Editor’s note: We endeavor to bring you the top voices on current events representing a range of perspectives. Below is a column arguing that we should not create more regulations for hedge funds. You can find a counterpoint here, where Marshall Auerback, a researcher at Bard College’s Levy Economics Institute, argues that we need greater financial regulation after the GameStop fiasco.
In the wake of the GameStop investor insurrection, hedge funds have suddenly become the Wall Street titans that everyone loves to hate. They are Wall Street’s latest version of the greedy Gordon Gekko.
The GameStop incident was a retaliation by millions of small stock traders who felt they were being shafted by the big bully institutional investors that had shorted the stock. Shorting stocks infuriates day traders because they hold stock values down. But they also put the laws of gravity back in sometimes runaway irrationally exuberant stock markets.
The entire financial upheaval of the last few weeks has predictably led to calls in Washington to place regulatory shackles on the big hedge funds like Citadel.
Does eliminating hedge funds or even curtailing them make sense?
Not if we want America to continue to be the financial capital of the world – with the most sophisticated and nimble capital markets. Hedge funds help provide tens of billions of dollars of at-risk start-up capital in great companies from Apple to Zoom. Hedging is thought to add to the riskiness of financial investing, but in many cases their value is in doing just the opposite. They reduce investment risk by offering an array of financial products that reduce the chance of big downside losses for investors with a portfolio of stocks and bonds.
This is what “hedging” a bet means. You protect your downside risks.
Hedge funds take the other side of Wall Street bets. They come to the benefit of ailing and failing companies – and they sometimes do this to their own detriment.
Some say that the exotic derivative products of hedge funds inflate financial bubbles, as happened during the financial crisis of 2008.
Some poorly run hedge fund products collapsed during the financial crisis. But higher risk derivative products weren’t what tanked the market in 2007-09. It was the mortgage market – which was supposed to be the Triple A rated mortgage bonds that we were told by Fannie Mae and Freddie Mac could never default – that went belly up. The institutions that failed were the largest New York banks and investment houses with the “safe” and most regulated investment portfolios. The blood in the streets would have run deeper were it not for the hedge funds.
It is instructive to note that hedge fund markets are much more common and fully integrated into the financial markets in the United States than in, say, Europe, where such funds are scarce and discouraged. But in the last decade or so as hedge fund managers have become more refined and sophisticated, U.S. financial markets stampeded ahead of the Europeans. Under Trump, the stock market wealth surged from $20 to some $40 trillion. The rise in high-velocity American companies from Tesla to Zoom to Doordash was facilitated by the early capital of hedge funds.
Of course, these markets are not the sandbox for the faint-hearted to play in. But the ethic of dreaming big and taking calculated risky leaps, even occasionally long-shots from center court, is what makes America the world’s financial and economic superpower. Hedge funds make the long shots possible, and yes, they mostly bounce off the rim. But some become billion, even trillion dollar companies.
Playing it safe, and losing our nerve, as it were, will only be a sign of America as a 21st century empire in decline, and give us slow-motion European progress. This will only invite financial surrender to China in the years to come.
Stephen Moore is a senior fellow at Freedom Works and a co-founder of the Committee to Unleash Prosperity.