Fire, ice but not everything nice for hedge funds
Feb 3rd, 2010 | Filed under: Hedge Fund Regulation, Today's Post
If 2008 was characterized by meltdown and 2009 was characterized by thaw, 2010 will be noted as the year hell finally froze over, at least when it comes to hedge fund and investment banking oversight.
For years, hedge funds have been threatened with tighter borrowing and lending practices, more scrutiny and less flexibility to hide behind the veil of being a private investment for the accredited. The gauntlet never quite came down, thanks to Goldstein, Madoff and a global financial crisis, allowing hedge funds to continue doing what they have always done.
But comments from officials at this year’s World Economic Forum in the cold, snowy mountains of Davos seem to suggest that the rhetoric may finally be snowballing into something a bit more onerous, and that banks, private equity firms and hedge funds may be looking at a new type of landscape with more stringent standards – at least if they want to remain in business.
Regulators from the world’s developed countries told bankers far and wide in Davos that greater regulation is indeed on the way – a defensive move aimed at avoiding a repeat of last year’s financial meltdown that dragged most of the world into recession. The remarks came on the back of President Barack Obama’s suggestion – dubbed the Volker rule (because it was former Federal Reserve Chairman Paul Volcker’s idea) of forcing banks to divest their private equity and hedge fund holdings as well as their prop trading desks to reduce their financial footprint and limit systemic risk.
Untangling banks, especially big ones, from proprietary trading and alternatives strategies is no small feat, judging from the prop-trading market segment chart shown below from a slideshow by the CME Group.
Of course, Davos and many other forums have heard talk like this before: After the technology bust, after the Russian debt default, the Asian financial crisis, Long Term Capital Management and even after Amarynth blew up. AllAboutAlpha wrote about how hedge funds were on the “Global Agenda” in Davos back in 2007.
The key difference this time around is that governments, after spending billions to bail out the banking and financial services industries, are now calling the shots, and are more likely than ever to push through reforms that will make investing a much more different space in 12 months time. Even former Treasury Secretary Hank Paulson is on the hell-needs-to-freeze-over warpath, noting on CNBC in the past week that he approached his former Goldman Sachs cronies “numerous times” about the crazy casino that is Wall Street.
For their part, the banks still appear to be very, very deep in denial. They have already come out swinging, arguing everything from prop trading and hedging is only a small portion of their businesses to liquidity will all but dry up if such activities are made extracurricular.
Elizabeth Warren, the woman in charge of the Troubled Assets Relief Program, or TARP, gave a passionate “now or never” diatribe on the “Daily Show” with Jon Stewart late last month, making plain that Wall Street is facing two choices: Either continue along the path of ever larger booms and busts that eventually turn into a financial atomic bomb, or make drastic changes that ensure the global financial system remains intact for at least the next 50 years.
Stewart called attention to a great quote she had, noting the lack of downside to the shenanigans of Wall Street in the 21st century: “Capitalism without bankruptcy is like Christianity without Hell.”
On the flip side, all the talk could actually end up being positive for hedge funds and other prop-trading shops, who presumably will find other places beyond the banks to get what they need.
Fire, or ice? The hedge fund industry, which rightly or wrongly is inexorably linked to the investment banking business, is likely in for both. One thing is for sure: Melt it, freeze it or pack it into a ball and whip it, it’s still the same thing.
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