Fed News: Chairman Bernanke is a big fan of the status quo
By Adam Lass
In this article
Chairman Bernanke fears that we might be tempted to over-regulate hedge funds.
He does not see the Amaranth Advisors' $6 billion collapse or the $1 trillion under hedge fund management as indicative of potential problems.
“Thus far, the market-based approach to the regulation of hedge funds seems to have worked well…”
Fed News: Chairman Bernanke is a big fan of the status quo
Yes indeed, the ostensible Fed chairman appears to be an adherent of Zen banking and regulation, a faith-based economic system based on the idea that if one does absolutely nothing, then one can be blamed for nothing that happens. No action = no bad karma.
A few recent example of Brother Ben's nearly cosmic reticence: He just spoke before the New York University law school-sponsored Global Economic Conference concerning the behavior and impact of massive hedge funds.
In case you missed it, hedge funds are largely unregulated investment groups that can purchase nearly anything that captures their imagination: stocks, bonds, options, futures, thoroughbred horse sperm, russet potatoes that look like Elvis, whatever. If the managers think it might someday gain in value, and can avoid getting fired when it doesn't, they can use their client's cash to buy some and stash it away for a rainy day.
Fed News: Activism is bad
Mr. Bernanke has fretted for quite some time that someday someone in the government might just want to look in on these guys to see if they actually had a grip on what they were doing. In his mind, this sort of activism would be “bad.”
Anyone remember the bad old days when the cowboys and cash jockeys at Long-Term Capital Management nearly bankrupted the entire global banking system by putting several billion of other people's money into the Russian stock market?
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The Connecticut-based hedge fund had a couple of Nobel Prize-winning game theorists on hand who were totally convinced that corrupt Russian oligarchs would act just like corrupt American oligarchs. So they disregarded their own (admittedly quite clever) hedging scheme and plowed in where even fools feared to tread.
Fed News: Rule breakers… or knee breakers?
Turns out that the Russian market was following a rule set that would be more familiar to Tony Soprano and Silvio Dante than Benjamin Graham and David Dodd. In the end, all the money “vanished” and the U.S. Federal Reserve was forced to (very quietly) bail out LTCM so as to avoid a global banking crash.
Shortly afterward, under pressure from an overly curious Congress, the Presidential Working Group, captained at the time by financial heavyweights like Robert E. Rubin, Alan Greenspan, Arthur Levitt and Brooksley Born, determined that “something ought to be done” and that it would keep a sharp eye on these hedge funds in the future.
Guess who's pretty much running the Group now? Why it's Brother Ben! And his comments before that aforementioned astute collegiate panel in the wake of some pretty outrageous recent hedge fund losses like Amaranth Advisors' $6 billion “oops” last September?
Fed News: Has the Fed been enjoying a “liquidity lunch?”
“Thus far, the market-based approach to the regulation of hedge funds seems to have worked well, although many improvements can be made.” After all, Bernanke went on to note, the collapse of LTCM came nearly 10 years ago during “a period of severe financial stress.”
Not to worry! Over the last decade, investors “have become considerably more sophisticated,” and so he supports the conclusions reached by the PWG in February, in that the hedge fund industry needs only increased vigilance on the part of investors rather than new government rules.
“To be clear, market discipline does not prevent hedge funds from taking risks, suffering losses or even failing -- nor should it… If hedge funds did not take risks, their social benefits -- the provision of market liquidity, improved risk-sharing and support for financial and economic innovation, among others -- would largely disappear.”
I'm sure Zen Ben will be glad to meditate on those 9,000 hedge funds with more than $1 trillion in assets that the American taxpayer would be required to bail out, should the cowboys again experience another period of great stress.
Ommmm.
***
Adam Lass is the founder and manager of the WaveStrength Group, and is a contributing editor for Taipan Financial News. As the creator of WaveStrength's proprietary analysis system, Adam's expertise has shaped a franchise of successful investment newsletters and services, including WaveStrength Options Weekly and WaveStrength Apex.
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Related Resources
The Fed: Brother Ben's latest comments on financial regulation.
The Treasury: The 1999 hedge fund report.
The Minutes: The FOMC minutes, wherein they decide not to mention their fear of the need to raise rates.