Bernanke: Be Cautious of Hedge Fund Growth

Financial authorities must stay attuned to any potential risks posed by the growth of hedge funds, an investment domain of the wealthy that has become more popular with smaller investors, Federal Reserve Chairman Ben Bernanke suggested Tuesday.

"Authorities should and will try to ensure that the lapses in risk management of 1998 do not happen again," Bernanke said, referring to the collapse of Long-Term Capital Management, a hedge fund that had received a $3.6 billion private bailout.

Bernanke made his remarks to a conference in Sea Island, Georgia, on hedge funds and risk organized by the Federal Reserve Bank of Atlanta. A copy of his remarks was distributed in Washington.

While Bernanke made a case for close monitoring of hedge funds, he shied away from advocating that they be directly and more heavily regulated like banks.

"Direct regulation may be justified when market discipline is ineffective at constraining excessive leverage and risk-taking but, in the case of hedge funds, the reasonable presumption is that market discipline can work," Bernanke said.

Today some 7,000 to 9,000 hedge funds in the United States command an estimated $1 trillion in assets and are believed to account for as much as 20 percent of all U.S. stock trading.

Debate about hedge funds — their benefits and risks — abated for a time but "has now resumed with vigor — spurred no doubt by the creation of many new funds," Bernanke said.

Hedge funds — high-risk, largely unregulated and secretive investment pools — have traditionally been the investment domain of the wealthy but have become popular with small investors in recent years.

TheSecurities and Exchange Commission, concerned about the explosive growth in recent years of hedge funds and their virtually unbridled operations, brought them under new supervision early this year.

Under the SEC rule, most hedge fund managers now must register with the agency. That opens the funds' books to SEC examiners and makes them subject to an array of regulations including accounting and disclosure requirements. The examiners will be able to conduct inspection "sweeps" of hedge funds.

Bernanke, who took over the Fed job on Feb. 1, questioned the usefulness of various proposals for regulatory authorities to create and maintain a computer data base contained detailed financial information on hedge funds.

"I understand the concerns that motivate these proposals but, at this point, remain skeptical about their utility in practice," he said.

The Fed chief suggested that financial institutions and others that do business with hedge funds make sure they are doing all they can to sufficiently blunt their risks. "Continued focus on counterparty risk management is likely the best course for addressing systemic concerns related to hedge funds," Bernanke said.