A Global Perspectives White Paper            Hedge Funds & the          Global Economic Crisis                   Willing C...
Contents                              “It was quite convenient to blame theIntroduction              2   Hedge Funds. They...
Huge Short Selling of banking stocks inThis led to panic from many              2008 certainly served to accelerate theinv...
illustrated clearly in the losses          graded by the rating agencies and sold incaused by mortgage back               ...
Hedge Fund did not contributesignificantly to the global housingbubble nor did they play a pivotal orsystemic role in the ...
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Hedge Funds and the Global Economic Crisis - Willing Culprit or Easy Scapegoats? - Global Perspectives White Paper - September 2012

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The summer of 2012 marked 5 years since the slow onset of an economic crisis that first became known as the Credit Crunch and then the half decade that became known as the Great Recession.

At the time and over the last few years, Hedge Funds have received a large portion of the blame for the economic crash. They have often been portrayed as one of the main culprits responsible for causing the global financial crisis.

With the benefit and hindsight of recent history we can now look back with some perspective and see if the crisis really was the fault of the Hedge Fund Industry. Is there some basis to the claim that the industry was significantly responsible for the worst economic crash since the Great Depression; or were they merely a scapegoat for a seething public and outraged politicians and media?"

Sign up for all our monthly White Papers at-

http://www.globalperspective.co.uk/#!white-papers

Or email: - shane@globalperspective.co.uk

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Hedge Funds and the Global Economic Crisis - Willing Culprit or Easy Scapegoats? - Global Perspectives White Paper - September 2012

  1. 1. A Global Perspectives White Paper Hedge Funds & the Global Economic Crisis Willing Culprits or Easy Scapegoats? By Shane Brett, Managing Director Global Perspectives www.globalperspective.co.uk th Date 29 September 2012
  2. 2. Contents “It was quite convenient to blame theIntroduction 2 Hedge Funds. They were an easyWilling Culprits? 2 target, in that they were super-rich, a lot of them were American, and they wereEa sy Scapegoats? 4 presented as bad people. They wereConclusion 4 blamed for what was happening to our banking system, which in reality was complete rubbish”. Kate Walsh, Sunday Times, 2010. Introduction The summer of 2012 marked 5 years since the slow onset of an economic crisis that first became known as the Credit Crunch and then the half decade that became known as the Great Recession. At the time and over the last few years, Hedge Funds have received a large portion of the blame for the economic crash. They have often been portrayed as one of the main culprits responsible for causing the global financial crisis. With the benefit and hindsight of recent history we can now look back with some perspective and see if the crisis really was the fault of the Hedge Fund Industry. Is there some basis to the claim that the industry was significantly responsible for the worst economic crash since the Great Depression; or were they merely a scapegoat for a seething public and outraged politicians and media? Willing Culprits? The first really significant event to signal a coming financial storm occurred in the UK on August 9th 2007, when BNP Paribas halted redemptions from 3 of its Hedge Funds due to a disappearance of liquidity in the market.
  3. 3. Huge Short Selling of banking stocks inThis led to panic from many 2008 certainly served to accelerate theinvestors as they tried to get their general speed of economic collapse.capital back from financialinstitutions. Hedge Funds liquidated As the effects of the Lehman collapse intheir holdings from many Prime Sept 2008 reverberated throughout theBrokers, making them more financial system, the end of the yearsusceptible to financial collapse. brought further evidence to some that the Hedge Fund industry was rotten and at theAfter the failure of Long Term heart of the economic crash. Bernie MadoffCapital Management in 1997 the admitted that the Hedge Funds he had beenHedge Fund industry had shown that running for over two decades were in factthe failure of a large fund had the gigantic Ponzi schemes and that he hadpotential to pull down one of the defrauded investors of $65 Billion – theleading investment banks and lead largest fraud in world history. This merelyto a wider systemic crash by also served to reinforce the negative image ofpulling down larger commercial the Hedge Fund industry in the eyes of thebanks. regulators, politicians and the general population.In the recent crisis Hedge Fundswho acted as short-sellers have Hedge Funds seemed to have brushedbeen accused of contributing to the aside basic checks of investment andcollapse of bank shares and the operation due diligence to invest colossalexacerbation of the financial panic sums of money with this incredible(Short selling of course sees confidence trickster. Everyone from theinvestors borrow and sell shares in a regulators to the investors to his Feedercompany in the hope of buying them Fund managers came across looking foolishback cheaper in the future for a and hopelessly outwitted. But it was theprofit). Hedge Fund industry that deservedly took most of the blame.We should be clear about this, whileShort Selling is an important part of Elementary oversight and basic duemarket activity and some would say diligence was systematically ignored.an essential tool in restoring market Despite screaming red flags and plenty ofequilibrium of inflated valuations whispering, the industry was content to let(having helped expose multiple sleeping dogs lie, as long as the smooth,frauds including Enron), massive stable long term returns continued year aftervolumes of short selling right in the year.middle of an economic crisis doesnot help financial stability. Another charge against Hedge Funds is that it was their use of Excess leverage whichIf the Hedge Fund industry has one contributed to the scale of the financialcharge against them that will stick it losses. There is certainly some truth in this,is this. Especially when it became as leverage was used across the boardknown that some Hedge Funds were particularly to amplify investment returns.making massive Funds (e.g. Odey),by shorting UK banks – that later That is fine when times are rosy andhad to be bailed out with public markets are growing but it simply magnifiesmoney. the problem when liquidity dries up and there is an economic crash. This wasGlobal Perspective swww.globalperspective.co.ukEmail: Shane@globalpers pective.co.ukPhone: +44 (0) 20 3239 2843
  4. 4. illustrated clearly in the losses graded by the rating agencies and sold incaused by mortgage back every corner of the globe. The globalderivatives as the underlying loans purchase of these securitised assets meantwent sour. The losses were far in the effects of the crisis was felt worldwideexcess of the mortgages (e.g. as in the collapsed of exposed Germanthemselves, because investors Landesbanks).including Hedge Funds hadborrowed significantly to take out It is also worth noting that in America thesynthetic positions through Credit massive growth of Sub-Prime mortgageDefault Swaps. lending (through Freddie Mac and Fannie Mae) was partially caused by well intentioned but misguided government policies, aimed at making homeownershipEasy Scapegoats? available to sections of the public who otherwise would never have qualified.However from a wider viewpoint it isobvious that the crisis is the result of This combined with a long period ofexcessive worldwide debt. This regulatory loosening by manywas built up by both individuals (US, governments (for example by the repeal ofUK, Ireland), Governments (Greece, the Depression-era US Glass-Steagall ActPortugal, France), as well as private separating investment and commercialdebt being guaranteed by sovereign banking) which paved the way for anstates (Ireland, US, UK). explosion of bank lending.The quarter century from 1982 Banks not only lent hugely in relation to theirknown as the Great Moderation capital base (further reducing their Capital(characterised as it was by low Ratios to historically low levels), they alsoinflation, low interest rates and rising became more dependent on short termemployment) led to a loosening of financing in the money markets to financefinancial regulation and an ensuing this expansion. This was especially riskydebt expansion and asset bubble. where this short term capital was being lent back out for long term loans (as Britain’sWhile Hedge Funds certainly played Northern Rock found out to its cost). Thistheir part in borrowing widely to type of funding is exactly the sort offinance investment (some would say financing that dries up overnight in a creditspeculation), they were just one crunch.sliver of a wider debt bubble thatgrew throughout the global economyover the past quarter century.The banks created the global Conclusionhousing bubble by reducing therequirements for mortgage Looking back on this recent history we canqualification and massively now see fairly clearly it was the banks thatincreasing their property lending. caused this economic crisis. It was the excesses of the banking industry, throughThe private market then took these the accelerated growth of debt and laxloans and packaged them into lending criteria that planted the seeds oftranches for sale to different global economic collapse.investors. They were erroneouslyGlobal Perspective swww.globalperspective.co.ukEmail: Shane@globalpers pective.co.ukPhone: +44 (0) 20 3239 2843
  5. 5. Hedge Fund did not contributesignificantly to the global housingbubble nor did they play a pivotal orsystemic role in the crisis. Otherplayers such as mortgage lenders, Sign up for all our monthlythe credit rating agencies and of White Papers at-course the banks themselves wereto blame for causing the crisis. http://www.globalperspective.co.uk/#!white - papersWhile Hedge Funds may not havebeen substantially responsible for Or email: - shane@globalperspective.co.ukthe global economic crisis, some oftheir activities definitely contributedto the scale of the collapse.However it is worth rememberingthat unlike the banks, no HedgeFund anywhere worldwide receivedany public money, nor did any haveto be bailed out by a government.Tellingly, after the financial crisis Look out for our forthcoming e-bookOliver Stone changed the script of in Q4 2012 “-his movie “Wall Street 2” fromfocusing on the Hedge Fund industry “The Daily 200,000 - Why theto that of Investment Banking. Commodities Supercycle is just beginning & which commodities youNevertheless, the crisis that began 5 need to buy”.years ago has provided regulatorsworldwide with the pretext theywanted to regulate the AlternativeInvestment Industry far more closely. To pre-order email:-The same regulators, who have Shane@globalperspective.co.ukbeen so sharply criticised for theirfailures in averting the crisis, havebeen enacting widespreadlegislation in the US and Europe tobring Hedge Funds firmly within theirregulatory remit.This means that whether HedgeFunds were responsible or not, theGlobal Economic Crisis will deeplychange the nature and structure ofthe industry through increasedglobal regulatory requirements.Global Perspective swww.globalperspective.co.ukEmail: Shane@globalpers pective.co.ukPhone: +44 (0) 20 3239 2843

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