Smart Hedge Fund

Economists Saw Risks In Hedge Funds

It is only a matter of time before the next hedge fund blowup hits us. This time we were lucky since Amaranth didn't bring a rippling effect like LTMC.

More than half of respondents in the latest WSJ.com economic survey -- 23 out of 41 who answered the question -- said regulation and supervision of hedge funds is too light; 16 economists said it was "just right" and two said it was "too tough." About 60% said hedge funds pose a risk to financial markets. "We just don't know if they're dangerous," said Diane Swonk at Mesirow Financial, and when it comes to financial markets the "unknown is unacceptable."

The explosive growth of hedge funds and their aggressive use of borrowed money have raised alarms about whether a financial crisis could set off a chain reaction of hedge-fund failures that could cause chaos in the financial system. Hedge funds, investment pools for wealthy investors that make big bets on stocks, interest rates and other markets, have roughly $1.2 trillion in assets, twice the level of five years ago.

The markets had a brush with hedge-fund turmoil in 1998, with the near-failure of Long-Term Capital Management, a fund that was hobbled amid a Russian debt default. Worries intensified last month following the massive losses suffered by Amaranth Advisors, a hedge fund that lost nearly $5 billion in one week on a bad bet on natural gas, though there was no chain reaction.