Hedge Fund Persuasion Runs the Nation. Hedge fund investors can exert significant political and economic influence.
Hedge fund most momentous trade: George Soros’s bet against the British pound in 1992.
At the time, the British government had tied the value of the pound to that of other European currencies. Many people contended that the pound’s exchange rate was too high in this arrangement and was weighing on the British economy.
George Soros’s hedge fund wagered that the government would ultimately have to let the pound fall in value, prompting the fund to sell billions of pounds and buy other European currencies. The selling pressure was too much for the British government, and the pound left the currency arrangement. The day it dropped out was known as Black Wednesday.
When the dust settled, some politicians saw Soros’s actions in a positive light. They said the pound’s exit allowed the British economy to flourish.
The impact of Mr. Soros’s trades may have been even more far-reaching. Britain’s departure from the arrangement influenced its decision not to join the European single currency, according to Norman Lamont, Britain’s chancellor of the Exchequer at the time.
“After Black Wednesday, it was politically impossible for any government, Conservative or Labour, to join the euro,” Mr. Lamont wrote in The Daily Telegraph.
After the success of his pound wager, Mr. Soros’s fund focused on Asian currencies. They were vulnerable because, like the pound, their value was fixed in a way that could create unsustainable economic imbalances. The bets by Mr. Soros and others forced some countries to abandon the rigid approach to managing currencies, said Sebastian Mallaby, author of “More Money Than God: Hedge Funds and the Making of a New Elite.”
Since then, developing nations have mostly avoided fixed currency arrangements, a choice that has generally served their economies well. “The upshot was that emerging markets broadly adopted flexible exchange-rate regimes,” Mr. Mallaby said.
Hedge funds never make bets as a selfless way to free nations from suffocating currency regimes. And those regimes might have collapsed anyway. But the hedge funds probably hastened their demise, leading to relief sooner rather than later.
Hedge fund actions also contributed to a landmark legislative change in the United States a decade ago.
Kynikos Associates and other hedge funds had doubts about Enron’s books and were betting that its shares would decline. Eventually, fraud was exposed, and Enron, an energy trading company, went bankrupt in 2001.
The company’s collapse, with the crash of other fraudulent businesses, helped create the political climate for an overhaul of how companies report their financial condition. A result was the Sarbanes-Oxley Act of 2002.
It is possible, even likely, that something like Sarbanes-Oxley would have developed anyway. But the hedge funds’ ability to pick up on the fraud played an important role in shaming the main players. Auditors, regulators and banks largely missed Enron’s skulduggery, underscoring the need for big changes.
“I can’t think of one major financial fraud in the United States in the last 10 years that was uncovered by a major brokerage house analyst or an outside accounting firm,” James S. Chanos, founder of Kynikos, said in testimony before Congress soon after Enron’s collapse.
Hedge funds also played an early role in the housing bust, which affected millions of people and led to deep societal changes. Managers like Michael Burry of Scion Capital and John Paulson saw the shakiness of the housing market well before regulators, politicians and banks did.
While house prices would have collapsed without hedge funds, the funds helped lead to the crash. In particular, their bearish housing bets helped convince Wall Street, a critical part of the mortgage machine, that the good times were ending.
As early as 2005, Mr. Burry pestered investment banks for ways of betting against housing, according to “The Big Short: Inside the Doomsday Machine,” by Michael Lewis. Eventually, the banks provided the financial instruments that allowed Mr. Burry to place the bearish trades. Soon, firms like Deutsche Bank and Goldman Sachs were betting heavily against housing in a similar way.
When the establishment started to turn against subprime mortgages, the game was up.