Forbes raises a question about whether The Goldman Sachs Group (NYSE: GS)'s $9 billion hedge fund, Global Alpha, will fail. I don't know, but rumors to that effect raise serious questions about whether the banks will be able to clean up the messes they make in pursuit of those eight figure bonuses. That's because Global Alpha is a symptom of a bigger problem -- the Black Box Market.
I pointed out that Global Alpha was having problems a few months ago in this post. So it doesn't surprise me to read that it's down 16% for the year. Global Alpha lets computers make decisions. Its investors just have to trust that those computers always make money no matter what happens. Unfortunately, the 1998 collapse of Long Term Capital Management demonstrates that smart computer programs can fail at the point of maximum peril.
And this brings us to the Black Box Market. As this morning's announcement by BNP Paribas that three of its subprime hedge funds will not redeem investors' money suggests, the global capital markets are at risk because of their opacity. Specifically, The Black Box Market entails four mysteries:
- The public does not know who owns how much of these impossible-to-value financial concoctions;
- The institutional investors themselves do not know how to put an exact value on them;
- For quantitative hedge funds, nobody knows how they are making investment calls -- except perhaps a few of the authors of their software; and
- To maintain their competitive edge and keep their investors from fleeing in fear, hedge funds will not disclose how they make money.
The result is that scary surprises on a large scale will keep popping up all around the world. The remaining question is how much money investors will need to lose before policymakers force open the Black Box Market.
Peter Cohan is president of Peter S. Cohan & Associates He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in Goldman Sachs.
