Ben Bernanke May Have an Interesting Time
Daniel Gross Bangs His Head Against the Wall

Unhedged Hedge Funds

Brad Setser worries that many "hedge funds" will find that they have charged too little for selling insurance against volatility to other folks:

Roubini Global Economics (RGE) Monitor: I thought hedge funds were supposed to be hedged: Wasn't a key selling point of hedge funds that they could make money even when the (US) stock market was falling, unlike mutual funds?... I fully realize hedge funds do a whole lot of different things these days, and that in many ways the name "hedge fund" doesn't tell you much about what a hedge fund actually does.... Among my current worries: the temptation to make money (lots of it) by selling insurance against a more volatile world when volatility was falling may have been too great for some folks to resist. Paul McCulley:

With policy makers removing sources of volatility risk from markets, actual volatility falls, which like gravity, pulls risk premiums -- the market compensation for underwriting volatility -- lower. More specifically, P/Es rise, term premiums narrow, credit spreads tighten, and implied volatilities in options fall. As this process unfolds, the forward-looking return on risky assets falls, but their real time actual return is heady, as lower risk premiums are capitalized. This is a perfect prescription for bubbles.

Well said. The real time return -- not the forward looking compensation for taking risk -- may have come to dominate too many (financial) decisions. I am one of those curmudgeons who thinks a more unbalanced world will likely prove to be a more volatile world. We will see.