The summer of 2012 marked 5 years since the slow onset of an economic crisis that first became known as the Credit Crunch and then the half decade that became known as the Great Recession. At the time and over the last few years, Hedge Funds have received a large portion of the blame for the economic crash. They have often been portrayed as one of the main culprits responsible for causing the global financial crisis. With the benefit and hindsight of recent history we can now look back with some perspective and see if the crisis really was the fault of the Hedge Fund Industry. Is there some basis to the claim that the industry was significantly responsible for the worst economic crash since the Great Depression; or were they merely a scapegoat for a seething public and outraged politicians and media?" Sign up for all our monthly White Papers at- http://www.globalperspective.co.uk/#!white-papers Or email: - shane@globalperspective.co.uk

1. A Global Perspectives White Paper
Hedge Funds & the
Global Economic Crisis
Willing Culprits or Easy
Scapegoats?
By Shane Brett,
Managing Director
Global Perspectives
www.globalperspective.co.uk
th
Date 29 September 2012

2. Contents
“It was quite convenient to blame the
Introduction 2 Hedge Funds. They were an easy
Willing Culprits? 2 target, in that they were super-rich, a lot
of them were American, and they were
Ea sy Scapegoats? 4
presented as bad people. They were
Conclusion 4 blamed for what was happening to our
banking system, which in reality was
complete rubbish”.
Kate Walsh, Sunday Times, 2010.
Introduction
The summer of 2012 marked 5 years since
the slow onset of an economic crisis that
first became known as the Credit Crunch
and then the half decade that became
known as the Great Recession.
At the time and over the last few years,
Hedge Funds have received a large portion
of the blame for the economic crash. They
have often been portrayed as one of the
main culprits responsible for causing the
global financial crisis.
With the benefit and hindsight of recent
history we can now look back with some
perspective and see if the crisis really was
the fault of the Hedge Fund Industry. Is
there some basis to the claim that the
industry was significantly responsible for the
worst economic crash since the Great
Depression; or were they merely a
scapegoat for a seething public and
outraged politicians and media?
Willing Culprits?
The first really significant event to signal a
coming financial storm occurred in the UK
on August 9th 2007, when BNP Paribas
halted redemptions from 3 of its Hedge
Funds due to a disappearance of liquidity in
the market.

3. Huge Short Selling of banking stocks in
This led to panic from many 2008 certainly served to accelerate the
investors as they tried to get their general speed of economic collapse.
capital back from financial
institutions. Hedge Funds liquidated As the effects of the Lehman collapse in
their holdings from many Prime Sept 2008 reverberated throughout the
Brokers, making them more financial system, the end of the year
susceptible to financial collapse. brought further evidence to some that the
Hedge Fund industry was rotten and at the
After the failure of Long Term heart of the economic crash. Bernie Madoff
Capital Management in 1997 the admitted that the Hedge Funds he had been
Hedge Fund industry had shown that running for over two decades were in fact
the failure of a large fund had the gigantic Ponzi schemes and that he had
potential to pull down one of the defrauded investors of $65 Billion – the
leading investment banks and lead largest fraud in world history. This merely
to a wider systemic crash by also served to reinforce the negative image of
pulling down larger commercial the Hedge Fund industry in the eyes of the
banks. regulators, politicians and the general
population.
In the recent crisis Hedge Funds
who acted as short-sellers have Hedge Funds seemed to have brushed
been accused of contributing to the aside basic checks of investment and
collapse of bank shares and the operation due diligence to invest colossal
exacerbation of the financial panic sums of money with this incredible
(Short selling of course sees confidence trickster. Everyone from the
investors borrow and sell shares in a regulators to the investors to his Feeder
company in the hope of buying them Fund managers came across looking foolish
back cheaper in the future for a and hopelessly outwitted. But it was the
profit). Hedge Fund industry that deservedly took
most of the blame.
We should be clear about this, while
Short Selling is an important part of Elementary oversight and basic due
market activity and some would say diligence was systematically ignored.
an essential tool in restoring market Despite screaming red flags and plenty of
equilibrium of inflated valuations whispering, the industry was content to let
(having helped expose multiple sleeping dogs lie, as long as the smooth,
frauds including Enron), massive stable long term returns continued year after
volumes of short selling right in the year.
middle of an economic crisis does
not help financial stability. Another charge against Hedge Funds is that
it was their use of Excess leverage which
If the Hedge Fund industry has one contributed to the scale of the financial
charge against them that will stick it losses. There is certainly some truth in this,
is this. Especially when it became as leverage was used across the board
known that some Hedge Funds were particularly to amplify investment returns.
making massive Funds (e.g. Odey),
by shorting UK banks – that later That is fine when times are rosy and
had to be bailed out with public markets are growing but it simply magnifies
money. the problem when liquidity dries up and
there is an economic crash. This was
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4. illustrated clearly in the losses graded by the rating agencies and sold in
caused by mortgage back every corner of the globe. The global
derivatives as the underlying loans purchase of these securitised assets meant
went sour. The losses were far in the effects of the crisis was felt worldwide
excess of the mortgages (e.g. as in the collapsed of exposed German
themselves, because investors Landesbanks).
including Hedge Funds had
borrowed significantly to take out It is also worth noting that in America the
synthetic positions through Credit massive growth of Sub-Prime mortgage
Default Swaps. lending (through Freddie Mac and Fannie
Mae) was partially caused by well
intentioned but misguided government
policies, aimed at making homeownership
Easy Scapegoats? available to sections of the public who
otherwise would never have qualified.
However from a wider viewpoint it is
obvious that the crisis is the result of This combined with a long period of
excessive worldwide debt. This regulatory loosening by many
was built up by both individuals (US, governments (for example by the repeal of
UK, Ireland), Governments (Greece, the Depression-era US Glass-Steagall Act
Portugal, France), as well as private separating investment and commercial
debt being guaranteed by sovereign banking) which paved the way for an
states (Ireland, US, UK). explosion of bank lending.
The quarter century from 1982 Banks not only lent hugely in relation to their
known as the Great Moderation capital base (further reducing their Capital
(characterised as it was by low Ratios to historically low levels), they also
inflation, low interest rates and rising became more dependent on short term
employment) led to a loosening of financing in the money markets to finance
financial regulation and an ensuing this expansion. This was especially risky
debt expansion and asset bubble. where this short term capital was being lent
back out for long term loans (as Britain’s
While Hedge Funds certainly played Northern Rock found out to its cost). This
their part in borrowing widely to type of funding is exactly the sort of
finance investment (some would say financing that dries up overnight in a credit
speculation), they were just one crunch.
sliver of a wider debt bubble that
grew throughout the global economy
over the past quarter century.
The banks created the global Conclusion
housing bubble by reducing the
requirements for mortgage Looking back on this recent history we can
qualification and massively now see fairly clearly it was the banks that
increasing their property lending. caused this economic crisis. It was the
excesses of the banking industry, through
The private market then took these the accelerated growth of debt and lax
loans and packaged them into lending criteria that planted the seeds of
tranches for sale to different global economic collapse.
investors. They were erroneously
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5. Hedge Fund did not contribute
significantly to the global housing
bubble nor did they play a pivotal or
systemic role in the crisis. Other
players such as mortgage lenders, Sign up for all our monthly
the credit rating agencies and of White Papers at-
course the banks themselves were
to blame for causing the crisis. http://www.globalperspective.co.uk/#!white -
papers
While Hedge Funds may not have
been substantially responsible for Or email: - shane@globalperspective.co.uk
the global economic crisis, some of
their activities definitely contributed
to the scale of the collapse.
However it is worth remembering
that unlike the banks, no Hedge
Fund anywhere worldwide received
any public money, nor did any have
to be bailed out by a government.
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The same regulators, who have Shane@globalperspective.co.uk
been so sharply criticised for their
failures in averting the crisis, have
been enacting widespread
legislation in the US and Europe to
bring Hedge Funds firmly within their
regulatory remit.
This means that whether Hedge
Funds were responsible or not, the
Global Economic Crisis will deeply
change the nature and structure of
the industry through increased
global regulatory requirements.
Global Perspective s
www.globalperspective.co.uk
Email: Shane@globalpers pective.co.uk
Phone: +44 (0) 20 3239 2843