Hedge fund execs have mixed views on oversight

Five prominent hedge fund managers on Thursday told Congress they support a new central exchange to open the murky world of some complex investments partly blamed for the global financial crisis, but the billionaires offered differing views on the need for stricter regulation of hedge funds themselves.

The managers testified at a House hearing examining the role of hedge funds in the crisis, and the risks that critics say they pose to the financial system. Hedge funds, vast pools of capital holding an estimated $2.5 trillion in assets, operate mostly outside of government supervision.

As the market crisis has deepened, hedge fund selling has been widely cited as one of the reasons for the increased volatility that pounded stock and bond markets last month. After terrible results for many hedge funds in recent months, some managers at the hearing acknowledged suffering losses in their highly touted funds.

The House Oversight and Government Reform Committee is attempting to assess the role of hedge funds in the financial crisis and what could go wrong with them in the future, said its chairman, Henry Waxman, a California Democrat. "Some say hedge funds have become a shadow banking system," he said.

A new regulatory regime for hedge funds, as some lawmakers have urged, could be a pressing issue under the administration of President-elect Barack Obama. Hedge funds' wealth represents a vast source of potential tax revenue to meet demands on government spending. The political allegiances and donations of many hedge fund managers have tilted Democratic in recent years; hedge funds and Wall Street banks gave heavily to Obama's campaign.

Billionaire investor and liberal activist George Soros, who runs a hedge fund, testified that new regulations were needed to gauge the underlying financial strength of banks. But he warned against "going overboard" with regulations that could do more damage than good to the financial system.

Soros, who amassed a fortune betting on global currency markets and has given heavily to Democrats' campaigns, also criticized the Bush administration's handling of the $700 billion financial rescue program.

"A deep recession is now inevitable and the possibility of a depression cannot be ruled out," Soros predicted in his written testimony.

The five hedge fund managers each earned on average more than $1 billion last year in an industry that has become stunningly profitable and powerful. But Waxman and others noted that some of their earnings can be taxed at the 15 percent rate for capital gains, while teachers, firefighters and other ordinary Americans pay much higher rates as income taxes.

Fund manager John Paulson _ who foresaw the distress in subprime mortgages and reaped billions by betting against the related securities _ defended the tax regimen. But Soros and James Simons, president of Renaissance Technologies, said they'd be OK with the rate levied on managers who take a share of hedge fund profits being raised to 35 percent.

Hedge funds have grown explosively in recent years while operating secretively. They have lured an increasing number of ordinary investors, pension funds and university endowments _ meaning millions of people now unwittingly invest in hedge funds indirectly.

Some fund executives at the hearing voiced support for stricter disclosure requirements for hedge funds. Yet they showed greater enthusiasm for putting new, stricter rules on banks and the amount of borrowed money they should be allowed to have relative to their capital.

Kenneth Griffin, CEO and president of Citadel Investment Group, insisted that no new regulation of hedge funds was needed.

The creation of public exchanges or clearinghouses would provide needed transparency for credit default swaps and reduce financial risks, several of the fund executives said.

Credit default swaps, a roughly $60 trillion worldwide market, played a large role in the credit crisis that brought the downfall of Lehman Brothers Holdings Inc., a government rescue plan for giant insurer American International Group Inc., and Merrill Lynch & Co. selling itself to Bank of America Corp. The swaps are commonly used contracts to insure against the default of financial instruments such as bonds and corporate debt. But they also are bought and sold as bets against bond defaults.

Hedge funds are major purchasers of complex derivatives such as credit default swaps.

Earlier this year, the implosion of hedge funds at Bear Stearns cost investors $1.8 billion and began a domino effect that pushed the investment bank itself to the brink. It was purchased by JPMorgan Chase & Co. in March with a $29 billion federal backstop.

Hedge fund assets dropped by $100 billion in October as investors withdrew their money and funds were forced to sell stock, worsening the volatility. Roughly $60 billion of the $100 billion in asset losses came from investor redemptions, according to a report released Wednesday by Eurekahedge, a data and research provider.