Regulation Risk

Investing regulators enforce fair competition among investors, big or small. Insider trading is under current scrutiny. Series of cases are dug out. This is great news for all investors. So far, the culprit is on hedge fund managers. Obviously, hedge funds, due to its less regulated form, are easier to violate rules, although there might have no rules yet.

Hedge funds are not as big as banks. Even the defunct Bears Stern, was much larger than the largest hedge fund. This is because banks have other income resources. Also because of their sizes, too-big-to-fail was the main consideration when problems arose. Regulation biased to dominant players' stability. This biasedness is debatable because the dominant players might have done thing recklessly. Should they be punished? But in the eyes of regulator standpoint, it is easier to keep the largest ship from Titanic. That is the case everywhere, in every system.

Understanding the priority in regulator's shoes, investors can keep a note. Raise an example, John Paulson made billions in the subprime crisis by buying CDS. His trades seemed extremely brilliant in retrospect. However, many others saw the same problems in the mortgage craziness. Many of them approached differently to short the mortgage market. When Lehman blew up, government barred short trading. Many hedge funds stuck in their positions and blew up too. Paulson's positions, in the form of CDS, were not affected by the regulation. Up to this point, you can see how smart the trade is and how lucky Paulson had picked this path. From Paulson's stand point, the reason of going with CDS was because of limited risk in this trade and lower costs than other approaches. He didn't and had no way to foresee short rule's disallowed. This seems a nuance was proved to have extremely different outcome.

When opportunities come, there may be many ways to grab them. To learn from others is the best way to excel.