From Volume 84, Number 6 (September 2011)
“Banks don’t lend anymore. Hedge funds have stepped in.” Lee Sheppard wrote these words in 2005, but the financial crisis starting in 2008 has shone a spotlight on this significant change in the reality of modern finance. What role hedge funds may have played in causing the financial crisis is debatable, but few will dispute that U.S. businesses have had trouble finding capital even as the economy, on the whole, has started to recover.
There are many possible contributors to the onset of the capital crunch. Among them are banks, which had difficulties meeting capital requirements, in part because their balance sheets were weighed down by mortgage-backed securities that proved to be less valuable than initially thought, and in part because of changes in accounting rules, as well as increases in minimum capital reserve requirements. The U.S. government and the Federal Reserve responded by combining to invest trillions of dollars to purchase “toxic” securities, guarantee loans, provide additional loans, and make direct capital injections into troubled financial institutions.