AND THE WORLD’S LARGEST HEDGE FUND IS….

Market Folly recently released this list of the world’s largest hedge funds and I just couldn’t help but laugh at the list.  Unfortunately, it really shouldn’t be a laughing matter, but one of grave concern.  Among the top hedge funds are several TARP recipients and bailout beneficiaries.  Of course, the firms that received these generous donations are not actually hedge funds at all.  No, they are “bank holding companies” that have been declared “too big to fail” (you know who you are).  In other words, they have been declared vitally important components of the United States economy.  So important that they cannot fail under any circumstance.

That is fine with me I guess.  If we want to designate certain firms as “too big to fail” or in JP Morgan’s case, “too BIGGER to fail” following the Fed’s crafty merger with Washington Mutual and Bear Stearns, then maybe these important banks should not be allowed to fail.  Perhaps they truly are too important in greasing the U.S. economic engine that they should not fail.   But if this is the non-capitalist route we should so choose to take then let me pose a bigger and far more important question (excuse me while I bold this and capitalize it so you can pretend I am screaming this at Congress):

IF A COMPANY IS SO LARGE AND SO VITALLY IMPORTANT TO THE UNITED STATES ECONOMY THAT IT CANNOT BE ALLOWED TO FAIL THEN WHY DO WE ALLOW THESE COMPANIES TO EFFECTIVELY GAMBLE WITH THEIR CASH HOARDS?

If there is one thing we have learned from this crisis it is that markets are not efficient (see here for more on efficient market myths).  They are incredibly complex dynamical systems that are driven by irrational participants.  Barring remarkable and very high levels of risk management, this effectively deems no company unable to fail.  That is of course, unless their operation is so cut and dry and so low-risk that failure would only be possible under some sort of nuclear holocaust scenario (you get my point I hope).   These modern day hedge funds (or money center banks as we once referred to them) have proven that their need for profit growth and excessive risk makes them all too vulnerable to failure.  And that puts us all at risk.

What’s so insane in all of this is that we actually allow a firm like JP Morgan or Goldman Sachs to effectively gamble their money every day in highly unregulated markets while also proclaiming themselves to be “too big to fail”.  If you’re too big to fail then you’re too big to take excessive risk.  If you’re too big to take excessive risk then your trading and “risky” operations should be ENTIRELY separate from the function you vitally serve to the nation – providing liquidity and loans.

The nice thing about most of the companies on this list is that they won’t demand or receive a bailout if they fail.  If Steve Cohen blew up SAC tomorrow the government would probably give him a nice stiff middle finger.  I am certain the taxpayer would be happy to do the same.  The equity markets would tremble for a few weeks, but following an orderly unwinding no bailout would even be necessary.  However, if you’re a bank who has been deemed “too big to fail” and carries a highly complex derivatives book alongside a massive consumer bank reserve book then it’s time that we ensure you can never fail and put the United States economy at risk again. Whether that is done through harsh regulation or breaking up these firms is up to Congress, but something must be done and it must be done sooner rather than later.

Of course, most of the firms that this is targeted at are not even on this list, but we should be preemptive in making sure they never get on this list.  Obama has spent a great deal of time talking loudly, but where is his big stick?