Essay --

Introduction The Hedge fund industry is surrounded by many debate and controversy. Lack of excessive returns, unclear impact, oversight on the market are all subjects of concerns for the public and market participants. The hedge fund industry worries small investors and financial professional who do not know how to accurately assess the risks associated with hedge funds. Hedge funds are mainly operating like mutual funds but not the managers. Oversight and low regulation allow them to not make public information on their profits and losses or investment strategies. Hedge funds rely a lot on volumes to achieve profits. Systemic risk became a major part of the debate since LTCM in 1998. Story of LTCM Background Long Term Capital Management - LTCM - was a hedge fund that was established in 1994 by John Meriwether who was a successful bond trader at Salomon Brothers. Meriwether was one of the first on Wall Street who hired professors and academics who applied models based on financial theories to trading. This team demonstrated an ability to precisely calculate risk and generated amazing returns (Goldberg, M., 2012). The partners of LTCM included a professor from Harvard University, Nobel Price-winning economists, a former vice president of the Board of Governors of the Federal Reserve, and other successful bond traders. This group of traders and academics attracted about $1.3 billion from different institutional clients (Goldberg, M., 2012). Investors were not allowed to take any money out for three years and paid $10 million to get into the fund. Annual return in 1995 was 42.8% after management took 27% off the top in fees. In 1997 LTCM successfully hedged most of the risk from the Asian currency crisis by ... ...ge (Goldberg, 2012). Should the Fed have intervened? In order to save the U.S. banking system, the President of the Federal Reserve Bank of New York William McDonough convinced 15 banks to bail out LTCM with $3.5 billion, in return for a 90% ownership of the fund. Also, the Fed started lowering the Fed funds rate as a assurance to investors that the Fed would do whatever it took to support the U.S. economy. Without that direct interference, the entire financial system was threatened with a collapse (Amadeo, 2012). However, the Fed brokered and intervened a better deal for the LTCM managers and shareholders. This was the precedent for the Federal Reserve's bailout role with AIG, Bear Stearns, Fannie Mae and Freddie Mac during the financial crisis. Once financial companies realized that the Fed would bail them out, they were more willing to take risks (Amadeo, 2012).