From the FINANCIAL TIMES:
…But the real danger lurking in the shadows of the financial system is “tail risk” – the possibility that a hedge fund, or even an insurer, might become too big or too reckless. It is true that hedge funds have, on average, less debt on their books than banks. But there is little stopping them from loading up on leverage if they want to juice-up returns. And, as Long Term Capital Management showed in 1998, one big failure is enough to shake the entire system.
But even if they do not cause a crisis, hedge funds can exacerbate a turmoil – just ask Morgan Stanley and Goldman, whose hedge fund clients withdrew billions of dollars in a few days in 2008. A rush to the exit by several leveraged funds trying to get out of the same trade could have devastating ripple effects.
The US rules acknowledge this problem by allowing the authorities to periodically add names to the “systemic list”. But expecting regulators to spot black sheep in a flock they do not shepherd is unrealistic. By the time the watchdogs realise a shadow bank is a threat, it could be too late to stop the contagion…
Click here to read the full article.
