Hedge Fund Paranoia

The New York Times is, well, amazing. In a front page, column one, article by Jenny Anderson ("Deals by Banks and Hedge Funds Raise Questions") the story is on how banks, that loan money to hedge funds, often also rent space and services to hedge funds (UBS runs a "hedge fund hotel").  This "concerns" regulators.  Why?  Banks are just providing a business service and may use a lower rent to attract other business connections -- just as milk prices can be a loss leader in grocery stores.  This is not illegal.  Ms. Anderson then links the "problem" to, first, soft dollars, and second, to front running in trading.  On soft dollars, not all hedge funds use them to pay rent, and even if they do it is not a market problem unless the soft dollar returns do not benefit the fund itself (as opposed to the personal pecuniary interests of the managers) and the fund's investors do not know of the leakage.  Paying rent would seem to be a fund expense.  At the very end of the piece Ms. Anderson acknowledges that several of the large investment banks do not think renting space makes business sense and do not do it.   

The more obvious move in the article is to mention hedge fund front running in the middle of the piece -- what does this have to do with renting space?? Nothing.  Hedge funds are traders and those that front run should be prosecuted.  There is no evidence that they front runner more or less than other groups of traders. 

At the end of the piece she throws in a description of the "prime brokerage" business, banks that provide a variety of financial services to hedge funds.  Here there is a potential problem but she does not discuss it.  At issue is whether the prime brokers are overexposed to hedge funds risk, whether the brokers have risk limits and controls in place that are sensible.  Several officials in the Federal Reserve have given speeches on the issue before banks asking for careful lending practices that accurately assess risk.  At the core of the controversy is our belief in the integrity of our banks.  Will our banks, independent actors from the hedge funds, price accurately the risks they take when they deal with hedge funds?  There is no reason to believe that, on average, they do not and will not. 

The article is a mess. Throw in a rambling description of legitimate business deals, add a dose of insider trading, and imply that the entire hedge fund industry is corrupting our banks.  It plays on hedge fund paranoia, apparently to the delight of the New York Times daily editor.   

We need to relax.  Hedge funds, on average did not have a great year.  Their returns, on average, did not match the popular indexes.  The bloom is off the rose on the industry and investors are getting much more savvy on selecting among the funds.