In defence of hedge funds - or casses-toi, Sarkozy

http://ftalphaville.ft.com/blog/2007/09/27/7660/in-defence-of-hedge-funds-or-up-yours-sarkozy/


Zut alors! And we thought les Francais were all hedgie-haters. Mais non. Business school Edhec has struck back, eager to show that despite the French president Nicolas Sarkozy might have to say on the subject the French are not laying the blame for the summer’s ructions at the door of the funds.[...]

Their three lessons from the subprime crisis are as follows, says Edhec.

1. Hedge funds not to blame - investment in hedge funds makes up less than five per cent of total institutional investment, and strategies with high exposure to credit risk account for 20 per cent of less of total assets. Hard to believe, suggest Edhec, that the transfer of credit risk have been done with hedge funds alone as counterparties. In fact, “the problem is that banks, not hedge funds, have been affected by excessive investment in asset-backed securities and in structured credit that have turned out to be illiquid and those banks have thus appeared insolvent to their counterparties in the money market.” Thus, they argue, it is the most heavily regulated institutions that have required the intervention of central banks.

2. Crisis is linked to over-regulation, not under-regulation - Edhec says: “the crisis of confidence in the financial information reported by lenders was caused by the unexpected halt by a major bank in the valuation, subscription, and redemption of so-called dynamic funds. So it was caused not by unregulated parties or by forbidden or murky practises but by regulation that failed utterly to take into account the major risk of illiquidity that goes along with the default risk traditionally associated with credit instruments.” The rules on the use of credit derivatives have done nothing to protect investors, they add, and in fostering the illusion of protection may have done harm. As it happens, French and European regulations that attempt to define rules for the eligibility of assets and the classification of investment funds are a failed approach to the protection of investors and to the resolution of the problems posed by asymmetric information, goals that justify regulatory intervention.. ..Regulators would do well to settle for a smaller but more effective role.”

3. Regulation in the works will increase the risk of market illiquidity - new accountancy rules (IFRS) and insurance industry rules for risk management will have two consequences, says Edhec. The “better” of the two - they’ll encourage investors to stop taking risks, but will “lead to the disappearance of institutional investors capable of taking risks, a phenomenon that will discourage equity capital investment and, more generally, lead to the creation of a rentier economy with disastrous social consequences.” The worse of the pair is that the financial industry will “attempt to skirt these rules through risky financial engineering. The summer’s crisis is but an early warning.“

Funny to see EDHEC argiung with overregulation...