Question

explain the role of hedge funds in 2008 Global cirisis. (max350 words)

Answer 1

Hedge funds caused the 2008 Global crisis by adding too much risk to the banking system.

In 2001, the Federal Reserve took the Fed rate down to 1.5% to fight the recession. During the market downturn, investors sought out hedge funds to gain better returns. As a result, massive amounts of money was poured into hedge funds. With an increase in funds, hedge fund managers started to invest in exotic derivatives like mortgage-backed securities. These were very profitable.

With low-interest rates, loans became affordable to many new homeowners. As demand for the mortgage-backed securities rose, so did the demand for the underlying mortgages. Banks became big investors in hedge funds with their customers' deposits. As a result, banks started to put pressure on their mortgage departments to lend to anyone. They didn't care if the loans defaulted because they sold the mortgages to Fannie Mae and Freddie Mac.

With the decrease in number of reasonable investment alternatives, fund managers started piling into similar risky investments. That meant that probability of failure was high. Investors were more likely to withdraw funds quickly at the first sign of trouble.

In 2004, with increase in rates, homeowners could not pay mortgages. They started to default. It happened with many homeowners, with this, like a domino effect, prices came down sharply. All the previous good investments became bad investments. People started to realize the bubble and the system collapsed in 2008.