Why Anxiety? The NYT Editorializes for Hedge Fund Regulation

Michael Giberson

Predictably, in the wake of the Amaranth blow up that became public last week, a few politicians and editorialists are calling for increasing regulation of investment pools. The New York Times, despite laying out a few of the salient facts in the editorial itself and having access to other pertinent information in the newspaper’s own articles of last week, concludes “regulators need to act now to translate their various calls for hedge-fund oversight into enforceable rules and, in some instances, into concrete proposals for Congress to enact.�?

Facts from the editorial: Amaranth lost $6 billion. Amaranth is only one of 9,000 investment pools. These investment pools manage an estimated $1.2 trillion in assets.

Reported in the Times last week: “Even as Amaranth Advisors lost billions of dollars … more fortunate traders raked in big profits.�?

Do the math: $6 billion divided by $1.2 trillion = one half of one percent.

So, the most newsworthy investment pool “meltdown�? (as the Times editorial calls it) involves an estimated one half of one percent of all the money held in investment pools by wealthy investors, banks and pension funds, and some fraction of the money just flowed into other investment pools. (Not one half of one percent of all of their investments, just one half of one percent of money put into higher-risk-hoping-for-higher-returns investment pools.)

The Times worries that markets could be vulnerable to a “debilitating chain reaction�? should Amaranth have had to default on borrowed funds. While the losses at Amaranth will likely trouble a few people for a while – perhaps that 32-year old trader will lose his Ferrari – this just doesn’t seem to be a reason for much public consternation, much less public policy reform.

The Washington Post, to my surprise, reached a reasonable conclusion when it editorialized on the Amaranth losses:

Regulators deserve credit for pushing banks to limit their exposure to hedge funds. … But it’s equally important to praise regulators for what they haven’t regulated, since freewheeling hedge funds do a lot to stabilize the financial system. Because they can invest in anything and can bet on declines in prices as well as increases, hedge funds scour the world for illogically priced assets, and their buying or selling moves prices to a rational level. …. Mutual funds, which don’t bet against the market and which mainly aim for average performance, contribute far less to this process of price discovery, which allocates the world’s savings to the countries, companies and individuals who are likely to use it best.

3 thoughts on “Why Anxiety? The NYT Editorializes for Hedge Fund Regulation

  1. As I have been saying to anybody who has asked over the past week – this is a non-story. Of course, most (non-economist-type) people don’t realize that the NG futures market is basically zero-sum. Amaranth may have lost a lot of money on those trades, but every dollar they lost was made by somebody else. Some money was shifted from one pile to a bunch of other piles – that’s all. And as you mention, not a big percentage of the total of all the piles.

    Except to the Amaranth investors, this *should be* a total non-story.

  2. The economist had a great mini section about this very thing this week. As someone who works tangentially with credit derivative products, they are a great thing to hedge risk upon. We use it to basically turn variable rate transactions into fixed rate ones, which opens up previously unavailable opportunities.

    I am curious though as to how these swaps and cap agreements will perform under different market conditions- i.e. higher and more volatile interest rate baselines.

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