that kind of coin had to be doing something illegal.

I don't buy it, myself. Calls for hedge-fund regulation don't come out of the politics of envy: they come from people like Geithner who are paid to worry about systemic risks. It's true that many, indeed most, hedge funds pose no systemic risk at all. But that's not the point. If you knew which funds were risky, you could cut off the risk right there. The problem is that we don't. And that in a world where investors care much more about return than they do about risk, someone should be worrying and regulating.