The world of hedge funds is as mysterious as it is profitable, and remains highly opaque even after a raft of new reforms aimed at strengthening financial stability. While there is general agreement among policymakers that the the so-called shadow banking system was at the epicenter of the financial crisis of 2008, hedge funds still face little or no regulatory scrutiny, despite their size and importance in financial markets.
That worries Andrew Lo, a professor at MIT’s Sloan School of Management. For him, the basic registration requirements for hedge funds are not nearly sufficient to give regulators a broad sense of the potential risks present in the markets. On the sidelines of an International Monetary Fund meeting, Lo compared the relationship to that of a parent keeping tabs on a growing teenage child.
Let’s say you’re a parent and your child has started dating. You don’t necessarily need to know everything they are doing, but you’d at least like to know who they are going out with.
That’s a particularly apt analogy since the main concern for financial sector regulators is that losses in the unregulated sector might deal a large blow to the banking system itself, forcing another round of bailouts.
Lo, who also runs an investment fund called Alpha Simplex, said during his presentation that the Dodd-Frank financial reform law still leaves regulators powerless to manage this highly-influential part of the financial system:
