This is just the start of the new era of hedge fund scrutiny discussed in recent issues of The Elliott Wave Financial Forecast. The key point of the hedge fund proponent in this article is that if hedge funds pose “such a dire threat, then why haven't” they “been tainted by the many financial scandals of our time?” His opponent rightly points out, however, “There have in fact been more than a ‘few, small scandals’ related to hedge funds. And these frauds, bankruptcies and disruptions to the global financial system will continue without significant regulatory changes.” Our point is that they will, in fact, accelerate as the markets head lower.
The “all-the-same-markets” coverage in the last two issues of EWFF have touched on the critical role hedge funds play in the unfolding drama. Interestingly, even the hedge fund supporter in the WSJ article notes that there is a “serious issue raised by the growth in hedge funds: systemic risk.” He even cites LTCM’s 1998 failure as “instructive.” “There were worries that it could spark a more general panic in the markets and threaten the functioning and strength of key financial institutions. Without question, this could happen again.” The opening pages of the May and June issues addresses this potential.
The WSJ's hedge fund defender also adds that “no government institution short of a global, omniscient regulator is likely to nab a future LTCM in advance. In truth, our largest commercial and investment banks are the primary line of defense. They seriously don't want to extend credit to hedge funds that might blow up. The problem is that the banks are also profit-seeking enterprises, and hedge funds can be very profitable customers. Standards can slip.” They always do at the end of a long advance like that of 2002-2006. The hedge fund proponent urges the creation of a rainy day, hedge fund blow-up fund as insurance against disaster. Of course, it’s a little late for that. At this point, there’s no way banks have enough capital to cover the potential loses. In other words, the hedge funds that survive the debacle may wish they hadn’t.
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