There are various forms of risk, or losses contingent on a presumed-nondeterministic event. Hedging considers an event considered likely to occur, such as the performance of a company improving, and attempts to isolate that event from trends in the overall market by, for instance, short-selling competitors' stock in addition to buying the company's own stock. In this case the "market risk" is hedged, because the influence on both the companies simultaneously exerted by the overall market cancels out across the pool of investments. (The above is basically "long/short equity.")

When such a risk factor is mitigated by a combination of investments, it's said to be hedged. An investment taken out for the sole purpose of mitigating such a risk factor is a hedge.

It's not entirely accurate to say that e.g. buying gold is a "hedge against inflation;" a true hedge against inflation would arrange a collection of assets whose value is expected to increase regardless of whether there is inflation or deflation because the effects of inflation on the components of the collection offset each other. Gold is much more often an unhedged bet that inflation and various other things will happen.

The idea that hedge funds are innately extremely risky is rather incomplete. Rather, they are a form of managing risk, much like insurance. The failure of hedge funds and the economy's vulnerability to them is not innate to hedge funds; in fact, it's often claimed that hedge funds have evolved into little more than high-priced mutual funds. Rather, it's a consequence of more complex financial instruments such as credit derivatives and numerous obscure forms of speculation for which hedge funds have driven the demand, and massive overinvestment in them.

A more accurate portrayal of the danger of hedge funds is that they act as insurers for stock, currency, and other speculators, ensuring that no matter the outcome, the investors profit. Their failures are similar to those of insurance companies; a large-scale catastrophe happens that can't be hedged or insured against, and the losses in that event are compounded by the hedge funds or insurance companies.

Now I will tell you how they bring about such a catastrophe. With no risk and no liabilities, concentrated wealth will seize progressively more of the money supply and ownership of assets. Consumer demand will collapse because so much of the consumers' money has been taken away. That event will be too large to hedge against, particularly as pertains to credit derivatives, so the hedge funds collapse, and it's over.

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How can you claim that capitalism is committing suicide when it doesn't even exist in the USA?

In the USA, we have:
-an income tax, a graduated one no less
-welfare
-an inflationary monetary system
-government interference at every level of business

Thanks to graduated income taxes, prosperity is punished and no one is justly compensated for his labor. Thanks to the inflationary fiat monetary system, the common person's long-term savings is decimated by inflation, making savings impossible, and creating a dependence on debt and WELFARE, which can only be supplied by destroying other people's productivity through income taxes.

Moreover, government regulation has raised the bar of entry to entrepreneurship, destroying millions of possibilities for the poor who WOULD work if the government would only let them.

All these things distort and destroy the free market. Instead of a free and capitalist economy, we have a society filled with dependent working poor, people who live two paychecks away from homelessness. The monetary system, the income tax system, and the government regulations only get in the way of them picking themselves up out of this disguised form of poverty.

This is not capitalism. It is socialism behind a mask of obfuscatory language. When it wrecks the economy completely, people like you are going to whine and moan for socialism to save you, AND THEY WILL GIVE IT TO YOU. It's what they wanted you to ask for the whole time. You will then be the eager slave of a totalitarian regime. Socialism, after all, is slavery to the State.

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Ivins' column actually, I think, understands the problem of regulation without understandig hedge funds.

Hedge fund returns are actually remarkably stable, across the board. While there have been a few high-profile collapses, (LTCM being one) that was becuase the managers didn't realize that once you take advantage of an inefficiency in the market, other people will catch on real soon. That means the neat trading strategy you invent will be exploited by another firm soon enough and you won't make theprofits you did before, and the market inefficiency will disappear. To be replaced by another, usually.

Anyhow, hedge funds are just like mutual funds except they tend to trade in more complicated instruments and short stocks. For those reading this who don't know what that means, shorting a stock means you borrow the stock at a high price, sell it, and then when the loan comes due give the stock back (it was your "collateral" in a sense). You pocket the difference if the stock drops in price--otherwise you have to buy it in order to give it back to the lender. It's basically borrowing and then selling something you don't own.

This is a risky strategy, but useful if you aren't so confident that your stock prices will always rise. (The same process can be applied to bonds as well, though it is a bit more complicated).

Hedge funds are designed to provide steady returns over medium to long periods. They are not always successful. One reason people wanted the registration provision was that it would mean the returns are easier to track. As it is it is very difficult to find that information even if you are already an investor.

The damage they can do to an economy is inversely proportional to the size of the economy involved. The US economy is so darned big it would be difficult for any one firm to do much damage. Even the Depression was hardly due to the actions of any one financial institution, or even several.

The real problem with hedge funds is that they are pools of money with no oversight, but most people are unaffected. There are rules as to how much money you have to have to even invest--you must usually have $1 million or more of liquid assets (no valuing your house) and at least $250,000 to invest in cash.

It is illegal to include hedge funds in 401(k) plans.

Pension plans sometimes invest in them, but the amounts are still relatively small and the pension managers are supposed to be sophisticated investors--that is what you pay them for. If your company has some bozo from HR running the pension fund, you have bigger problems than hedge funds.

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America has a privately regulated market system. I agree that calling it capitalism is a stretch, but only because most people ignorantly confuse the absence of government regulation as "Capitalism."
The fact is that we do not have "free markets" in the correct sense of the phrase. To have a "free market" specific market conditions must be present, generally referred to as (1) "perfect competition" (no buyer or seller can unilaterlly influence the price); (2) "perfect knowledge" (all compettiors know equally what is going on the market); and (3) "perfect mobility" ( all competitors can move to where they have the greatest competitive advantage).

The fact is that capitalist "free markets" are a propaganda and political fiction. They don't exist in real life. Look at agriculture. Producers have products that spoil. Cartelized middlemen can simply wait out the producers and they will have no choice but to unload there products and any price the midlemen want to give. Agricultural producers naturally lack "perfect mobility." The only way to CREATE a free market in agriculture (and we are taking about our food supply here)in the usual public sense of the word is through government regulation. Price regulation/supports with producer cooperatives, or a mix thereof.


The same scenario is correct for virtually every other sector of our economy, and certainly more so of the so-called "global economy" There are actually almost no "free markets" in existence in any nation of the world.

The only way to obtain a stable, predictable "capitalist" economy is through stable predictable government regulation, with the form and type of regulation titrated to the natural conditions and requirements of the products or service being produced.
The financial sector is perhaps the most important and least understood sector of a "capitalist economy" in this context. Because the financial sector is the central "clearing-house" of ALL SECTORS of the economy, to deregulate the financial sector gives it a blank-check to steal the rest of the economy (i.e., the rest of us) blind.

So, the only way to restore some stability is through renewed government regulation of the economy, beginning with the most important financial sector, which must be re-regulated to function as an investment mechanism, and not a speculatory device. The financial sector must be regulated so that profit occurs only through real investment that produces real products; profits and large incomes taken through paper transactions must be taxed away.
That means a return to steeply progressive taxation with deductions only for domestic "productive" investment; a return to differential taxation of "earned" (salary and wage) income vs. "unearned" income (other receipts, excluding pensions derivative of earned income).
An example is Microsoft. There is no doubt that the failure of government to apply existing anti-trust laws against Microsoft, given its known ruthless practices, produced a very bad result, both with respect to the real threat of such great market power being used for public and non-public political purposes, but also in the stifling of many superior products. Properly regulated market conditions would have allowed much more promising development of other operating systems, OS/2 and Linux. The "Windows/Microsoft vs. other products" history is a classic example of "market-failure" through government inaction.

The posts re: "understanding hedge funds" and "understanding hedging" make sense only in the context of our present speculative environment, which I contend must be eradicated. The "America has no capitalism" interpretations are absolute balderdash, pure right-wing propaganda baloney, but opinion restated so often in our privately-regulated (i.e., controlled) media that many people have come to accept the erroneous concepts as real.

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I had better vote for the Democrats next time so that Ivins can make more money.
Here you have a case of the democrats trying to scare you into voting for them, but the dems don't actually want want to have to promise you national healthcare or taxing the rich, so they find something else to scare you with to make you vote for them.
diclaimer: I loathe both democrats and the GOP.

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I am the first to bash the Republicans over their stewardship of this country - but in this case Molly is flat out wrong both factually and assumptively - and I hate worse for our side to look uniformed about issues:

1. Average investors cannot invest in the private partnerships that are collectively called "hedge funds," without that partnership losing its exemption from registration of those shares under SEC law. To do so would mean that the partnership's interest would have to be registered in the same fashion that a public companies shares are registered - complete with all the reporting requirements of other publicly sold shares. There are exemptions for small numbers of non-"accredited" investors to be included in an exempt private partnership - but the number is small and the inclusion of those investors triggers higher levels of reporting and oversight similar to a registered offering - which usually makes it unattractive to the fund advisor. Unless your idea of "average" is $200K per year in income or $1MM+ in net worth, hedge funds continue to be the purview of weathy and "sophisticated" investors.

2. Pension Managers do invest some in hedge funds, just like they invest in other sophisticated instruments such as private equity funds or venture capital funds. These instruments are generally used to diversify the fund's holdings and provide stable returns across a variety of market conditions. This is not, however as nefarious as Molly would lead you to believe. Pension managers themselves are regulated by the SEC and have fiduciary responsibilities to the pension fund which includes making prudent investment decisions - as such their activities regarding hedge fund investments are overseen by the government - even if the action of the hedge funds is not.

The law that was struck down by the DC circuit was done so for good reason - the SEC overstepped their bounds and with their rule requiring private fund advisors to "look through" the fund to count end investors as "clients" and was making law where congress had not intended. Furthermore the SEC rule created a conflict of interest where the advisor had fiduciary duties to both the private partnership and the end investors of the private partnership - a situation which could easily result in a conflict of interest between the parties as what may be best for the partnership as a whole may at odds with what is best for certain individual investors. The rule as written had to go.

Finally, the entire second half of this piece is about the evils of hedge fund behavior as a reason for registration - the problem is that the examples that Molly used have nothing to do with registration, are illegal regardless of whether an entity is registered or not, and are examples where registration would have not been a factor in either detecting or deterring that behavior. It is a common mistake to confuse a lack of registration for a lack of regulation... Enties must abide the regulations set forth by congress in the various investment acts regardless of whether they are registered or not.

First, insider trading is illegal regardless of whether you are registered with the SEC or not - the decision of the judges about registration has NOTHING to do with whether insider trading would be legal or not or how insider trading would be detected or prosecuted by the government. The pressuring of an SEC official off of an investigation is likewise covered by statutes having nothing to do with hedge fund registration. Cont. in part 2...

(part 2 below)

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Which brings me to some of Molly's assumptions. The underlying assumption in this piece is that hedge funds must be registered either to protect Ma and Pa Mainstreet America, e.g., "average people now invest in hedge funds", or "pensions, gasp, invest in hedge funds" or that the SEC needs to protect the markets by knowing what hedge funds are up to - e.g., LTCM. This is an uniformed, yet very populist, view. First off, Ma and Pa Mainstreet, if they are investing in hedge funds, are already protected through the private offering exemption rules that restrict these partnerships to wealthy and sophisticated investors... if the congress feels that the standard is too lax and "average investors" are getting in over their heads then it should change the rules regarding exemptions of private offerings from registration rather than try to register the advisors of some of those private partnerships and not others, e.g., why should an advisor to a fund that invests primarily in pubic equities require additional oversight where one that advises a fund that invests in private equities or real estate does not?

In the second case, LTCM, there are two problems with Molly's position. First, the LTCM debacle could not have occured without the complicit participation of the banks that were willing to lend LTCM so much margin (which was at the core of the problem that LTCM created for the markets) - often in violation of their own internal rules and policies for making such loans - rules and policies that were required by, and overseen by, their registration with the SEC as broker-dealers... which of course begs the question of whether registration of "hedge funds" will do any good as it didn't in the LTCM case with regards to the banks that were involved in that debacle.

Second, the argument for market "protection" overlooks the real reason that hedge funds have been targeted for registration - the interests of corporate America. Registration of hedge funds under the guise of "protecting markets" brings with it a host of disclosure rules, including filing of positions purchased in public companies with the SEC and the requirement that funds disclose their proxy votes. Certain "activist" hedge funds have used to their buying power and ability and willingness to short shares as a tool to force underperforming management and boards (who are often too cozy in their relations to the detriment of shareholder) to take action with regards the status quo. And while the managers of corporate America paint these funds as "in it only for a quick buck" the reality is that these entities pose a real threat to underperforming managers in a way that many registered entities cannot - by forcing funds to disclose positions early and driving up their cost of share purchase - mangers can slow the acquistion of their company by these entities that see value in removing the managers, and use their influence on boards to take actions to protect their positions at the company, actions often not in the best interest of stockholders, before the fund can amass enough shares to wield real influence.

In the end, do we really want the government deciding how a group of qualified, adult, sophisticated investors should or shouldn't invest their money? Because to force registration on these private partnerships that is essentially what we would have to do. This isn't a case of "all regulation is bad." Its a case of "this regulation is bad" primarily because the reasons presented by Molly's argument for registration don't really do anything to solve those specific problems - and instead draw attention away from that fact by presenting hedge fund registration as a false panacea. Molly advocacy merely provides an example that those who loathe ALL regulation can point to as reason for undoing those regulations that ARE good and needed.

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I have always contended that capitalism is not a form of utility maximizing rationality or a purely economic system but rather a total integrated social system. The idea of artificially separating out economics from politics is futile and ahistorical. There has never been a pure laisse faire capitalist system because it is impossible. The state was always actively present at the beginning of all epochs of newly emerging class societies and used its power to shape class relations in favor of the powerful classes. Capitalism is no exception. The state conferred property upon and absorbed risk for the newly emerging capitalists. They granted the railroads land, limited liabilities for utilities investing in nuclear technologies, provided research at government expense for many emerging industries, allowed the dismantling of the effecient, clean, safe, and cheap electric trolley systems in nearly 90 large US cities over the 1930s and 40s in order to make way for the automobile and then with tax payer money built the federal highway system in order to facilitate urban sprawl. When this required increasing amounts of oil accelerated depreciation allowances for exploration made this possible. When foreign oil dependance became an issue the US military entered the scene! The state has facilitated a centralized, foreign dependant, costly, inefficient, environmentally hazardous, and income and wealth concentrating capital intensive model of corporate capitalism based on high income consumerism. It is currently skewing wealth towards the rich with tax cuts and other policies favoring the very largest corporations in the interest of sustaining only high income consumption. Tax writeoffs for gas guzzling vehicles over 6,000 pounds is but one good example. This has led to maximum profits for a few big transnational corporations, poverty for a growing number of workers, and a massive public debt for the state. This is the same state that represses alternatives. It is obvious that the US state is a Capitalist State. Capitalist states exist today as feudal states existed in medieval times and slave states in ancient times. The state is but the executive committee for the management of the affairs of the whole ruling class. The modern state is not separate from capitalism-it is a capitalist state!

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