Bernanke Cautions on Hedge Funds

The Fed chairman in a conference offers thoughts on the systemic risk implications of hedge funds.
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Federal Reserve

Chairman Ben Bernanke advocated for closer monitoring of hedge funds, suggesting that financial authorities could not "entirely eliminate systemic risk" but should endeavor to prevent potential risks precipitated by the burgeoning hedge fund industry.


who took office on Feb. 1, gave his remarks Tuesday at a financial markets conference on hedge funds and risk in Sea Island, Georgia, organized by the Federal Reserve Bank of Atlanta.

"Authorities should and will try to ensure that the lapses in risk management of 1998 do not happen again," Bernanke said, a reference to the collapse of Long-Term Capital Management, a hedge fund that had received a $3.6 billion private bailout.

Bernanke argued that the approach since taken to monitor risk, despite the rapidly increasing size, diversity and complexity of the hedge fund industry -- once the bailiwick of the wealthy investor -- has been effective.

Domestically, the chairman said, "regulatory authorities issued guidance on risk-management practices," and bank supervisors now actively monitor and conduct targeted reviews of banks' dealings with hedge funds.


Securities and Exchange Commission

has stepped up its risk-management inspections of larger broker-dealers, he added.

But Bernanke did not recommend direct regulation for the high-risk and largely unregulated funds, saying that "may be justified when market discipline is ineffective at constraining excessive leverage and risk-taking but, in the case of hedge funds, the reasonable presumption is that market discipline can work."

Renewed discussion of hedge funds, their benefits and risks has prompted calls for implementation of new policies, such as proposals for regulatory authorities to create and maintain a database of nonproprietary information about hedge funds.

Bernanke said that "such a public database might demystify hedge funds, but it would not address the central policy concern that opacity creates liquidity risk."

Additionally, Bernanke said that that the best course for addressing the systemic issues related to hedge funds and to ensure transparency is "likely a continued focus on counterparty risk management."

Such a focus places the onus of monitoring risk "squarely on the private market participants with the best incentives and capacity to do so," Bernanke said.