Hedge Funds: Scrutiny OK, But Not Too Much

A group of high-profile hedge fund managers came to Washington, D.C. Thursday, acknowledging that stricter oversight of their unregulated industry is certainly on its way, but warning that overregulation could be just as destructive.

Hedge funds have gotten plenty of negative attention this year for exacerbating the financial meltdown. First, they were blamed for causing the demise of struggling financial institutions by betting against the share prices of companies like Lehman Brothers, Freddie Mac (FRE), Fannie Mae (FNM), AIG (AIG), Washington Mutual and Wachovia (WB).

But the tides soon turned, as the market left few stocks or other investments unpunished, and hedge funds started buckling under the weight of the economic downturn. Over the past two months, many funds have been forced to liquidate holdings to meet redemptions, fueling volatility and the market's steep declines.

Broadly speaking, the industry posted a 16% downturn in the third quarter alone, according to data provider HedgeFund.net. That left hedge funds with $2.5 trillion, which is then leveraged perhaps fivefold in terms of assets. Performance losses accounted for $347.5 billion, as investors redeemed $117.3 billion and funds liquidated a net $10.9 billion of their positions. Before the House Committee on Oversight and Government Reform on Thursday, George Soros, chairman, Soros Fund Management, predicted that ultimately, the amount of money hedge funds manage will shrink 50% to 75%.

"It has to be recognized that hedge funds were also an integral part of the bubble," says Soros, "which now has burst."

Henry Waxman, chairman of the committee, said on Thursday that regulators are taking a closer look at the industry to determine the role hedge funds have played in the financial meltdown, and how they ought to be regulated going forward. He noted that hedge funds are "virtually unregulated," and that the government cannot say with certainty how many exist or how much money they manage.