第1章
The Secretive World of Financial Wizards
When Alfred Winslow Jones created the first "hedged fund" in 1949 with just $100,000, few could have predicted that his improvised investment structure would spawn a financial revolution. A former socialist who had worked undercover against Nazis, Jones was an unlikely financial pioneer. Yet by combining short selling with leverage and charging performance fees, he established a framework that would eventually produce fortunes that made J.P. Morgan look like a pauper. By 2006, the top three hedge fund managers each earned over $1 billion annually - more money than God, as the saying goes. These modern financial alchemists live extravagantly - private islands, personal jets with cribs, estates adorned with van Goghs - yet their greatest impact has been on finance itself, challenging academic orthodoxy about market efficiency while creating a powerful alternative to traditional banking structures that proved remarkably resilient during financial crises.
第2章
The Unconventional Origins of Financial Innovation
Alfred Winslow Jones took an extraordinary path to financial innovation. Born precisely at 9:00 on 9/9/1900, he worked on tramp steamers, studied Marxism, and served as an anti-Nazi operative before turning to finance. After witnessing Germany's economic collapse while working for the State Department in Berlin, Jones married Anna Block, a Jewish socialite and left-wing activist from a banking family. Their secret relationship forced his resignation in 1932, after which he continued working undercover for Leninist organizations in Berlin and London.
Jones's political views moderated through his sociological research. His doctoral thesis examined whether America faced class divisions like those enabling fascism in Europe. After interviewing 1,700 people in Akron, Ohio, he concluded that economic divisions didn't create polarized worldviews - effectively repudiating his youthful socialism. This launched his journalism career at Fortune magazine, where he advocated being "as conservative as possible in protecting the free market and as radical as necessary in securing the welfare of the people."
Jones's financial innovation was combining "speculative means for conservative ends." By routinely shorting part of his portfolio as insurance against market risk, he could invest more aggressively in promising stocks without worrying about market downturns. In his 1961 investor prospectus, he demonstrated how hedging created superior returns with less risk. A hedged investor borrowing to create a $200,000 portfolio ($130,000 long positions, $70,000 short positions) could outperform a traditional investor with $100,000 ($80,000 in stocks, $20,000 in bonds) - despite having less market exposure ($60,000 net vs $80,000).
Jones pioneered sophisticated risk management by measuring each stock's "velocity" (volatility relative to the S&P 500) and adjusting position sizes accordingly. He meticulously tracked returns from stock selection ("alpha") separately from market exposure ("beta") - anticipating academic breakthroughs in portfolio theory by years. His secretive approach established the culture of mystery that would define hedge funds for generations.
第3章
The Rise of Contrarian Trading
Despite Jones's failures at market timing, his funds thrived because of his innovative stock-selection system. Rather than picking stocks himself, Jones created a competitive structure where brokers ran "model portfolios" for his fund. His statistical methods precisely tracked each manager's performance, allowing him to compensate them according to results. This gave Jones an edge in the sleepy Wall Street of the 1950s, where investment decisions were typically made by committee and compensation wasn't tied to performance.
By the mid-1960s, Jones had achieved material comfort but maintained an aloof demeanor that alienated some colleagues. Unlike typical Wall Street moneymen, Jones disdained financial monomaniacalism, preferring literary pursuits, philanthropy, and intellectual conversations about politics rather than markets.
This detachment bred resentment. In 1964, one of Jones's managers left to establish a rival fund, followed by more defections including Jones's longest-serving fund manager. By 1969, hundreds of imitator hedge funds had emerged, many run by Jones's former associates, with industry assets reaching $11 billion. The term "hedge fund" entered Wall Street's lexicon.
In the late 1960s, Jones's funds began losing their edge. The managers abandoned proper hedging principles, treating shorting as a "sucker's game" while aggressively leveraging to buy go-go stocks. When the market crashed in 1969-1970, Jones's unhedged fund lost 35% of investors' money, worse than the market's decline. After two decades of success, his investment edge had vanished.
The period from 1969 to 1973 marked a watershed for the American economy. After two decades of confidence, stable jobs, rising wages, and financial stability, inflation tore this world apart. Rising from below 2% to 5.5% by 1969, it forced the Federal Reserve to tighten monetary policy, crushing the stock market. The go-go era was finished.
The market turbulence decimated the first generation of hedge funds. Between late 1968 and September 1970, the 28 largest hedge funds lost two-thirds of their capital, their hedging claims exposed as lies. By January 1970, only 150 hedge funds remained, down from as many as 500 a year earlier. The 1973-74 crash wiped out most survivors, with a 1984 survey identifying just 68 funds.
第4章
Masters of Market Contrarianism
Amid this devastation, Steinhardt, Fine, Berkowitz & Company emerged victorious. Michael Steinhardt, raised in Brooklyn by a single mother with a gambling-addicted father, brought his inherited confrontational temperament and short fuse to trading. By his mid-twenties, he had become "the hottest analyst on Wall Street."
Unlike their peers, Steinhardt's trio sensed the market's vulnerability in 1969. They properly hedged their portfolio when others merely pretended to, preserving capital through the 1969-70 downturn when the S&P fell 18%. By 1971, they were the only major hedge fund to have expanded during the shakeout, with returns 36 times better than the market.
In 1972, they turned bearish again, positioning their shorts to outweigh longs based on their analysis of accounting shenanigans and political delusions. When the market crashed in 1973-74, they made 12% and 28% while the S&P plunged 43%. Their success amid others' suffering made them targets of resentment, with short selling portrayed as nearly treasonous-a vilification Steinhardt later called "the height of professional satisfaction."
Two innovative factors likely explain their success within efficient market theory's exceptions. First was Tony Cilluffo's monetary analysis - tracking Federal Reserve bank lending capacity to predict market turns. When banks switched from spare lending capacity to hitting capital reserve limits, Cilluffo's model predicted stock market declines two months later. This relationship worked in both directions - when banks reported free reserves again, stocks would turn up imminently.
The second innovation emerged from changing patterns in money management. As the market shifted from individual investors to institutional dominance, investing became a professional business rather than the province of amateurs. This transformation created new opportunities in trading. The traditional system of specialists on the NYSE floor couldn't handle the new 100,000-share blocks that institutions wanted to move.
Steinhardt positioned himself perfectly to exploit this inefficient new market. Unlike most firms where trading was a back-office function, Steinhardt himself manned the trading desk, making multi-million dollar decisions instantly when brokers called with discounted blocks. His gambling instincts and senior authority made him the perfect counterparty for brokers needing quick decisions. In this uncharted territory without established trading guidelines, profits could be extraordinary - like earning half a million dollars in eight minutes reselling Penn Central shares.
第5章
The Birth of Scientific Investing
Paul Samuelson, Nobel Prize-winning economist, famously dismissed professional money managers in his 1967 congressional testimony, suggesting that randomly chosen stock portfolios typically outperformed mutual funds. "Most portfolio decision makers should go out of business-take up plumbing, teach Greek, or help produce the annual GNP by serving as corporate executives," he wrote in 1974.
Yet Samuelson's critique contained a crucial exception: he believed rare investment giants with genuine insights could beat the market. These exceptional talents wouldn't work cheaply for foundations or banks - they would form small partnerships to capture gains for themselves. Confident in his ability to identify these rare exceptions, Samuelson became a founding backer of Commodities Corporation in 1970 and invested with Warren Buffett around the same time.
After completing his PhD on cocoa markets, Helmut Weymar joined Nabisco where he convinced bosses to trade on his forecasting models. When cocoa prices fell below his model's predictions, he bought futures aggressively despite growing losses, eventually accumulating enough beans for two years of production. Just as his nerves were breaking, African crops failed and prices doubled, yielding massive profits.
Emboldened by success, Weymar and fellow PhD Frank Vannerson founded Commodities Corporation in Princeton with $2.5 million. Their team of econometricians specialized in different commodities, building sophisticated models for everything from cocoa to wheat. Disaster struck in 1971 when they bet heavily against corn blight rumors based on their pathologist's advice. When CBS News aired a contradictory report, corn futures jumped so dramatically that trading was suspended. By the time they could exit their positions, capital had plunged to $900,000.
After the corn debacle, Weymar reversed his position on Vannerson's Technical Computer System (TCS). Though initially skeptical of its seemingly simple trend-following approach, Weymar allocated more capital to TCS when it consistently made money while his fundamental cocoa model faltered. The system's built-in risk controls proved superior, requiring traders to program limits from the start. Even Paul Samuelson was converted, investing fresh capital in TCS despite trend-following having little academic standing.
Michael Marcus joined Commodities Corporation as an unlikely recruit - no economics degree, no doctorate, no use for computers or math. Despite skepticism, Marcus soon silenced critics by earning triple-digit returns, increasing his trading account by 2,500 percent over ten years. In some years, his profits exceeded those of all other traders combined.
第6章
The Philosopher Trader
In 1949, George Soros arrived at the London School of Economics during a time of intellectual ferment. The institution buzzed with diverse ideologies as Marxists debated libertarians and Keynesians faced their critics - all seeking to understand Europe's self-destruction and potential rebirth. Soros had already survived extraordinary hardship, having endured Nazi occupation in Budapest by assuming a Christian identity and witnessing horrific violence. At seventeen, he left Hungary for London, working menial jobs before finding a position as a lifeguard that allowed him time to read Smith, Hobbes, and Machiavelli before beginning his studies at LSE.
Karl Popper profoundly influenced Soros at LSE, teaching him that humans cannot know absolute truth but can only approach it through trial and error. This resonated with Soros, who had witnessed the dogmatic certainties of Nazism and communism in Hungary. Popper's "Open Society" concept would later inspire both Soros's investment philosophy and his philanthropy.
After mediocre grades and dead-end jobs, Soros found his way into finance through a Hungarian-run brokerage, eventually reaching Wall Street in 1956. Though initially planning just a five-year financial career to fund his philosophical ambitions, his investment talent proved too lucrative to abandon. By 1969, he launched his own $4 million hedge fund, the Double Eagle Fund, applying his "reflexivity" theory that challenged efficient-market orthodoxy by recognizing how investors' perceptions both misinterpret and actively change market reality.
By 1981, Soros had achieved extraordinary success, transforming his initial capital nearly a hundredfold to $381 million despite difficult 1970s markets. Profiles called him "the world's greatest money manager," with rivals saying "we're playing tennis and he's playing something else." Yet success consumed him physically-his back would seize up when his portfolio was troubled-and emotionally, as he compared himself to "a boxer in training" sacrificing all personal life.
After parting with his partner Jim Rogers and suffering his fund's first-ever loss in 1981, Soros stepped back from markets. When he returned in 1984, psychoanalysis had helped him achieve balance. He replaced visceral trading signals with intellectual discipline, keeping an investment diary that captured his thinking during "the killing of a lifetime"-his legendary bet against the dollar. Unlike conventional economists who believed currency markets moved toward equilibrium, Soros recognized that speculative flows created self-reinforcing cycles that drove currencies far from equilibrium before eventually triggering dramatic reversals.
第7章
The Billion-Dollar Currency Bet
The Plaza Hotel meeting in September 1985 proved Soros's theory correct when five major powers agreed to push the dollar downward. Rather than taking profits after his immediate $30 million gain, Soros aggressively increased his positions, even shouting at his traders when they tried to sell yen. By December, he had loaded up on another $500 million worth of yen and German marks while shorting the dollar further. His conviction came from understanding that perceptions alone had driven the dollar up, and that Plaza was the trigger for a self-reinforcing reversal.
The trade yielded astonishing rewards-a 35% gain worth $230 million in just four months. Soros joked that his investment diary, later published as "The Alchemy of Finance," had earned him the highest author honorarium in history. The 1987 publication cemented his celebrity status, with Paul Tudor Jones making it required reading for his employees.
The 1987 crash tested Soros's theory and nerve. After Black Monday's devastation, Soros's reputation suffered but quickly rebounded. By year-end, Financial World ranked him as Wall Street's second-highest earner, behind only Paul Tudor Jones.
The crash's aftermath cemented Soros's status as an investment folk hero and helped create the modern "macro" hedge fund. His approach in The Alchemy of Finance bridged two separate investing traditions - the fundamental analysis of equity investors and the chart-following instincts of commodity traders. Soros's example showed both camps there was wisdom in the other's approach. Within a few years, commodity specialists like Paul Tudor Jones and equity people like Stan Druckenmiller were simply regarded as "macro" investors.
The crash delivered a crippling blow to efficient-market theories that Soros had long criticized. When corporate America's value bounced wildly in a single week, it validated Soros's theory of reflexivity over academic models. The crash forced economists to reconsider three key assumptions: that price changes followed normal probability distributions; that institutional frictions didn't matter; and that investors were purely rational. This triple assault on efficient-market theory vindicated hedge funds and helped explain their success.
第8章
The Tiger's Hunting Ground
In spring 1984, Columbia Business School hosted a debate between efficient-market defender Michael Jensen and challenger Warren Buffett. Jensen argued that successful investors were merely lucky, comparing them to people who happened to flip coins successfully - if a million people flip coins, some will get five heads in a row by pure chance.
Buffett cleverly turned Jensen's coin-flipping metaphor into a hedge fund manifesto. He described a hypothetical national coin-flipping contest where after ten rounds, 220,000 participants would remain, growing increasingly cocky about their "technique." After twenty rounds, the remaining 215 contestants would become insufferable, publishing books on coin-flipping expertise. Then Buffett flipped the argument - if 40 winners came from the same zoo, wouldn't that suggest more than luck? Stock-picking success isn't randomly distributed but clusters in "villages" defined by investment approach. Buffett proved his point by showing how nine money managers from Ben Graham's value-investing tradition had all beaten the market without exception.
Unlike the isolated Louis Bacon who hid behind screens of data, Julian Robertson was a southern charmer and networker who hired in his own athletic image. Tiger Management employees endured grueling retreats with log-rafting competitions in Idaho's mountains and mandatory fitness regimens. Robertson launched Tiger in 1980 at age forty-eight, inspired by A.W. Jones's hedge fund model. Despite squeaking orders during his first winter in a tiny office with broken heating, Robertson maintained tight control while following Jones's approach - picking stocks long and short, dismissing market timing as "gibberish," and eventually expanding into international markets and macro investing.
Between May 1980 and August 1998, Tiger earned an astounding 31.7% annually after fees, demolishing the S&P 500's 12.7% return. This success defied efficient-market theory because Robertson used no fancy quantitative strategies or philosophical vision - just straightforward company analysis. His simple approach: manage aggressively, limit position sizes to 5% of capital, and persist through downturns. While Tiger benefited from launching during a bull market and the merger boom of the 1980s, Robertson consistently outperformed even with his shorts in place.
第9章
The Psychological Edge
Robertson's success began with an updated version of A.W. Jones's performance incentives, but with a crucial difference: it wasn't just about money. Robertson's Carolina charm made people desperate to please him. Working at Tiger meant joining an elite special-forces unit where Robertson made you believe you could outthink and out-hustle every rival. He operated from an open desk, surrounded by young analysts, with two assistants manning giant Rolodexes that connected him to industry insiders. When analysts pitched ideas, Robertson would immediately call three friends in that company to test the recommendation. The emotional payoffs were extreme - his praise ("That is the be-yest idea Ah ever saw") could send an analyst soaring, while his criticism ("That is the dumbest idea Ah ever heard") could devastate.
Robertson built his network masterfully, drawing in celebrities like Paul Simon and Tom Wolfe as investors, then using their star power to recruit talent. When he targeted Goldman analyst Michael Bills, Robertson deployed Lew Lehrman to praise his investment prowess, then arranged for Wolfe to call Bills about his military pilot father, connecting through Wolfe's book "The Right Stuff." Tiger's investor roster included countless industry captains who provided valuable insights.
Robertson's talent for extracting the best from people was his clearest advantage, though difficult to define precisely. His approach wasn't dramatically different from other managers - he simply executed better. His character judgments sometimes misfired (dismissing companies because their bosses cheated at golf), but he was right more often than wrong. Robertson's long-termism also distinguished him from Wall Street's typical twelve-to-eighteen-month horizon. He sought investments that might double in three years and held them tenaciously through difficulties.
As globalization replaced takeovers in the 1990s, Robertson expanded internationally despite not being a natural cosmopolitan like Soros. His swashbuckling style suited travel - jetting to Hong Kong with buyout tycoon Teddy Forstmann, racing through Europe, and exploring Brazil's beaches. Everywhere he went, Robertson charmed his way into elite circles, convincing each host to connect him with their top contacts.
第10章
The Rock-and-Roll Trader
The late 1980s marked hedge funds' turning point. After nearly dying in the early 1970s bear market, the industry exploded from a few dozen funds to over a thousand by 1992. Financial commentators celebrated the "Big Three" - Soros, Robertson, and Steinhardt - while younger rivals expanded rapidly behind them. These hedge fund moguls formed an interconnected elite, hunting on each other's estates and gathering annually in the Bahamas, signaling the birth of a new Wall Street force.
Paul Tudor Jones II, born in 1954 to a Memphis cotton family, brought theatrical flair to trading. After studying economics at Virginia and apprenticing in cotton trading, he founded Tudor Investment Corporation in 1983 with backing from Commodities Corporation. Jones approached markets as psychological warfare - part poker, part battlefield - where understanding other traders' emotions mattered more than economic fundamentals. He deployed calculated flamboyance as a trading weapon, screaming orders down phones and deliberately keeping rivals off-balance. Sometimes he placed small orders across multiple brokers to stay hidden; other times he ambushed markets "guns blazing" to trigger buying frenzies. A 1986-87 documentary captured his wild trading persona - transforming from preppy calm to warrior-like frenzy when markets opened, complete with lucky Bruce Willis sneakers and an inflatable Godzilla atop his trading screen.
Despite his theatrical trading style, Jones's intellectual framework was surprisingly dubious. His young economist Peter Borish created charts comparing 1980s markets to the 1920s, later admitting he manipulated starting points to force the comparison. Jones built anecdotal evidence around this shaky foundation - Wall Street's excessive pay, stretched bank capital, and art market bubbles - predicting an imminent "total rock and roll" crash. Though he returned 136% in 1985 and 99% in 1986, Borish's crash prediction was actually for spring 1988, missing the actual October 1987 collapse. Jones also embraced questionable theories like Kondratiev waves and Elliott wave analysis, claiming they explained his success despite their contradictions. In reality, Jones thrived through agile short-term trading, not long-range forecasting.
第11章
The Billion-Dollar Sterling Attack
In autumn 1988, Stan Druckenmiller joined Soros Fund Management despite warnings from friends and skepticism about becoming Soros's "ninth permanent successor." Though stylistic opposites - philosophical Soros versus football-loving Druckenmiller - they were ideal investment partners. Druckenmiller combined equity analysis with strong currency and interest rate understanding, plus technical analysis skills. This unique blend let him anticipate economic trends affecting stocks while using stock insights to inform bond and currency trades.
Following Soros's move to London, Druckenmiller fully adopted his mentor's investment philosophy. He implemented Soros's long/short equity approach while using borrowed capital to trade S&P futures, bonds, and currencies. Like Soros, he maintained connections with company executives to detect early economic trends, and most importantly, learned to seize opportunities aggressively when the right moment arrived.
German unification in 1992 created the perfect storm for Europe's exchange-rate mechanism. The Bundesbank raised interest rates to combat German inflation just as other European economies needed lower rates to fight recession. This forced currencies like the British pound and Italian lira to the bottom of their permitted trading bands. Druckenmiller, aided by portfolio manager Scott Bessent's insights into Britain's vulnerable housing market, recognized an asymmetrical betting opportunity. With British mortgages generally not fixed-rate, any Bank of England rate hike to protect the pound would immediately hurt homeowners and deepen the recession. Druckenmiller invested $1.5 billion betting against the pound by August, seeing virtually no scenario where sterling would strengthen against the mark.
When Druckenmiller read Bundesbank president Helmut Schlesinger's comments suggesting a broader currency realignment was needed, he immediately recognized their significance and told Soros it was time to move. While Druckenmiller planned to build his position steadily, Soros objected: "That doesn't make sense." If there was almost no downside, why not "go for the jugular" and jump straight to $15 billion? This was Soros's genius - recognizing when to go nuclear. Both men got on the phones themselves, frantically selling sterling to anyone who would take the other side. As word spread of their massive selling, other traders joined the avalanche, and the pound was knocked out of its permitted band.
第12章
The Quant Revolution
Renaissance Technologies, perhaps the most successful hedge fund ever, was founded by James Simons, a mathematician and code breaker whose Medallion fund returned an astonishing 39 percent annually between 1989 and 2006. Simons combined his passions for mathematics, code breaking, speculation, and entrepreneurship to create an extraordinary money-making machine.
A lifelong speculator since his student days, Simons had worked at the Pentagon's Institute for Defense Analyses before winning the American Mathematical Society's Oswald Veblen Prize in geometry. His early trading relied on hunches about commodities, but his mathematical mind yearned to substitute models for intuition. Beginning in the late 1970s, he recruited brilliant mathematicians including Leonard Baum, James Ax, and Elwyn Berlekamp - all with backgrounds in cryptography and pattern recognition.
Their breakthrough came from applying code-breaking algorithms to detect "ghostly patterns" in market data - faint signals hidden in statistical noise that economists lacked the specialized mathematical tools to find. Though early efforts showed only moderate success, by 1988 Simons and Ax launched the Medallion Fund, with about 15% of capital driven by short-term signals developed by Henry Laufer, a mathematician who had discovered patterns in market movements following news events.
In 1993, Simons recruited Peter Brown and Robert Mercer from IBM's research center - a duo who would eventually take over Renaissance when Simons retired. Brown was a high-energy character who slept just five hours nightly and once traveled the office by unicycle, while the poker-faced Mercer was described by his former boss as an "automaton" for his calm demeanor.
At IBM, Brown and Mercer had revolutionized computerized translation through statistical methods rather than traditional linguistics. Instead of teaching computers grammar rules, they fed massive bilingual Canadian parliamentary records into computers and let algorithms find correlations between language pairs. Their approach outperformed competing systems and scandalized traditional linguists who demanded to know "Where's the linguistic intuition?" - to which the implicit answer was "there isn't any." As their manager Fred Jelinek provocatively noted, "Every time I fire a linguist, my system's performance improves."
This approach - letting computers find patterns without imposing human preconceptions - fundamentally differed from competitors like D.E. Shaw. While Shaw often started with market theories to test against data, Brown and Mercer fed data to computers first and let them discover patterns. While Eric Wepsic at D.E. Shaw argued that trading signals should have intuitive explanations to avoid statistical flukes, Mercer countered that "some signals that make no intuitive sense do indeed work" - and these nonintuitive signals often proved most profitable.
第13章
The Greatest Trade in History
Daniel Sadek's journey from Lebanese war refugee to California car salesman took a dramatic turn around 2000 when he noticed his Mercedes customers were all in the mortgage business. Discovering he could get a mortgage lending license without training (unlike the 1,500 hours required for a barber's license), Sadek launched Quick Loan, which by 2005 had become one of America's top fifty subprime lenders with 700 employees. His marketing was brazen - "No income verification. Instant qualification!!" - despite numerous fraud complaints filed with California regulators.
In 2006, hedge-fund manager Kyle Bass heard about Sadek and recognized him as emblematic of America's mortgage bubble. Between 2000-2005, subprime loan volume had quadrupled, increasingly flowing to people who couldn't repay. Bass's firm Hayman Capital identified how Sadek's mortgages were being packaged into bonds, shorted them heavily, and waited.
John Paulson made the greatest killing of all. This unassuming Harvard Business School graduate had built his hedge fund from $2 million in 1994 to $4 billion by 2005, specializing in merger arbitrage and cyclical market turns. His hiring of Paolo Pellegrini, a "romantic type" Italian with a history of chasing offbeat ideas, finally gave Pellegrini a place where his unconventional style was valued. Together they would make one of the greatest trades in financial history.
Paulson's mortgage trade represented the ultimate hedge fund opportunity. After identifying mortgage securities as capitalism's weakest spot, he meticulously structured a trade with minimal downside and astronomical upside. His genius lay in recognizing that mortgage bonds - particularly BBB tranches - offered unprecedented asymmetry: a $1.4 million insurance premium could yield $100 million if the securities failed.
Working with Pellegrini, who discovered that even flat (not falling) home prices would trigger devastating defaults, Paulson created a simple yet stunning risk-reward table: a $600 million fund risking just $42 million could potentially earn $5.5 billion - a 909% return - if mortgage bonds suffered an 80% default rate.
When Wall Street banks created the ABX subprime mortgage index in July 2006, Paulson pounced, accumulating $7.2 billion in short positions. By February 2007, as New Century Financial and HSBC announced shocking mortgage losses, his fund gained an astonishing 66% in a single month. By summer, he was making $1 billion in a single day.
第14章
The Future of Finance
The conclusion examines hedge funds' ethical standing and their role in the financial system. While acknowledging that hedge fund managers "are not angels" with a history of blemishes from Steinhardt's collusive trading to Askin's fraudulent models, the author argues they shouldn't be judged against perfection. The industry's structure has worried regulators since the Douglas Aircraft case, where well-placed clients potentially leaked privileged information to fund managers. Yet there's no evidence hedge funds engage in fraud more often than rivals - a 2003 SEC inquiry found none.
The central argument is that hedge funds are "small enough to fail" - a crucial advantage over too-big-to-fail institutions. When hedge funds blow up, they cost taxpayers nothing, unlike the $10 trillion in government assistance provided to failing institutions during the 2007-2009 crisis. This crisis accelerated the shift of economic power to emerging economies and damaged capitalism's legitimacy, with President Obama reluctantly "helping out a bunch of fat cat bankers."
The financial system faces a catch-22: many institutions are too big to fail, but government bailouts encourage even more risk-taking, creating a vicious cycle. Neither laissez-faire approaches nor tougher regulation offers complete solutions, as regulation is "genuinely difficult" with slippery judgments about capital requirements and risk definitions. The author proposes encouraging small-enough-to-fail institutions with strong risk-control incentives - specifically hedge funds, which have proven their resilience with thousands closing without taxpayer bailouts.
While hedge funds charge significant fees (1-2% management plus 20% performance), evidence suggests they outperform alternatives. A study by Ibbotson, Chen, and Zhu analyzing 8,400 hedge funds between 1995-2009 found they returned 7.7% after fees, including 3 percentage points of genuine alpha. This compares favorably to private equity, where venture capital generates 4-5% alpha but buyout funds barely match the S&P 500, while locking up capital for a decade.
Hedge funds benefit major institutions like Harvard and Yale, whose endowments returned 8.9% and 11.8% annually from 1999-2009 despite the credit crisis. If hedge funds disproportionately benefit the wealthy, the solution is progressive taxation, not restricting their activities.
