Failing to regulate the buy side

By Felix Salmon
May 3, 2010
Chris Frates has a good story today on the magnitude of buy-side lobbying efforts:

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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.


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Regulating buyers is going to take some penetrating work by some mighty sharp cookies.

Characterizing the buyers of Abacus as little old ladies is no more ingenuous than saying (as Goldman does) that these are sophisticated institutional investors who know what they are doing.

The problem, of course, is that the buyers are not buying with their own money so their incentives are skewed by the same herd behavior as other institutional money managers.

I suspect that the economic theory that informs policy making assumes that buying and selling decisions are made by the owners of the money who are seeking personal benefit. That doesn’t sound like the current world.

Maybe there is an economics based on an economy where decisions are made by agents and salesman, but I’m unaware of it (my economics study was a long time ago.) Doesn’t capitalist economics assume that owners of capital have an influence in the uses of that capital?

Salesman will always go for the sale. But securities buyers today are fund managers in investment companies, pension funds, banks, and other institutions that agglomerate the savings of outsiders. This is true of most hedge funds and private equity but here the incentives can be even more disconnected and opaque.

Free market purists live in a dream world of rational investment decisions. But other economists still fail to consider the effect on markets of decisions being made by those incentified by keeping their jobs and maximizing bonuses. Maybe there’s a Nobel out there for some visionary economist who can adapt capitalism to a world in which often owning capital carries little real influence.

Posted by RichardR1 | Report as abusive

The lobbying has worked to the extent that the system doesn’t appear to need to.

Wall Street is like a state within a state, except it has no separation of powers. As long as there are no external controls, the health of the system continually deteriorates for lack of internal logic, ethical guidelines or accountability.

What we’re seeing now are the results of attempts to self-medicate. And they’re not good.

Posted by HBC | Report as abusive

Hard to imagine an asset bubble without buyers.

Posted by chernevik | Report as abusive