RAND Center Study: Hedge Funds Not a Primary Cause of the Financial Crisis but Calls for More Regulation Anyways (With Lofchie Comment)

According to a study conducted by RAND Center for Corporate Ethics and Governance, although hedge funds worsened the financial crisis in certain ways, the industry did not play a pivotal role compared to other agents (e.g., credit rating agencies, mortgage lenders and issuers of credit default swaps). The report states that most of the research on the impact of the shorting of financial stocks during the crisis concluded that short selling by hedge funds wasn't a major factor in worsening the crisis (despite what some banks' executives argued at the time).

In addition, the study suggests that Dodd-Frank and other reforms (which are focused on the largest hedge funds) may not be sufficient to address the risks posed by large numbers of small- and medium-sized hedge funds that pursue similar strategies. The study did not assess whether direct regulation of leverage and liquidity should be extended to a broader set of hedge funds. Rather, it identified the leverage and liquidity of hedge fund portfolios as an area that policymakers and regulators should continue to follow. The study concludes by stating that regulations should be better coordinated across national jurisdictions.

The report includes a review of previous studies and a survey of 45 fund managers, lawyers and regulators.

Lofchie Comment: I found this Report, while well written and researched, to be disappointing in that there seemed such a gap between (i) its analysis of the causes of the financial crisis and the risks posed by hedge funds, on the one hand, and (ii) its recommendations on the other. As noted above, the Report found that hedge funds essentially played a bystander role in the crisis. The Report attributed the crisis as being primarily caused by other actors or macro-economic factors. In some respects, the Report even found that hedge funds played a stabilizing role in the crisis. Yet rather than question whether the very significant new regulations applicable to hedge funds can be justified, its ultimate conclusion is essentially, "even though hedge funds didn't actually cause material problems in the financial crisis, and, even though we have not concluded that the new regulations of hedge funds serve any benefit, we should have yet more regulations on top of those we have just adopted." At that level of infinite caution that something might go wrong, it is really impossible to quarrel with the Report: maybe something will go wrong, and maybe some new indeterminate regulations would prevent that unknown problem. As long as one assumes that regulations are always to the net good, and that the economy can withstand an infinite amount of regulation, such advice is inherently safe. On the other hand, I don't think all regulations do more good than harm, and I think that the economy can not withstand unlimited regulations: we sometimes have to make choices as to what to regulate and what not. For me, the Report did not identify any risks in hedge funds that persuaded me that some indeterminate further regulations could be justified and, in fact, in light of the opinion's expressed in the Report as to the causes of the past crisis, the Report implicitly (unfortunately not explicitly) raised questions as to the desirability of certain existing regulations.

View study in full by linking through press release here (links externally to RAND website; further link to study at bottom of page).