Hedge Funds and Systemic Risk

Hedge Funds and Systemic Risk

Hedge Funds and Systemic Risk

Hedge Funds and Systemic Risk

Excerpt

Hedge funds are investment pools open to high-net-worth investors and institutions but not to the general public. In part because of this restriction, hedge funds have, until recently, been subject to reduced reporting and oversight regulations. They have also been reluctant to provide even general information on their operations and strategies to the public, fearing that such information could be construed as making a public offering. The result has been very poor public understanding of hedge funds and their role in the financial system.

Like other participants in the financial system, hedge funds invested in many of the financial instruments linked to the financial crisis of 2007–2008. As a consequence, their role in the financial crisis and potential contribution to systemic risk have drawn increased attention from Congress, regulators, participants in the financial system, and researchers. With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Pub. L. 111-203), regulations are currently being developed that have the potential to significantly affect the hedge fund industry and its role in the financial system.

To improve the general understanding of hedge funds, this report provides an overview of the hedge fund industry, of hedge fund strategies and operations, and of the role of hedge funds in the financial system. To better understand how hedge funds might contribute to systemic risk, it investigates the role hedge funds played in the financial crisis and revisits the consequences of a large hedge fund’s failure in the late 1990s. It also examines whether and how the ongoing financial reforms address the potential systemic risks posed by hedge funds.

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