J Chen, total hedge fund exposure is only $175 billion. that amounts to less than 4% of the total US Market capitalization; and over 60% of the hedge fund assets are in markets outside the US, so the net exposure is about 2%; one day's up and down for the Dow
13:06 DJS Greenspan, Other Regulators Oppose Tighter Controls On Hedge Fund
13:06 DJS Greenspan, Other Regulators Oppose Tighter Controls On Hedge Funds
WASHINGTON -(Dow Jones)- Top U.S. banking regulators generally bristled
Thursday at the notion of tightening oversight on the largely unregulated $175
billion hedge-fund industry, but conceded that greater control may be needed
over financial institutions that invest in such funds.
In the wake of the bailout of Long-Term Capital Management L.P.,
Federal Reserve Board Chairman Alan Greenspan and several other financial
regulators Thursday endorsed a new study of hedge funds, their risks and their
use of leverage.
"Any direct U.S. regulations restricting their flexibility will
doubtless induce the most aggressive funds to emigrate from under our
jurisdiction," Greenspan said in testimony before the House Banking Committee.
"The best we can do in my judgment is what we do today: Regulate them
indirectly through the regulation of the sources of their funds," Greenspan
said. "We are thus able to monitor far better hedge funds' activity. If the
funds move abroad, our oversight will diminish."
Greenspan said the Fed lowered its threshold for intervention in the
Long-Term Capital Management case because of fragility in the financial
markets. "Our sense was that the consequences of a fire sale triggered by
cross-default clauses, should LTCM fail on some of its obligations, risked a
severe drying up of market liquidity," he said. "The plight of LTCM might
scarcely have caused a ripple in financial markets or among federal regulators
18 months ago."
New York Fed President William McDonough said he intervened to aid a
private-sector bailout of Long-Term Capital Management because of "more
widespread financial troubles" that could have occurred in the wake of a
failure of the hedge fund.
"There was a likelihood that a number of credit and interest-rate
markets would experience extreme price move and possibly cease to function for
a period of one or more days," McDonough said.
Nevertheless, the New York Fed president stopped short of calling for
additional oversight of hedge funds and instead also backed a new study of
their activities.
Both Greenspan and McDonough testified that U.S. bank regulators may
need to toughen rules that require financial institutions to "stress-test"
their exposures to various financial risks. "This is an area in which much
work has been ongoing," Greenspan said. McDonough said the Fed recently urged
banks to conduct such stress tests in a broader supervisory letter on credit
underwriting.
Bruce Lindsey, market regulation director for the Securities and
Exchange Commission, said Long-Term Capital Management was unusually leveraged
and may be an extreme case in the hedge fund community.
"Although we have not verified these figures, preliminarily they
suggest that LTCM may have been an extreme case since, as discussed above, at
one point LTCM's leverage approached 50-to-1," Lindsey said.
"It would be premature to to conclude that regulation is necessary,"
Lindsey added. "We must avoid the temptation to readily label certain
investment strategies as inherently dangerous or risky."
Long-Term Capital Management is one of as many as 4,000 hedge funds
that aren't subject to the same kind of strict disclosure and oversight rules
as mutual funds because participants presumably have the resources to look
after themselves.
Securities laws limit participation in each fund to 500 investors.
Individuals must have incomes of at least $200,000 in each of the past two
years ($300,000 for couples) or a net worth of at least $1 million.
Commodity Futures Trading Commission Chair Brooksley Born, who is
leading an agency charge to more tightly regulate the over-the-counter
derivatives market, broke ranks with the other financial regulators.
"It has highlighted an immediate and pressing need to address whether
there are unacceptable regulatory gaps relating to hedge funds and other large
OTC derivatives market participants," Born said before the banking panel.
"This episode should serve as a wake-up call about the unknown risks
that the OTC derivatives market may pose," she added.
Born warned that a congressional effort to block the CFTC from
furthering its regulatory review of derivatives is risky. "To tie its hands
during this time of economic stability and growing awareness of the potential
dangers in the swaps market could pose grave risks to the American public,"
Born said.
Congress this week agreed to language in a pending agriculture spending
bill to restrict the CFTC derivatives review.
Some observers expect regulators to shy away from calling for more
direct hedge-fund regulation because hedge funds are established as private
entities open only to wealthy and sophisticated investors and, in theory,
should be able to absorb unexpected market turns. Securities and Exchange
Commission Chairman Arthur Levitt testified Tuesday that he doubted there was
any need for new regulation of hedge funds and said Long-Term Capital's woes
appear to be an aberration.
Long-Term Capital Management borrowed heavily on behalf of its wealthy
investors. It employed sophisticated computer modeling and derivatives -
often-complex financial instruments whose value is derived from an underlying
security, commodity or asset - in hope of producing a profit, no matter which
direction stock prices or interest rates moved as a whole.
But the models failed to account for the sudden collapse of the Russian
ruble in late August or the dramatic intensification of the global financial
crisis, which has widened the spread between interest paid on U.S. Treasury
securities and other less-safe securities.
The four-year-old fund's chairman, John Meriwether, is one of Wall
Street's most celebrated traders and his senior partners include two Nobel
laureate economists and a former vice chairman of the Federal Reserve.
At first, their strategy was remarkably successful but it was in the
long run, Greenspan said, "a strategy that was destined to fail."
He said it was regrettable that Meriwether and his partners retained a
small stake in the reorganized fund but said, "The creditors felt that, given
the complexity of market bets woven into a bewildering array of financial
contracts, working with the existing management would be far easier than
starting from scratch."
House Banking Committee Chairman Jim Leach, an Iowa Republican who
called Thursday's hearing, said the terms of the Long-Term Capital Management
rescue plan "raise troubling questions of financial concentration and
antitrust."
"The bailout may involve a tendency toward concentration that the
Justice Department has an obligation to review," Leach said.
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All Rights Reserved.
10/01 1:06p CDT |
