Opening The Fed Lending Window To Hedge Funds

September 30, 2008 by Douglas A. McIntyre

Cammonopoly_wideweb__430x3250The poor and middle class like to spit on the rich when they are down. It happens so rarely.

The idea of bailing out hedge funds or helping them in any way runs counter to the best instincts of most citizens, regulators, and law makers. The wealthy do not need a Good Samaritan.

Allowing hedge funds to fail is likely to accelerate and put pressure on whatever forces are in place that are moving down the markets. By some estimates, hedge funds control over $2 trillion. Most of the investments they have made involve some level of leverage. As those investments lose their value in the crisis, hedge funds have few resources to pay back the money which has created that leverage..

According to The Wall Street Journal industry experts are "expecting between 10% and 20% of the hedge-fund industry’s assets to be withdrawn by year end." That means a lot of investments will be sold off, and many of those will be stocks. An equity market recovery could certainly be undermined by that level of liquidation.

The Federal Reserve has seen fit to open its emergency short-term lending window to banks and brokerage firms. The agency said that the average level of borrowing last week was $188 billion a day.That money is supposed to be paid back in short order.

It is hard to imagine how unpopular it would be to lend cash from the Fed for hedge fund rescues. But, it would offer  some indirect aid to banks. Hedge funds which fail may not be able to pay off all of their debts.

The financial crisis has created a period when unpopular decisions reign. Voters are clearly writing their Congressmen and telling them not to vote for the bailout package. In the House, there were 235 votes against the measure. It is hard to blame the representatives. Without a seat in Congress, where will they find work during a recession?

By inviting in hedge funds, the Fed could do a great deal to deleverage the system at one of the pressure points where the use of credit has been least accountable.

An act of saving the rich only makes sense to the extent that it saves the poor as well.

Douglas A. McIntyre