Are Hedge Funds a Giant Scam?

My instincts are torn on this issue. On the one hand, my instinct is to say that based on my admittedly somewhat thin understanding of what hedge funds do, they seem like a giant scam. On the other hand, my awareness that my understanding is somewhat thin makes me skeptical that this could really be the case. Under the circumstances, the impressive establishment credentials of this piece -- a "think tank town" item in The Washington Post by Dean P. Foster of the Wharton School and H. Peyton Young of Oxford and the Brookings Institution -- carries a lot of weight with me.

These guys aren't smart-ass twentysomething bloggers and they say that while it's not necessarily the case that all hedge funds are huge scams, a lot of hedge funds are huge scams exploiting the fact that if you make a few bets with small odds of enormous downside, the probability favors you putting together a few years' worth of incredibly impressive returns and getting in a position to make a lot of cash. Nassim Taleb's The Black Swan discusses many related issues.

Photo of hedges in the New York Botanical Garden by Flickr user MoToMo used under a Creative Commons license