Tuesday, August 08, 2006

FED ACTION AND MARKET REFLECTION
US stock market regulator considers controls
Los Angeles Times-Washington News Service

Eight years ago, the collapse of a hedge fund named Long-Term Capital Management triggered fears of international financial instability. Since then, hedge funds have quadrupled the volume of money they manage and account for perhaps 30 per cent of trading on US stock markets.
Meanwhile, the regulatory response has been confused. Two years ago, the Securities and Exchange Commission decided to require hedge fund managers to register and submit to inspections. This was opposed by Alan Greenspan and got a cool response from regulators. In June a federal court vacated it.
Having inherited this mess, SEC Chairman Christopher Cox is pondering how to fix it. His objectives should be to mend fences and to tread lightly on this industry.
Hedge funds, which exist to come up with futuristic trading strategies that others haven't tried, are the classic example of an innovative industry with which regulators can't keep up.
There are three types of argument in favour of regulating hedge funds, and none is persuasive.
The first invokes systemic risk: If a hedge fund collapses, the banks that lent to it may collapse, too, causing a chain reaction through the financial system. This danger is real, but banks that lend to hedge funds have a strong incentive to manage it by limiting their exposure and by monitoring the risks that the funds take.
The second is that they are havens of insider trading and other sorts of manipulation. The law already empowers regulators to go after hedge fund managers for financial crimes. It's not clear that extra regulations would add much.
The third concerns investor protection. The SEC suggests that by inspecting hedge funds it can reduce the danger that investors will lose money. Some fund managers calculate that submitting to mild regulation now may be smarter than waiting until the political storm that would follow the scandalous blowup of a crooked player in their industry.
Wealth limit needs to be raised
There is one fix that does make sense, and Cox has proposed it. Hedge fund customers are currently required to have personal wealth of at least $1 million a relatively low threshold given that home equity counts toward it. But hedge funds make sense only for families richer than that. The $1 million hurdle should at least be doubled.

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