Hedge funds may pose a risk to U.S. economy

Kevin G. Hall and Robert A. Rankin | McClatchy Newspapers

last updated: August 07, 2007 03:14:27 PM

WASHINGTON — Wild mood swings on Wall Street are nothing new, but the recent quaking in financial markets has a worrisome new wrinkle: It's being driven more by what isn't known than by what is.

That's because a huge share of the money that's flowing through U.S. financial markets is being invested by giant "hedge funds" that aren't subject to much regulation. No one really knows what they own. And there's a chance that some of what they own is worthless.

The funds — managed pools of investors' money, often supplemented with huge borrowings from banks — often bet on highly speculative and exotic financial derivatives, such as "options," which more regulated mutual funds aren't allowed to buy, and that poses risks to all the U.S. financial institutions that are tied to them, as much of Wall Street is. It poses risks to the broader economy as well, and those risks are impossible to measure because no one knows how risky hedge fund assets are.