Superstars in the Emperor’s New Clothes
Hedge Funds and Private Equity Funds. What is at Stake?
Hedge Funds (HFs) and Private Equity Funds (PEFs) were the superstars in the canopy of the finan-
cial markets in the nineties. In recent years they have become a controversial issue. With the present
crash, even more questions have been raised, as the HFs, among the different factors, played a
prominent role with respect to responsibility for the disaster.
This paper looks at Hedge Funds and Private Equity Funds very much as a subclass of the more gen-
eral type of institutional investors. HFs and PEFs are two special cases of this type of actors which is
shaping the contemporary international finance system to a large extent. The institutional investor is at
the centre of a new mode of accumulation which emerged after the end of Bretton Woods. The con-
cept of institutional investor describes a historical change in the function of ownership. The rather pas-
sive function of traditional ownership has been transformed into a systematic economic activity. It has
been professionalized and institutionalised. The search for the maximum profit in the shortest term
possible becomes the only rationale in the activities of institutional investors.
The new structure was called the shareholder-value regime, asset and wealth driven economy, or fi-
nance capitalism. Whereas previously financial markets had a subordinate and instrumental role to the
real economy, this relationship has been turned around. This change affects the entire society: econ-
omy, social structure, politics and culture. Hedge Funds and Private Equity Funds are the most ad-
vanced expression of the spirit and dynamics of the shareholder-value regime. They are the vanguard
of the new asset-driven and wealth-oriented type of economy.
The new system has particular consequences on the following three areas:
• financial stability: systemic instability has considerably increased;
• distribution and equity: the new system leads to a constant redistribution from below to above;
• policy space or democracy: the transnationalisation of finance creates transnational spaces,
which prevent the individual nation state from exercising regulatory access. Democracy is both
historically and structurally inseparably connected with the territoriality principle of the nation
Hedge Funds and Private Equity Funds are strong catalysts in implementing the new regime of accu-
mulation. The business model of HFs is characterised by high leverage and intransparency. Mostly
based in Offshore Centres they are not supervised and regulated. The model brings the logic of the
shareholder regime to perfection.
HFs are growing fast in terms of assets, activities and number. They have considerable market shares
in certain sectors of the financial markets.
Hedge Funds are heavily involved in the present crash and suffered from dramatic losses. They had a
high share of trade in complex derivatives, which were at the root the crisis. The crisis has shown that
the attributing a risk reducing role to the HFs is like assigning the position of fire prevention to a pyro-
HFs have begun to expand to emerging markets, thus transferring the specific risks of these players to
the target countries.
A specific risk of HFs not only for emerging markets but for other developing countries derives from
the reaction of HFs to the present crisis. Given that the traditional areas of business are drying up,
they reorient their deals among others towards speculation with raw materials, oil and food. This leads
to an increase in prices. This particularly hits the oil importing countries and those who depend on raw
material and food imports. The rising food prices have in some countries led to riots.
The paper argues that Hedge Funds don’t have any useful function for national economies or the
world economy. They are sheer cash machines for speculators. Therefore, it would be the best, to ban
them. As long as the political balance of power does not allow for that, regulation should aim at trans-
parency, including fully into supervision and limiting leverage to a sustainable level.
Just as with Hedge Funds, Private Equity Funds only became a relevant factor when the financial
markets were liberalised and deregulated. The business model of PEFs has many similarities with
HFs. The decisive difference to HFs is that PEFs don’t invest into portfolio speculation but in the real
economy. They buy a company for the purpose of reselling it at a profit three to six years later. Once a
PEF has gained control over a company it is subject to restructuring, i.e. laying off of personnel, can-
cellation of social benefits, outsourcing, filleting, etc. Therefore, they often are called “locusts”.
Quantitatively PEFs are less important than HFs. Nevertheless they are a catalyst for subordinating
the behaviour of management to the logics of shareholder orientation. They serve as conveyor belt for
the asset and wealth driven model of economy to the whole economy.
PEFs are also beginning to be active in developing countries, in particular in emerging markets. 6% of
all PEFs investment in 2005 was outside industrialised countries. They are particularly active in merg-
ers and acquisitions. The Petro-Dollar economies are a main source of PEFs in developing countries.
Unlike Hedge Funds, Private Equity Funds might have positive effects in certain cases, if they are
properly regulated, for instance as venture capital. However, this requires limitation of leverage, su-
pervision and participation in decision making of the management through stake holders, first and
foremost employees and trade unions.
Parallel to regulating PEFs, alternatives for company funding should be developed. In particular the
“traditional” type of finance through bank loans should be restored, by creating incentives for banks to
provide capital, including venture capital.