Macroeconomics

Hedge Funds in the Aftermath of the Financial Crisis

Topics - Macroeconomics

${ numberSection } ${ text }
Hedge Funds in the Aftermath of the Financial Crisis

Chapter in Restoring Financial Stability: How to Repair a Failed System (Wiley, 2009)

Hedge funds have certainly been in the thick of the current financial crisis. The collapse of two highly levered Bear Stearns hedge funds initiated the collapse of subprime-backed collateralized debt obligations (CDOs). But hedge funds didn't cause the growth in the subprime mortgage market, or make housing prices collapse so that subprime loans would default, or force GSEs, commercial banks and broker-dealers to hold $785 billion worth of CDOs on their books.

In fact, there is very little evidence to suggest that hedge funds caused the financial crisis or contributed to its severity in any significant way. That said, hedge funds, or subsets of hedge funds, may still generate systemic risk that imposes externalities on the financial system. A fund that is sufficiently large and levered (like Long Term Capital Management [LTCM] in 1998) could generate systemic risk.

We outline four policy actions.

  • Hedge funds (of sufficient size) should provide regulators with regular and timely information about both their asset positions and leverage levels.
  • If a hedge fund falls into the class of large complex financial institutions, then that fund should be treated as a systemic institution to be regulated (and taxed) as such.
  • Hedge funds in a systemic-risk subset may need regulation to discourage investors from withdrawing funds after bad performance, which may lead to a run on the fund's assets under management.
  • Regulators should improve public transparency of hedge fund asset positions and leverage, which may occur organically (e.g., by creating a clearing house/exchange for OTC derivatives).

AQR Capital Management, LLC, (“AQR”) provide links to third-party websites only as a convenience, and the inclusion of such links does not imply any endorsement, approval, investigation, verification or monitoring by us of any content or information contained within or accessible from the linked sites. If you choose to visit the linked sites, you do so at your own risk, and you will be subject to such sites' terms of use and privacy policies, over which AQR.com has no control. In no event will AQR be responsible for any information or content within the linked sites or your use of the linked sites.

 

The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results.

 

Hypothetical performance results have many inherent limitations, some of which, but not all, are described herein. Hypothetical performance results are presented for illustrative purposes only.

 

Diversification does not eliminate the risk of experiencing investment loss.

 

Certain publications may have been written prior to the author being an employee of AQR.

This material is intended for informational purposes only and should not be construed as legal or tax advice, nor is it intended to replace the advice of a qualified attorney or tax advisor.