Sayeth a German academic, contra everything that every hedge fund lobbyist has said (and that everybody believed) since 2007.
Hedge funds, on the other hand, adversely affect all three other types of financial institutions. During crises, the spillovers become very large, making hedge funds more important transmitters of shocks than commercial banks or investment banks….
Hedge funds are opaque and highly leveraged. If highly leveraged hedge funds are forced to liquidate assets at fire-sale prices, these asset classes may sustain heavy losses. This can lead to further defaults or threaten systemically important institutions not only directly as counterparties or creditors, but also indirectly through asset price adjustments (Bernanke 2006)….
during more volatile market conditions, the effects from shocks are striking, particularly those from shocks to the hedge fund industry. Adverse conditions in hedge funds increase the risk in all other types of financial institutions, even when shocks to other industries remain small. During crisis times, shocks from hedge funds have substantial effects on all three other types of financial institutions we study. The largest impact appears to be on investment banks, which experience a spillover response around three-quarters the size of the initial shock to the hedge fund industry.
How Important Are Hedge Funds in a Crisis? [FRBSF Economic Letter]