Why We Need a Superfund for Hedge Funds

Abstract:     
The current financial crisis has led to numerous calls for regulation of hedge funds. This article argues that the appropriate response is a combination of mechanisms: establishment of a Superfund financed by a tax on hedge funds, whose revenues are then used to conduct market purchases of "toxic" financial assets, along with supporting regulations. This article develops this solution by focusing on the market failures caused by hedge funds, namely the externalities posed by liquidity risks, and the inability of market prices to provide information about the valuation of financial securities. It then considers possible solutions through the prism of our past experiences with environmental protection. This analysis suggests that the Superfund will be not only applicable to this financial crisis, but will remain effective even as hedge funds and their strategies evolve.

Number of Pages in PDF File: 39

Keywords: Hedge Fund, Liquidity Risk, Valuation, Systemic Risk, Market Failure, Regulation

JEL Classification: G28, K22

Accepted Paper Series