Could hedge funds be part of the solution? Could short-selling hedge funds be doing the market and regulators a valuable service? Surely you jest. However, that's exactly what ex-Wall Street Journal columnist Jesse Eisinger hints at in his story about restructuring the financial system in the current issue of Conde Nast Portfolio.
"We need more dissidents. We need to make the world a safer place for short-sellers to criticize companies. Regulators should publicly praise short-sellers, rather than periodically ban their activities. Critics and whistle-blowers, no matter how self-motivated, should be regularly consulted about suspicious companies, not dismissed as cranks once they expose wrongdoing." Really. Page 47.
For hedge funds to be a respected part of a new financial world order, two things need to happen. Regulators, analysts and shareholders need to aggressively seek the opinion of independent parties and be much more skeptical of corporate claims and the CEO bully pulpit. That shouldn't be too hard.
Second, short-sellers and hedge funds of all stripes need to admit they are part of the system and behave like they have an interest in stability in the market, preventing fraud and encouraging financial fair play. Once they take their positions, they must go public in cases where systemic risk, fraud, or deceptive accounting is afoot. Profits will still be made, but full-blown crises might be averted.
What hedge funds cannot do is sit on the sidelines grinning like the Cheshire cat. In a new financial world order, it is not sufficient to be the smartest guy in the room. You also need to be responsible.
In the same issue of Portfolio, John Paulson, whose funds made $15 billion in 2007 by betting against homeowners, banks and mortgage companies in 2007, is scrutinized along these lines. "Left unexamined is the uncomfortable moral dimension of Paulson's achievement. If he saw all of this coming, was it right for him to keep his own counsel, quietly trading while the financial system melted down? Do traders who figure out a way to profit from our misery deserve our contempt or our admiration, however grudging?"