Treasury crackdown faces challenge

Date: Friday, March 27, 2009
Author: Patrice Hill, The Washington Times

Congress welcomed the Treasury's proposed crackdown on the big financial firms and free-wheeling markets that were implicated in the global financial crisis, but some of the country's richest and most powerful financial interests signaled Thursday that they will oppose the plan.

While the larger goal of the plan is to impose greater controls on the big banks and Wall Street firms that are the top recipients of Treasury's $700 billion in bailout cash, the provisions to subject secretive hedge funds, private equity funds and venture capital funds to regulation for the first time may draw the most heated opposition. Those funds were not central players in the crisis and have not received any bailout money.

"Hedge funds were not the root cause of the problems in our financial markets and economy," said Richard Baker, president of the Managed Funds Association, which represents hedge funds. "In fact, hedge funds were significantly less leveraged than banks and brokers, performed significantly better than the overall market, and have not required or sought federal assistance."

"We believe that private equity investments do not create systemic risk," said Private Equity Council President Douglas Lowenstein. "Private equity firms invest in companies, not exotic securities, and their investors are long-term investors, eliminating the 'run on the bank' type of risk that helped create the current financial crisis."

While private equity funds and venture capital funds played no known role in the crisis, hedge funds have been blamed for seeking to profit from the collapse of banking and financial stocks by short-selling those stocks. Lehman Brothers, Bear Stearns, Merrill Lynch and other big banks and Wall Street firms that failed last year claimed they were victims of predatory short-selling. Hedge funds do not deny that they profited handsomely from the tactic, which was a principal reason they outperformed other investment funds last year.

The administration's move to regulate the private funds is ironic, as they are among the only ones with ample cash and ability to buy up billions of dollars in distressed loan and real estate assets coming out of the shell-shocked economy, Mr. Baker said. The administration is looking to these wealthy funds to help clean up the $1 trillion toxic loan mess banks are facing. It proposed earlier this week to form partnerships with the wealthy funds to buy up the soured loans.

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The financial firms are not without clout, though public furor over the crisis has diminished their influence. In the 2008 campaign cycle, securities and investment firms were the third-largest contributors to the presidential and congressional races with $63.1 million in contributions, according to Opensecrets.org. Two-thirds of that sum went to Democrats; President Obama was the top recipient.

Still, financial firms - especially big bailout recipients like Citigroup and American International Group - know they have to be careful in countering the strong momentum for financial reform and re-regulation in Congress, which would reverse decades of financial deregulation that started during the Reagan era in the 1980s. Public opinion polls have shown since last fall that the public wants to crack down on the financial companies responsible for creating the global crisis.

"There is clearly no political goodwill toward financial services in general and everyone within financial services is being lumped into the same bucket," said Andrew Newington, managing partner at BC Partners. Although he hopes for "rehabilitation and redemption somewhere down the track," he said, "I'm still not telling taxi drivers that I work in the hedge fund industry."

The plan on hedge funds is one of the more notable rollbacks of deregulation. It would require all hedge funds, private equity funds and venture capital funds to register and report their activities to the Securities and Exchange Commission - a move the industry successfully fought off in court in 2006 when the SEC tried to impose a registration requirement.

The administration sought to soften the requirement by stipulating that the information provided to the SEC would not be disclosed to the public. George Soros and a few other hedge fund managers have testified they would be willing to accept the registration requirement if their trading information is kept private.

But under the administration plan, the biggest funds whose failure might pose a risk to the financial system would be subject to more extensive controls and even seizure by a "super-regulator" created to police the global markets.

Treasury Secretary Timothy F. Geithner justified the assault on previously unregulated funds in testimony before the House Financial Services Committee by pointing to the massive scandal involving some hedge funds run by Bernard Madoff. Other proponents of regulation point to the Federal Reserve's arranged rescue of the Long-Term Capital Management hedge fund in 1998, out of concern that the fund's collapse would worsen a market crisis at that time.

Hedge fund executives insist that the $1.5 trillion industry has been misunderstood and unfairly tarred by association with Madoff, whose funds already were regulated by the SEC. The SEC had authority to prosecute Madoff but for years overlooked the huge Ponzi scheme that he perpetrated, they point out.

"There is hysteria about hedge funds, with hedge funds being the fountain of all bad things," Hugh Hendry, chief executive of Eclectica Asset Management, said at a Reuters conference.