“Sometimes libertarians deserve to win an argument”

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So says the Washington Post in its editorial on hedge fund regulation:

There are three types of argument in favor of regulating hedge funds, and none is persuasive.
The first invokes systemic risk: If a hedge fund collapses, the banks that lent to it may collapse, too, causing a chain reaction through the financial system. This danger is real, but the banks that lend to hedge funds have a strong incentive to manage it by limiting their exposure to hedge funds and by monitoring the risks that the funds take. Since the Long-Term Capital debacle, this is what banks appear to be doing. Regulatory prodding has encouraged the banks to get smarter, though in some cases the rules perversely permit hedge funds to borrow more if they take on extra risk — an example of how oversight of this complex industry can backfire.
The second argument for regulating hedge funds is that they are havens of insider trading and other sorts of illegal manipulation. It’s true that some prominent cases of fraud involve hedge funds, but this isn’t surprising given their size. The law already empowers regulators to go after hedge fund managers who commit financial crimes. It’s not clear that extra regulations would add much.
The third argument for regulation concerns investor protection. The SEC suggests that by registering and inspecting hedge funds it can reduce the danger that investors will lose money. Some hedge fund managers are happy to accept this line: To reassure anxious clients, some choose to register with the SEC anyway, and they calculate that submitting to mild regulation now may be smarter than waiting until the political storm that would follow the scandalous blowup of a crooked player in their industry. But this is a case of hedge funds and their customers trying to ensure their reputations by gaining a regulatory seal of approval. The regulators should decline to become a security blanket.

Posted by on August 6th, 2006 at 11:23 am


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