Stop Blaming the Hedge Funds

As Alan Greenspan stated this week, banning the short selling of financial stocks is a “bad idea.”

Although Mr. Greenspan likely has economic theories to back up his reasoning, my rationale is somewhat simpler.

It is a bad idea, because it is part of a series of actions, which seek to point the finger at the wrong party – here the “bad” short-sellers – rather than dealing with the true causes of the financial crisis.

Last year, when people were still naively assuming this was a problem that could be “contained” and that it was only an issue of “subprime mortgages”, both the popular press and regulatory responses pointed fingers at the easy victims of criticisms – the mortgage brokers and the so-called “subprime borrowers” who manipulated Wall Street into giving them a mortgage.

Now that it has become clear that this crisis is far more complex and far reaching, regulators continue to look outside of Wall Street for someone to blame for the crisis. Here they point the fingers at investors who have anticipated the failures we are now seeing materialize.

Perhaps this is an example of the common psychological experience that is at the failure of many relationships and careers: when things go wrong, it is very hard to look in the mirror and recognize that you are the cause of the problem.

As a fellow Harvard JD-MBA, I have a lot of respect for Mr. Cox and his SEC, and perhaps by demanding that investors explain “under oath” why they have the positions they do, he is looking in the mirror at the best ways his organization can address the regulation of financial trades.

However, this article (SEC Pushes Hedge Fund Oath in Manipulation Probe), which discusses the proposed “oath,” seems to indicate that what is going on is something deeper. That somehow Mr. Cox and others think that hedge funds really are to blame is a sad example of today’s politics: rather than looking the root causes of the crisis – bad incentives and too much leverage at financial institutions – the government is looking for an easy explanation.

Unfortunately, wasting time on issues like this will only make fixing the real causes of the problem that much harder and more difficult as would be investors become more skittish as they await the next regulatory intervention.

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