Jeremy Warner: In half-hearted defence of hedgies

Hedgies make easy scapegoats, yet European leaders are shooting at the wrong target in proposing a regulatory crackdown on this once burgeoning sub-sector of the financial services industry. I don’t want to speak too soon, because it’s a racing certainty that one of their number will have turned out to have run off with all his investors’ money before the recession is out. Bernie Madoff, who wasn’t so much hedging as ponzying, is already a case in point.

Yet there is very little evidence to suggest hedge funds had any more than a marginal impact on the credit crisis, either in cause or effect, and to see Gordon Brown throwing his lot in with the Germans and French in demonising the industry is a bit much after 10 years spent actively trying to encourage it.

The German and French governments have always seen the London and New York hedge-fund communities as symbols of Anglo-Saxon finance and therefore something to be controlled at all costs. In Germany, hedgies are lumped in with private equity as a biblical plague of locusts.

In France, which has spawned some of the most accomplished hedgies around and whose banking industry in any case has a proud tradition in complex financial instruments, attitudes are a bit more ambivalent but nonetheless hostile. At root, it may be that the French simply like to regulate, and, along with Germany, resent the constant leeching of the brightest and the best to New York and London.

As for Mr Brown’s conversion to the path of righteousness, this seems to be a case of mere political opportunism. In today’s febrile environment, hedgies are as much the objects of public hatred as bankers, the more so as many of them are a good deal richer.

In truth, hedgies are just fund managers, albeit in many cases exceptionally well rewarded and secretive ones. Some trade equities, others trade bonds, currencies and commodities. Some are known mainly for their activism, others for their shorting.

Yet one of the things that is meant to unite them – heavy leverage – turns out to be a bit of a myth. On average, hedge funds tend not be particularly highly leveraged, and by the heroic standards of leverage that the banks took on during the boom, they look to have been relatively well behaved.

Certainly, they have proved a much better credit risk than banks. None of them have yet had to be bailed out with taxpayers’ money and those with heavy leverage have on the whole managed to pay it off quite quickly, thereby helping the banks in their balance-sheet reductions.

The biggest sellers of equities in the crash were not hedge funds, but mutuals, though there is some evidence of forced selling of corporate bonds by hedgies. In any case, hedge funds seem to have played very little role in the systemic breakdown of the financial system, if any.

I’m not trying to argue that hedgies are paragons of virtue. Far from it. Hedgies are speculators – no more, no less – and a lot of them aren’t even particularly clever. Many of their pay structures are indefensible. What’s more, some of them can indeed be categorised as part of the “shadow banking” system which allowed credit to expand out of control beyond the reach of ordinary capital regulation.

Yet as a breed, they were not the root of the problem. Regulate them by all means – as far as London is concerned, their management companies are already regulated – and it must be right to stop the pernicious and secretive use of tax havens as technical repositories for the money. But there is little point in driving the managers offshore, and any worries that remain over leverage can easily be dealt with through smart capital regulation of the banks that lend to them.