Bailout

Failing to regulate the buy side

By Felix Salmon

Politico’s Chris Frates has a good story today on the magnitude of buy-side lobbying efforts:

The Private Equity Council and the Managed Funds Association paid lobbyists more than $7.3 million last year and almost $2 million in the first three months of this year…

In 2009, the financial industry hired 940 former federal employees, including at least 70 former members of Congress, to peddle influence, according to a recent Public Citizen report…

As one Democratic financial industry lobbyist put it, ?When the A-Team leaves the Hill and they go back to the Hill to lobby, you don?t stand a chance.?

The buy side lobbyists alone have hired three former members of Congress and many more former Hill staffers, including two senior Chuck Schumer aides.

The lobbying seems to have worked, in that very little proposed financial-reform legislation really touches the buy side. And one of the problems here is that if the reforms have the effect — as I hope they will — of shrinking Wall Street’s investment banks, then there’s a good chance that such activities will simply resurface elsewhere, in what you might call a “shadow investment banking” system of large hedge funds like Citadel.

I’d be a fan, then, of a leverage cap on hedge funds and private-equity shops, which are structured so similarly to hedge funds that we’ve got to avoid the hedgies simply reclassifying themselves as PE just to get around regulations.

I’d also like to see some way of aggregating the intelligence of any hedge funds which see and bet on systemic risks. The systemic risk regulator, whoever it turns out to be, doesn’t have anything like the profit motive of hedge funds when it comes to identifying exactly where the risks might be, and I don’t think that a formal reporting requirement to the SEC will do the job. I’d rather see human contact: although it’s hard to force hedge fund managers to be honest about their positions, a lot of them are in fact happy to talk to a non-competitor in confidence if they think there’s willingness to listen.

One lesson of the financial crisis is that prime brokers actually did a good job of managing the risks within hedge funds: they seem to have learned their lesson from LTCM. But of course those managed risks were largely bilateral: no one was netting them out, or looking at large-scale correlations across firms. I’d like to see some such mechanism in the financial reform bill, although it’s not going to happen. Just because the buy side wasn’t a huge cause of this last crisis, doesn’t mean it won’t be a major part of the next one.

Full post as published by Macroprudential on May 03, 2010 (boomark / email).