Hedge Funds under Fire


Hedge funds can breathe a sigh of relief During their April 13 scrutiny by the House Banking Committee in Washington, they were largely exonerated of causing recent stock and bond market volatility.

The hearings took place amid growing suspicion derivative markets and products, punctuated by the near collapse of Metallgesellschaft (see Futures, April 1994) and the news Procter & Gamble may sue Bankers Trust after taking a $157 million hit to close out two interest rate swaps.

But federal regulators said U.S. bank exposure to hedge funds does not pose particular safety and soundness risks either to any individual bank or to the banking system, and that regulatory safeguards already in place appear adequate to avert any serious system-wide problems.

"National bank exposure to hedge funds is relatively small," said Comptroller of the Currency Eugene Ludwig. For the most part, such risk is collateralized, he explained, and subject to credit risk controls that would apply in an extension of credit to any highly leveraged borrower.

Federal Reserve Board Govern John LaWare said it "would be wrong to single out hedge fund as being responsible for moving global prices of financial assets or as being a major source of risk in financial markets."

George Soros, chief advisor to the $10 billion Quantum group Of investmnent funds, rejected implications that hedge fund activities are harmful or destabilizing. He also spurned assertions that hedge funds move markets.

LaWare also downplayed press reports of large-scale hedge fund selling in the U.S. Treasury market, insisting that "at least some of the price adjustment in bond and stock prices" this year can be viewed as "an unavoidable correction to an unsustainable situation."

The regulators said, however, there is cause for concern about the potential systemic impact of hedge fund activity. The rapid growth in volume and complexity of derivative instruments and the rapid improvements in technology and telecommunications have increased the rate that shocks spread through the financial system.

Soros said he prefers supervision to regulation and urged lawmakers to "beware of the unintended consequences" of imposing a new regulatory scheme.

"If regulations are to be introduced, they ought to apply to all market participants equally," Soros said. "It would be wrong to single out hedge funds."

House Banking Committee Chairman Henry Gonzalez (D-Texas), who introduced legislation April 12 that would require banks to disclose their derivatives dealings, said hedge funds "deserve extra scrutiny because they often leverage their capital with loans from banks, creating the possibility of large defaults when a hedge fund fails." who visited the White House to examine Mrs. Clinton's records in April, says, "Refco was very right (at that time). …

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