July 23, 2004
Kudos to Commissioner Donaldson. Why must we wait until after the next financial crisis to put in place the tools necessary to protect the US economy from hedge funds?
Hedge funds, in search of volatilty, are starting to dominate trade in the credit derivatives market. This is worrisome because during an economic downturn, these swaps allow groups of hedge funds to easily bring a company to its knees by hindering their access to credit. As we saw in 2003, it's easy. Just get short the bonds, short the stock, bid for outsized amounts of credit protection in the swaps market and throw in a few rumors. Once they get the ball rolling, the ratings agencies panic and lower the company's rating which forces bond holders to sell setting off a death spiral. It is a lay-up trade. A real winner, except for the US workers who lose their jobs as the credit-starved companies are forced to retrench.
The SEC needs the ability to look behind the curtain in order to detect and discourage collusion and trading strategies which threaten the credit markets and the greater economy.