Sunday, March 28, 2010 0 comments ++[ CLICK TO COMMENT ]++

Opinion: EU and its hedge fund side show

The financial crisis clearly illustrates how greater regulation is required, but I have no idea why the EU is going after the shadow banking system (hedge funds, private equity, etc.) Yves Smith at Naked Capitalism seems to be in favour of such a move but as far as I'm concerned, it's a complete waste of time and detracts from the real reform that is required.

Some policymakers in the EU appear to believe that these players were the cause of the financial crisis and/or made it worse. Recent stories have even suggested the belief by some that countries like Greece wouldn't be in a crisis if hedge funds didn't bet against their bonds. If one sat back and thought about it, they would quickly realize that none of that is true.



In case someone forgot, it should be pointed out that hedge funds weren't the ones with the spectacular losses that threatened the non-financial economy. The unfortunate funds, those that did go bankrupt, also were not the parties lobbying and seeking government bailouts and capital injections. All the core problems and big mistakes were made by banks, not the hedge funds and private equity.

As Smith points out in her opinion piece, private equity does appear to have been horrible managers of banks (Smith says 50% of the bankrupt banks were run by private equity, whereas private equity owns a smaller percentage of banks i.e. their failure ratio is really high.) We need to keep in mind, however, that these funds tend to follow very risky strategies. Those running pensions funds and endowments may think private equity and hedge funds are no riskier than stocks or bonds but the reality is something else. These are risky funds using very risky and often unproven strategies. There is a reason that the SEC (and other regulatory agencies) prevent non-wealthy retail investors from investing in these funds. So the fact that a huge chunk of the bankrupt banks were run by private equity is not necessarily news.

Private equity, and certain types of hedge funds, also generally gets blamed by the public for, seemingly, running companies into the ground. The reality is that these funds often buy failing firms or companies in declining industries. Therefore, their failure rate is bound to be high. For instance, I am pretty sure that private equity funds and hedge funds would actually be one of the few investors who would consider buying companies in risky industries such as the newspaper industry (Warren Buffett, you may recall, has suggested newspapers are not worth it at almost any price anymore.)

Although the operations of these firms appear to the public as asset stripping a company to death, they are actually helping society by re-allocating capital (often from declining industries into emerging ones.) The only criticism I have of them is that they appear to be over-paid, arrogant, and have sold their soul to the highest bidder.

So, the way I look at it, hedge funds, private equity, and others, have stayed true to their capitalist roots. If they make money, it's theirs; if they lose, they shut up and go home without complaining.

Instead of the current path, I would urge policymakers in the EU to figure out why companies like Royal Bank of Scotland, HBOS, ING, and others, failed and almost brought their countries down. Regulating a similar re-occurrence will be far more helpful to the EU region than pursuing a side show policy targetting hedge funds and private equity.

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