Recent events contradict the theory that hedge funds are a threat to the stability of financial markets. In fact, they have proved their usefulness in containing damage and easing market fallouts.
Take the sub-prime market. Bear Stearns is dominating headlines after two of its hedge funds got caught out on sub-prime mortgage bets and lost a not insignificant amount of money. But how much have other hedge funds that have been shorting the ABX or selling sub-prime bonds been making this year? Probably as much as Bear Stearns has lost, if not more.
Adding further to the mix of buyers and sellers are hedge funds that have been buying up loans at a discount, bolstering the market, and bailing out financial institutions that had a sub-prime mortgage mess on their hands. If it hadn’t been for the ability of hedge funds to jump in, aiming to profit from niche opportunities, the blow to the financial markets over the sub-prime fallout might have been much bigger already.
Hedge funds don’t act in unison. There are buyers and there are sellers, and these days, with 10,000 hedge funds, there are a lot more buyers and sellers preventing markets from moving in one direction only; or at least in one direction only in a very short period of time.