You get a glimpse of what the secretive hedge fund business is about from John Paulson’s story, but if you want to know more about how the industry mushroomed in the 1990s, the book to read is More Money than God: Hedge Funds and the Making of a New Elite. Author Sebastian Mallaby was for many years a correspondent for the Economist. He had plenty of access to many of the ordinarily reclusive money managers who populate this relatively new niche in the asset management business.
George Soros was the hedge funds’ only well-known name in 1990, when they managed $39 billion in assets. But by the peak in early 2008, the figure was $1.93 trillion, thanks to such pioneers as Michael Steinhardt, Helmut Weymar, Julian Robertson, Paul Tudor Jones, Bruce Kovner, Stanley Druckenmiller, Thomas Steyer, James Simons, and David Shaw, all of whom populate the book. (In contrast, the four biggest banks in the U.S. had $7.7 trillion in loans and other assets earlier this year, more than twice as much as the next 46 banks put together.)
Hedge funds avoid regulation by accepting investments only from institutions and wealthy individuals, and by not advertising. Mallaby thinks that is as it should be, because fund managers have an outsized appetite for risk. They make money by betting against central bankers who defend unwise government policies, lending to institutions in need of liquidity, and scouting out mispricings. They are useful discoverers of bad news. They are small enough to fail — which they regularly do — without jeopardizing the financial system.
Mallaby thinks hedge funds may be the new merchant banks, and he likens them to the top investment banks — the Goldman Sachses and Morgan Stanleys of 50 years ago. If he is correct, it would have been nice to see him put in a word for the various proposals for quick-response investigations aimed at figuring out what happened whenever one of them blows up. After all, it is what we do when an airplane crashes.
The IMF Playwrights
Journalists write the playbills, but economists write the plays. Few positions offer a better view of the unfolding drama than that of chief economist of the International Monetary Fund. It is not surprising, therefore, that all three holders of the job in the last 10 years have written cogent, journalistic books on the dangers ahead.
Last year, Kenneth S. Rogoff of Harvard University, in collaboration with Carmen M. Reinhart of the University of Maryland, wrote the well-received This Time Is Different: Eight Centuries of Financial Folly (Princeton University Press). This year, Simon Johnson, who returned from Washington to MIT’s Sloan School of Management, published 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown (with coauthor James Kwak), and Raghuram G. Rajan, back at the University of Chicago’s Booth School of Business, delivered Fault Lines: How Hidden Fractures Still Threaten the World Economy.
Rajan, who now serves as an economic advisor to the prime minister of India, writes with the revisionist authority of someone who has come to see the last 30 years with fresh eyes. Flying into Moscow, he reflects on how far we have come: The highways are clogged with cars (which, of course, bring new problems). Returning to Washington, he notes that since the mid-1970s, nearly 60 cents of every dollar of real income growth has gone to the top 1 percent of households. The rifts that worry him are not just the imbalances in financial flows among nations; the inequalities that exist within the industrial democracies are just as dangerous.