Don’t “Hedge” On Your Beliefs

I think that is the lesson from this story about John Edwards that appeared in USA Today about his recent work with Fortress Investment Group to learn about hedge funds (and I don’t think he has, by the way, concerning the title of this post).

And if you guesses that I was going to link to a Wikipedia article on hedge funds for more background, then you’re “too cool for school.”

There’s no simple way to describe what a hedge fund is, but one way to look at it is to consider it as a basket of security types whose payment terms can be quite complicated, depending on whether or not we’re talking about an equity or a bond or a forward exchange contract based on a derivative calculation, for example (some derivatives are pretty reliable based on a sound projection of performance by a particular security, and some derivatives are dangerously unreliable based on utter fantasy; as noted here, the Barings Bank collapse as well as the government default of Orange County, California have helped give derivatives a bad name).

One of the major points for us to consider here, though, is that, overwhelmingly, hedge fund investors are high net worth individuals, though that is starting to change. Also, hedge funds are not subject to oversight by the SEC, NASD or other federal regulatory oversight body in the U.S.

And as far as understanding all of this is concerned, I think Edwards is just about in the same boat as we are on this based on this quote…

"I didn't feel like I understand, and to be honest with you still learning right now, sort of the relationship between that world and the way money moves in this country through financial markets," Edwards said.

Edwards said he also spoke to some Wall Street investment firms such as Goldman Sachs besides exploring the position with Fortress. He said his role was to advise the firm about what he saw happening economically in the United States and during his travels overseas.

U.S. hedge funds, now numbering more than 9,000 with assets estimated to exceed $1 trillion, traditionally catered to the rich, as well as pension funds and university endowments, but are increasingly luring less wealthy investors.

A cynic would say that Edwards is learning about this to find out how he can use hedge funds to lessen his dependency on public campaign financing, as other presidential candidates have done (as noted here), and that may be correct.

However, I think it’s good for Edwards to learn more about this issue because, as others have noted (and this article dated from last October does also), in the event of a world wide recession of some type, we could be looking at a hedge fund collapse (this excerpt tells us more about something that I guarantee no one wants to see)…

…according to an article in Forbes, another potential disaster is brewing on the horizon, over something called "credit default swaps" and hedge funds reportedly account for 58 percent of all trading in these derivatives.

A credit swap is sort of an insurance policy on a bond, often a junk bond. If the bond defaults, the seller of the credit default swap has to pay up.

According to Forbes the total amount of bonds, loans and other debt covered by credit default swaps is $26 trillion or twice the annual economic output of the U.S. which means if the economy goes into a recession, the hedge fund industry will be in trouble ... and so will its investors.

All of this is way too rich for my blood, but I’m glad it isn’t for John Edwards. If you’re going to advocate freeing us from the tyranny of the wretched years since November 2000, then you’d better understand how we got to this position, and a lesson of this type is bound to help provide some pieces to that puzzle that can be used effectively during the campaign and (dare I hope?) an Edwards presidency.

Update 5/12/07: The ignorance and inanity of our corporate media is truly astonishing and depressing at the same time (and by the way, to find an example of a rich Democrat who looked out for the rest of us better than anyone until Bill Clinton, look no further than here).