Unregulated hedge funds serving market better

By DAVID MOON, Moon Capital Management, LLC
August 10, 2008

If you hope your child will become a zillionaire, don't bother teaching him to throw a football; send him to Wall Street camp. All-star hedge fund managers earn more than $240 million a year. The top manager in 2006, relatively unknown James Simons, made $1.7 billion.

Peyton Manning made a paltry $30.5 million.

A hedge fund is an unregistered investment fund, a sort of souped-up, steroid-filled cross-breed of a mutual fund and an investment club.

Because regulation of these funds is limited, data are sketchy, but industry experts estimate that as much as $2 trillion is invested in various of these exotic vehicles.

With an abundance of money comes an abundance of attention, even if it isn't sought. For several years, regulators, politicians and journalists have speculated about the potential impact of a collapse in the hedge fund industry.

Some hedge funds borrow significantly, leveraging their purchasing power and exaggerating their returns ' both positively and negatively. Their managers control billions, if not trillions, of dollars.

Presumably they can move currency markets and interest rates. They are more powerful than a speeding bullet, else they wouldn't make all that money.

And, some think, they must be evil, because money is the root of all evil. Or something like that.

The anti-hedge fund argument suggests that with all that money and power, hedge funds should be regulated like mutual funds, banks, investment advisors and everyone else in the financial services industry, because not doing so places the financial system in peril.

As we approach the one-year mark of the credit crunch and banking meltdown, here is the intriguing observation: It is the most highly regulated businesses that have lost the most money and done the most harm to the financial system.

With the possible exception of the number of gallons allowed per toilet flush, banking is the most highly regulated activity in the U.S. Yet it was banks that financed 110 percent home loans or created stupid mortgage product like the negative-amortizing-option ARM.

For the most part, banks are run by employees. These employees may get valuable stock options when things go well, but they still get paid when nonperforming assets creep from 1 percent to 3 percent.

Hedge fund managers typically own their own firms. They invest their own money. They significantly participate in both the up side and the down side.

The banker is regulated by a bureaucrat, mostly concerned about ' well, whatever bureaucrats worry about.

The hedge fund manager is regulated by self-interest, or perhaps a higher power, like his wife.

Two of the more extreme examples of placing the financial system at risk, Fannie Mae and Freddie Mac, are not only highly regulated by the government, they were created by the government. They are government-sponsored enterprises.

The Federal Reserve, Federal Deposit Insurance Corporation, Federal Trade Commission, Office of Thrift Supervision, National Credit Union Association and 50 different state bodies regulate banks. If the bank is publicly traded, add the Securities and Exchange Commission to the list. Some banks also fall under the jurisdiction of the National Association of Securities Dealers and the Commodities Futures Trading Commission.

Self-interest run amok is an ugly thing, but in this credit crisis it has served the financial markets much better than thousands of regulations and multiple governing bodies.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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