In wake of SVB, Credit Suisse and other bank troubles, should hedge funds be banned to avert financial meltdown?
- Hedge fund traders targeting distressed companies to make a kill will fatten their clients’ pockets at the expense of further destabilising the financial system
- They were banned too late in 2008 for a crisis to be averted. The same mistake must not be made today
With all the damage being inflicted on financial markets right now, it begs the question whether the activities of hedge funds should be severely reined in or even banned altogether. Hedge funds might make a lot of money for a tiny, privileged few but it has to be weighed against the carnage they cause in terms of increased market volatility and the suffering they wreak when they go for the jugular of the businesses, banks and governments which they target.
Highly leveraged short-selling, risky options trades and complex derivative plays may work wonders for making a quick buck, but the cost of businesses going under, the lives ruined and the burden on taxpayers from costly bank bailouts cannot be justified.
Hedge funds may say it’s nothing personal and only business, but it wrecks livelihoods, jeopardises hard-won prosperity and, in the worst case, harms people when things go badly wrong. Have hedge funds outlived their usefulness to the world?
For me, it is personal. I have first-hand experience of the gut-wrenching feeling of watching the bank where I worked for over 14 years wiped out by the brute force of hedge funds and speculators piling in to destroy it. Fifteen years on from the collapse of Bear Stearns in March 2008, I can still feel the shock, anger and despair I experienced along with 14,000 workmates, many of whom lost their jobs and, in one sad case, a colleague who lost his life.
By the time traders had swooped in on Lehman Brothers six months later, trillions of dollars had been wiped off share values and the global economy had been plunged into deep recession.
It was only when the crash threatened to bring down the global banking system that the US Securities and Exchange Commission stepped in to ban short-selling of shares in banks and financial companies, a measure quickly repeated in other countries.
If the move was warranted then, why not now, when the world might be on the threshold of another global meltdown? At some point, the wanton destruction of global wealth at the hands of hedge funds, leveraged speculators and proprietary traders in the pursuit of profit has to stop. The world cannot afford to deal with another major financial crisis so soon after the Covid-19 pandemic, the global inflation spike and with the Ukraine war still raging.
Government finances are severely overstretched and in poor state of repair 15 years on from the 2008 crash. Global monetary policy remains deeply conflicted between the fight against inflation and the need to keep recovery on track this year. At this point, central banks can’t afford to drop interest rates back to zero again.
There must be better ways to tackle the crisis. If global policymakers have any chance of meeting hopes for 3 per cent world growth this year, they need to make some quick decisions to prevent a new breakout of major financial contagion.
In principle, there is nothing wrong with mainstream vanilla investment companies and pension funds selling equities which they own when economic and credit conditions warrant it. But hedge funds using high-risk options strategies and complex derivative structures as financial weapons of mass destruction to sell assets they don’t own hardly adds up to more efficient markets when mayhem and chaos ensue.
Considering the damage wrought by the collapse of Long Term Capital Management hedge fund in 1998, policymakers have had plenty of time to learn lessons from the past. When overleveraged high-risk traders fail, they fail spectacularly. This must be guarded against.
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It’s time to improve market transparency, rein in excessive risk and apply tougher rules to the hedge fund community. There is a strong argument that hedge funds should be charged a higher capital levy to pay for potential risk exposure to the world. A financial transactions tax would help limit turnover activity, constrain contagion risk and pay for a global insurance fund to cover future bailout costs.
A return to vanilla-based, bread-and-butter markets may be boring but it would be more manageable for a sustainable future.
If all else fails, global lawmakers need to rethink whether hedge funds do more harm than good and consider an outright ban. It won’t be personal, but absolutely necessary for the safety of the world.
David Brown is the chief executive of New View Economics
