Tuesday, October 14, 2008

Paulson comment foreshadows storm for hedge fund industry

According to an email sent to a colleague, former Lehman Brothers CEO Richard Fuld said Treasury Secretary Henry Paulson wants to "kill the bad HFnds + heavily regulate the rest." Fuld was in a very public battle with short sellers, but this sentiment held by Paulson (if accurate) should send shivers down the spine of the hedge fund industry.

With the ban on short selling, it is clear that Treasury and other regulators have view collateral limits on trading options of hedge funds simply as collateral damage the battle against the financial crisis.

More regulation seems inevitable and, the industry is not well-positioned to do much about it. For too long hedge funds have tried to fly under the radar, but it was naive to think that a $2 trillion industry would not attract outside scrutiny or regulatory interference. The industry resisted even the slightest infringement on independence, like registration. It turned a blind eye to high-profile cases of fraud and deception. It did not view challenges involving risk management, valuation, market practices and governance as risks to the entire industry.

Most important, the largest, most institutionalized funds did not band together (as was done in Europe) to create a unified front against unnecessary regulation and to serve as the voice of the industry in an increasingly shrill political and media environment.

It is ironic that Henry Paulson would want to kill the bad hedge funds and heavily regulate the rest. Isn't Goldman Sachs, after all, a giant hedge fund? However, the statement shows just how vulnerable the hedge fund industry is.

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