Jussi Raumolin, PhD, DEA, Scientific Writer, Helsinki, Finland
REGULATION OF HEDGE FUNDS January 31, 2009
When deregulation and liberalization of financial markets started in the 1980s it was claimed that actors are rational and free markets are self-regulated. On the basis of the history of financial markets those arguments were not justified but they were ideological, to a high degree.
This liberalization was supported by the creation of financial paradises and new tools, like hedge funds. Together with the spread of new information and communications technology, all this created an autonomous financial sphere. When it was prone to produce bubble economies and bank crises, one after another, the authorities imposed regulations on banks but not on financial paradises and hedge funds although major part of financial flows passed by them.
Excessive risk-taking and the use of highly-sophisticated mathematical models of risk-taking contributed the crisis in the US housing markets in 2007 which then spread to stock exchange markets and to bank and insurance companies. It then spread to global crisis and finally, it affected to so called real economy. The discussion of the coming of worst economic crisis since the Great Depression in the 1930s started in the autumn 2008.
This crisis has also been intellectual and scientific crisis. Only a few experts understood the new complex mathematical tools used in financial markets. Only a few economists saw and understood the coming and the spread of the actual crisis. The world is, however, filled with universities provided with teaching in economics and finance. There is either no lack of economic research institutes.
The need of regulation on financial markets is evident. In particular, the former gaps in regulation should be closed as unregulated activities greatly contributed to the crisis. It is not possible to discuss here about negative consequences of the liberalized financial markets, in general. If the EU wants to be a significant global actor, it should take the lead in the formation of a new global financial system. The EU should also introduce strict regulationson hedge funds.
Senators Carl Levin and Charles Grassley introduced legislation to impose government oversight on hedge funds in the U.S.A. recently. The new administration is preparing tighter regulations on financial markets, in general.
Those who are opposing to tighter regulations claim that they would stifle creativity and innovation. But innovation for the sake of innovation does not necessarily produce good results as we have seen during the last decades in the financial sphere. Hence, the question should be posed for what purpose one should promote innovation.
If economic depression and unemployment are major short-term problems, climate change, pollution and resources scarcities related to oil, water, food and fish are major long-term concerns. Hence one should pose the question what would like the financial system capable to address those problems.
This point of view stresses the importance of public goods and global commons. I would like to doubt whether an autonomous financial sphere is appropriate for those purposes. Hence the regulation of hedge funds is a part of the comprehensive regulation of financial system which would transform it to serve better common aims than excessive private profit –seeking provoking bubble economies and crises, one after another.