The Washington Post has a piece on hedge funds today which notes the recent problems with two funds operated by Bears Stearns and then comments that “the system may not be as crash-proof as once thought.” This comment raises the obvious question, why on earth would anyone think that hedge funds are crash-proof? Haven’t they heard of Long Term Capital (mentioned later in the article)? How about Amaranth? Hedge funds are distinguished from other funds by the fact that they have virtually no disclosure requirements. They can be investing in anything, taking enormous risks, and no one would know it. Furthermore, the compensation structure for managers gives them huge incentives to take enormous risks. Anyone who thinks this is likely to produce a crash-proof system must be on some really wild drug. I don’t care if rich people want to gamble in these funds (although I want to see their gambling taxed in the same way that gambling at casinos and state lotteries is taxed – a modest financial transactions tax will do the trick). However, it is outrageous that many private and public pension funds are getting into the act, quite likely in many cases having no idea what they are doing. (The public has grounds for concern about the private funds, because we guarantee the pensions.) If these bets go bad, as many no doubt well, I hope that the pension fund managers are held personally liable if they made investments in hedge funds where they did not understand how they money is being invested. These pension fund managers get good salaries – we can hire high-school kids at the minimum wage if the point is to throw money in the garbage.
--Dean Baker
