Saturday, October 11, 2008

Should Hedge Funds be banned?

One of the major reasons the stock market continues to tank is forced selling by hedge funds. It works like this:
1. Investors give the fund managers $100m to invest;

2. Prime Brokers lend the fund managers an additional $900m "on margin" to invest;

3. In good times, this leverage allows investors to ramp up profits as a $100m investment grows on a $1B base;

4. In good times, all this "buying" power drives up prices.

5. In bad times (that would be now):

  1. As the fund "loses" money, it's leverage begins to grow, the lenders get nervous and want their money back and/or more collateral from the fund;
  2. As the fund "loses" money, the investors get nervous and pull their money out;
  3. The combination of lenders pulling back on loans and the redemptions by investors forces the fund to liquidate its holdings;

This combination forces prices down. As prices fall, they are forced to sell more investments. Essentially, it becomes a giant snowball of selling as all the funds are forced to liquidate.

While I tend to favor free markets, I think hedge funds add little to the greater good and actually harm the markets as they add volatility. For that reason, I am starting to think they should be banned. At the very least, their ability to leverage up their positions should be severely limited.

What do you think?


Greenlight said...

Hey, Finance Guy!

Smart observation here. So how would you get the ball rolling to ban or regulate the Hedgies?

PS: I got here because I was looking for people who mentioned the Hartford debacle early on. That would be you.

Greenlight said...

Nevermind. Sounds like you've got a lot on your hands already. Good luck to you and your wife with the budgeting.

PS: Put your CDs, DVDs and books up for sale on Amazon. It's free. You can rip the media to a hard drive and back it up online for $5 a month. (Try Elephant Drive.)

You do need to do a little prep work, though. Buy bubble mailers (, and set up a PayPal account from which you can print mailing labels. Then you can drop them in the mail slot without having to stand in line. (The exception is international shipping, which homeland security has now required an in-person visit for -- so you may want to nix the international shipping options when you put something up for sale.) The last step is to keep track of your inventory, pricing, and related business expenses. You can write off a depreciated cost to you of buying the media if you are selling it. Also, you'll want to track every listing you make, so that you don't double list certain items and forget you've done so before a second buyer comes along.

Pop CDs and DVDs don't bring in much, but some classical, jazz, world and rarer stuff does. I estimate I pull in about $300-500/month this way.