After hearing on Lehman, AIG, regulators, Senate Oversight Committee had a hearing on hedge funds and its role in the crisis. The hearing was divided into 2 panels . First panel was of economists and second of hedge fund managers. Pretty big names appeared for hearing.
On reading the testimonies, one comes across mix views and there is no clarity. However, most of them lean towards the need to regulate hedge funds.
The most interesting of the testmonies was of George Soros ( that is a given):
The salient feature of the current financial crisis is that it was not caused by some external shock like OPEC raising the price of oil or a particular country or financial institution defaulting. The crisis was generated by the financial system itself. This fact-that the defect was inherent in the system-eontradicts the prevailing theory, which holds that financial markets tend toward equilibrium and that deviations from the equilibrium either occur in a random manner or are caused by some sudden external event to which markets have difficulty adjusting.
This is typical Soros stuff. After this, he says to understand the events, we need a new theory
This remarkable sequence of events can be understood only if we abandon the prevailing theory of market behavior. As a way of explaining financial markets, I propose an alternative paradigm that differs from the current one in two respects. First, financial markets do not reflect prevailing conditions accurately; they provide a picture that is always biased or distorted in one way or another. Second, the distorted views held by market participants and expressed in market prices can, under certain circumstances, affect the so-called fundamentals that market prices are supposed to reflect. This two-way circular connection between market prices and the underlying reality I call reflexivity.
Soros then explains the way the distorted views lead to bubbles and problems. It has helped a certain section:
Although market fundamentalism is based on false premises, it has served well the interests of the owners and managers of financial capital. The globalization of financial markets allowed financial capital to move around freely and made it difficult for individual states to tax it or regulate it. Deregulation of financial transactions also served the interests of the managers of financial capital; and the freedom to innovate enhanced the profitability of financial enterprises. The financial industry grew to a point where it represented 25 percent of the stock market capitalization in the United States and an even higher percentage in some other countries.
He then explains the political economy of financial markets and says efficient markets ideology became mainstream as crisis impacted the developing (those that had poor macro, poor institutions etc). Whenever crisis occurred in US like LTCM , Savings and Loan crisis etc authorities intervened and a largescale crisis was averted. And the ideology continued to prosper. He says he cried wolf 3 times:
I have cried wolf times: first with The Alchemy ofFinance in 1987, then with The Crisis ofGlobal Capitalism 1998, and now. Only now did the wolf arrive.
However, his theory lacks predicting events in fin markets. It helps more explain them. So, it still lacks a much needed aspect of fin system. He then says the regulators need to do something to manage the build oup of bubbles as their policies lead to creation of the same. He does not have very kind words for Alan Greenspan as well.
Finally on hedge funds he says:
Regarding hedge funds, it has to be recognized that hedge funds were also an integral part of the bubble which now has burst. Hedge funds grew to approximately $2 trillion of capital which at times controlled as much as $10 trillion or more in assets. But the bubble has now burst and hedge funds will be decimated. I would guess that the amount of money they manage will shrink by between 50 and 75 percent. During the current financial crisis, many hedge fund managers forgot the cardinal rule of hedge fund investing which is to protect investor capital during down markets. It is unfortunate that much of the money raised by hedge funds in pursuit of alpha
Interesting throughout. Typical Soros.