Hedge Funds Not a Primary Cause of the Financial Crisis, but Could Contribute to Systemic Risk
Sep 18, 2012
This report explores the extent to which hedge funds create or contribute to systemic risk, the role they played in the financial crisis, and whether and how the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 addresses the potential systemic risks posed by hedge funds.
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Hedge funds are a dynamic part of the global financial system. Their managers engage in innovative investment strategies that can improve the performance of financial markets and facilitate the flow of capital from savers to users. Although hedge funds play a useful role in the financial system, there is concern that they can contribute to financial instability. The collapse of Long-Term Capital Management (LTCM) in 1998 raised awareness that hedge funds could be a source of risk to the entire financial system. Hedge funds also invested heavily in many of the financial instruments at the heart of the financial crisis of 2007–2008, and it is appropriate to ask whether they contributed to the crisis. This report explores the extent to which hedge funds create or contribute to systemic risk (that is, the risk of a major and rapid disruption in one or more of the core functions of the financial system caused by the initial failure of one or more financial firms or a segment of the financial system) and the role hedge funds played in the financial crisis, the consequences of the 1998 failure of LTCM, and whether and how the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 addresses the potential systemic risks posed by hedge funds.
Background on the Hedge Fund Industry
The Collapse of Long-Term Capital Management
Hedge Funds and the Financial Crisis of 2007-2008
Potential Hedge Fund Threats to Financial Stability and Reforms to Address Them
Regulatory Reforms That Address Potential Systemic Risks Posed by Hedge Funds
The research described in this report was supported by a contribution by Christopher D. Petitt, principal of Blue Haystack, a financial research and consulting firm, and by the RAND Center for Corporate Ethics and Governance.
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