Quarles said that, while hedge funds provide steady funding to many marketplaces and help spread risks, they may also represent undue risk by using high amounts of leverage or by concentrating their investments in certain areas, Reuters reported. Hedge funds currently have an estimated $1 trillion in assets.
Quarles said the Treasury Department will examine whether the growth of hedge funds, derivatives, and other forms of alternative investments is changing the overall nature of risks to financial markets and institutions.
“While hedge funds provide certain benefits to the financial markets, they can also put stresses on it that need attention,” Quarles said in testimony prepared for delivery to a Senate banking panel, according to Reuters. “Excess leverage can greatly magnify negative effects of market conditions.”
He cited the risks to the financial system that occurred after the failure of hedge fund Long Term Capital Management in 1998, when it had assets of more than $125 billion but equity capital of $4.8 billion.