Report Says Hedge Funds Could Threaten U.S. Economy In Crisis

Feb 18 2011 | 8:16am ET

Hedge funds could pose a threat to U.S. economic stability in a time of crisis, according to a report by staff of the Financial Stability Oversight Council.

The 80-page FSOC report, obtained by Bloomberg News, is intended to help regulators decide which non-banking financial institutions need Federal Reserve supervision.

The FSOC counts 10 members, including Federal Reserve Chairman Ben Bernanke and Treasury Secretary Tim Geithner, and was created as part of the Dodd-Frank financial reform law in 2010.

Significant redemptions by hedge-fund investors could “cause activity in some markets to freeze,” according to the February 3 report.

Hedge-fund industry lobbyists say the funds are not systemically important enough to warrant supervision by the Federal Reserve and that the costs involved in complying with additional regulation would put them at a disadvantage to their competitors.

Hedge funds, according to the EurekaHedge Hedge Fund Index, managed $1.68 trillion as of January 2011. The FSOC report considers a $40 trillion industry that also includes retirement programs, private equity firms, specialty bank funds and insurance companies.

Bloomberg says the draft report, without making recommendations, outlines ways regulators could potentially monitor hedge funds—requiring, for example, information not now made public, like value-at-risk data.

In terms of private equity, the report says such firms could pose a risk due to the “highly leveraged nature of their portfolio companies and their use of bridge loans,” noting that about 250 of the industry’s roughly 2,000 managers oversee more than $1 billion in assets each.

Companies overseen by the council can be made to raise capital, increase liquidity or sell assets if they are seen to be too concentrated in one economic sector.

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