Why do hedge funds make money?...After all, virtually every industry, every business, everything that makes money, does so because it makes our lives better. The provision of investment capital is a vital function in society. Is that the function hedge funds provide? Not really. That is the function of long-only investors. Hedge funds and investment banks on the other hand, are both long and short - and long and short and long and short and long and short ad infinitum. And that's just the stocks. They can also be long and short the options, futures, and corporate bonds, credit default swaps, convertible bonds, etc. And that's just the corporate cpaital structures! We still have interest rates, commodities and currencies to think about.
...They may not provide investment capital, but they still make capital markets work better. They maket them more liquid. As speculators, they take the other side of derivative contracts from hedgers who need to transfer risk to someone willing to take it for a price. In short, they make markets more efficient.
...By the late 1990s, the prop desks were feedign their top students into the hedge fund industry and we witnessed a wholesale migration on efficiency capital from investment banks to hedge funds.
...In recent years, hedge funds started to compete with investment banks as the primary source of the world's efficiency cpaital. Investment banks fought back by inceasing salaries and increasing leverage. In short, as hedge funds started to steal away the business of banks, the banks, rather than learn to live with lower returns, elected to take on more risk in a bid to continue making just as much money. Worse yet, in their battle against hedge funds, banks were forced to fight with a hand tied behind their by the very governments now spending billions to rescue them.
Since 1998 and the LTCM hedge fund crisis, every year, domm-monger have been predicting that the hedge fund industry, the least regulated entity in our financial markets, would see massive bankruptcies and engender large scale destruction of capital. Meanwhile, at the first hint of a liquidity squeeze, it is the banks (again, the most regulated entities), that are going bankrupt in alarming numbers. Is this a coincidence? We do not believe that is. Meanwhile, and very alarmingly, policymakers are getting ready to prescribe yet more regulation to solve a crisis which finds its source in...excessive regulation.
....From 2000 to 2003 we had a huge bear market in equities, created by the previous Ponzi scheme called indexation. As a result of the indexation craze, pension funds, banks and insurance companies around th world found themselves undercapitalised. The regulators, always keen to close the barn door once the horses have fled, decided to prevent the undercapitalised institutions from buying any more equities. This left them with a pressing question: how to replace equities, the high return part of their portfolios? Since, according to the new regulations, they could ony buy bonds, they were forced, if they wanted to boost returns, to buy very low quality bonds, offering very high immediate returns.
...Now the beauty of capitalism is that a demand usually does not have to wait too long until a supply emerges....We have also learnt that there is no such things as a simulation which does not look good. And sure enough, the mathematical geniuses in charge of building new produces started to "design" portfolios of mortgages, mixing them in a way that, in the past, would have guaranteed the high returns needed, and the repayment of the principal at the end.
...The fact that the historical sample on which they built their computations had nothing to do with the current issus was of course never discussed. The ratings agencies, impressed by the soundness of the computation, and even more by the huge fees that they were getting for rating these (toxic) products, started to deliver investment grade ratings to products that had never met a free market...We had, at last, a junk bond with an AAA rating....
...It is thus fair to say that everything started with regulatory or political intervention, forcing a change in the asset or liability side of the balance sheets of financial institutions, without changing the other side. Preventing insurance companies, pension funds or banks from buying equities at the bottom of a bear market was a mistake of massive proportions. This decision reduced the future returns without reducing the future costs (since they are a function of contracts signed long before the intervention).
...Every crisis needs a scapegoat. Rather than take ownership of the monster that they have created, or simply explaining the temporary measures needed to be taken to reduce volatility and allow for an orderly clearing of markets, policymakers seem a little too eager to point the finger at "evil hedge funds".
...Instead of trying to figur out which hedge fund made the most moeny out of this crisis, and then attacking that manager for doing his job well, the public would be better served if journalists started to ask policymakers why the books of Lehmans et al were loaded with paper bought just a year or two ago and now worth cents in the dollar? And why was almost all of that toxic paper on the banks' balance sheets and not the hedge funds? Is it because people who work at hedge funds are so much smarter than people who work at investment banks? Or is it because hedge funds are free to look for returns in placess that make sense while banks and insurance companies, because of regulations, were made to chase yields in places where they did not really exist?
...They may not provide investment capital, but they still make capital markets work better. They maket them more liquid. As speculators, they take the other side of derivative contracts from hedgers who need to transfer risk to someone willing to take it for a price. In short, they make markets more efficient.
...By the late 1990s, the prop desks were feedign their top students into the hedge fund industry and we witnessed a wholesale migration on efficiency capital from investment banks to hedge funds.
...In recent years, hedge funds started to compete with investment banks as the primary source of the world's efficiency cpaital. Investment banks fought back by inceasing salaries and increasing leverage. In short, as hedge funds started to steal away the business of banks, the banks, rather than learn to live with lower returns, elected to take on more risk in a bid to continue making just as much money. Worse yet, in their battle against hedge funds, banks were forced to fight with a hand tied behind their by the very governments now spending billions to rescue them.
Since 1998 and the LTCM hedge fund crisis, every year, domm-monger have been predicting that the hedge fund industry, the least regulated entity in our financial markets, would see massive bankruptcies and engender large scale destruction of capital. Meanwhile, at the first hint of a liquidity squeeze, it is the banks (again, the most regulated entities), that are going bankrupt in alarming numbers. Is this a coincidence? We do not believe that is. Meanwhile, and very alarmingly, policymakers are getting ready to prescribe yet more regulation to solve a crisis which finds its source in...excessive regulation.
....From 2000 to 2003 we had a huge bear market in equities, created by the previous Ponzi scheme called indexation. As a result of the indexation craze, pension funds, banks and insurance companies around th world found themselves undercapitalised. The regulators, always keen to close the barn door once the horses have fled, decided to prevent the undercapitalised institutions from buying any more equities. This left them with a pressing question: how to replace equities, the high return part of their portfolios? Since, according to the new regulations, they could ony buy bonds, they were forced, if they wanted to boost returns, to buy very low quality bonds, offering very high immediate returns.
...Now the beauty of capitalism is that a demand usually does not have to wait too long until a supply emerges....We have also learnt that there is no such things as a simulation which does not look good. And sure enough, the mathematical geniuses in charge of building new produces started to "design" portfolios of mortgages, mixing them in a way that, in the past, would have guaranteed the high returns needed, and the repayment of the principal at the end.
...The fact that the historical sample on which they built their computations had nothing to do with the current issus was of course never discussed. The ratings agencies, impressed by the soundness of the computation, and even more by the huge fees that they were getting for rating these (toxic) products, started to deliver investment grade ratings to products that had never met a free market...We had, at last, a junk bond with an AAA rating....
...It is thus fair to say that everything started with regulatory or political intervention, forcing a change in the asset or liability side of the balance sheets of financial institutions, without changing the other side. Preventing insurance companies, pension funds or banks from buying equities at the bottom of a bear market was a mistake of massive proportions. This decision reduced the future returns without reducing the future costs (since they are a function of contracts signed long before the intervention).
...Every crisis needs a scapegoat. Rather than take ownership of the monster that they have created, or simply explaining the temporary measures needed to be taken to reduce volatility and allow for an orderly clearing of markets, policymakers seem a little too eager to point the finger at "evil hedge funds".
...Instead of trying to figur out which hedge fund made the most moeny out of this crisis, and then attacking that manager for doing his job well, the public would be better served if journalists started to ask policymakers why the books of Lehmans et al were loaded with paper bought just a year or two ago and now worth cents in the dollar? And why was almost all of that toxic paper on the banks' balance sheets and not the hedge funds? Is it because people who work at hedge funds are so much smarter than people who work at investment banks? Or is it because hedge funds are free to look for returns in placess that make sense while banks and insurance companies, because of regulations, were made to chase yields in places where they did not really exist?
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