Financial speculation was a significant cause of the Wall Street meltdown of 2007 that is still leaving more than 9% of Americans unable to find work.
Hedge Funds are important vehicles of speculation. We can get some sense of what hedge funds do by looking at the early versions of these investment vehicles.
Originally called "hedged funds," they were first invented in the 1920s. They may have had something to do with the disastrous market crash of 1929 that plunged the whole world into a protracted depression that did not end until the coming of World War II.
The goal of these hedged funds was to hedge against losses in the market. The favorite technique is "selling short." This involves selling shares one does not actually own but has borrowed from someone else for a price. Suppose you hold $1000 worth of stock in a company which you suspect is going to lose market value. You borrow an additional thousand dollars worth of stock and sell that for $1000. As expected, the stock loses value and is down to $900 the next day. You then buy the stocks back which you just sold, at now only $900 and return them to the people you borrowed them from. They get what they lent you. But you made $100 – just the amount that your own personal stocks lost. Your losses are now reduced to the fee you paid the people from whom you borrowed the stock. The market goes down; you lose something but not as much as you might have.
Obviously you gambled. Had you been mistaken and the stock you borrowed had gone up, instead of going down, you would have lost a lot of money.
Gambling is what hedge funds do. In 2007 they lost big. We are still paying for those losses.
In the meantime, gambling continues unabated on Wall Street. According to recent reports, big banks – the ones the government bailed out – made 35% of their profits from hedge funds, in other words, from gambling. Since hedge funds are private and not open to the public, they are not regulated by the government. The gamblers can go and do whatever their gambling addiction demands.
While all this is happening in New York and other big commercial centers, the state of Massachusetts has gone through a deep process of soul-searching about allowing gambling casinos. The state is short of money. The promoters of these casino have promised $1 billion of new revenue for the state. But Massachusetts began life as a Puritan state. Besides for some people gambling is a dangerous addiction that ruins the gambler and their families. In addition, there are many semi-legal operations at the edge of gambling casinos. They attract, we think, undesirable sorts of persons. Gambling often involves people who are skating on thin legal ice.
It has taken Massachusetts legislators five years of consulting their conscience and a major financial crisis to finally give in to the to casino promoters. But there still is a great deal of handwringing and worrying about casinos and gambling. In New York, by contrast, gamblers are in command. They have the ear of the government. As likely as not some of them are friends of Treasury Secretary Timothy Geithner. Besides, unlike the gamblers in Massachusetts who may bankrupt themselves and their families, the Wall Street gamblers have the government on their side. When they face bankruptcy Uncle Sam will come to the rescue.
The parallel between the agonizing over gambling in Massachusetts and the national government's total, unquestioning acceptance of gambling on Wall Street is really startling.
The people of Massachusetts are correct. Gambling is dangerous. It is a fool's game as we saw in 2007. Sooner or later gamblers lose everything. Sooner or later ordinary taxpayers like you and I will be asked to foot the bill for the foolishness and recklessness at Goldman, Sachs and other speculative businesses.
Hedge funds should either be made illegal or, at least, be regulated very strictly. But as long as the Wall Street gambling hedge funds practically run the government, we have no prospects that these funds will be reined in or regulated.
Unless the Occupy Wall Street heroes remain in the street.