There are attempts ongoing to heavily regulate hedge funds and the private equity industries. Opponents of such regulation claim that these industries pose no systemic risk to the financial sector and play a positive role for economic recovery. Here is a paper which supports such views:
Walter Münchau shows why Greece needs very substantial growth rates not to default:
So, does last week’s agreement mean an end of the Greek crisis, as some of the optimists claim? Let us start with some simple back of the envelope analysis of Greek debt sustainability. This will show that default - under any realistic political and social assumptions - must now be the most probable outcome.
Greece currently has a primary deficit (before interest payments) of 7.9%. On the assumption of 2% nominal growth during the adjustment period, a marginal interest rate of 6% on future debt, the primary balance Greece needs to achieve debt sustainability is a surplus of almost 5%. read more
In its latest issue, the French magazine ENTREPRENDRE has a story about rich French people who leave the country due to its high tax environment and physically move to countries such as Switzerland. The article is already introduced on ENTREPRENDRE's cover page with the title "le scandal de l'évasion fiscale" (the scandal of fiscal evasion). The authors should be reminded that there is a relationship between taxes, tax evasion and the way a country is governed:
Here is an excerpt from abstract of the Dhammika, Hines study:
"This paper analyzes the factors influencing whether countries become tax havens. Roughly 15 percent of countries are tax havens; as has been widely observed, these countries tend to be small and affluent. This paper documents another robust empirical regularity: better-governed countries are much more likely than others to become tax havens. Using a variety of empirical approaches, and controlling for other relevant factors, governance quality has a statistically significant and quantitatively large impact on the probability of being a tax haven."
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In spring 2009 the European Commission has announced that it will propose a Directive on Alternative Investment Fund Managers (AIFMs) with the objective to create a comprehensive and effective regulatory and supervisory framework for AIFMs at the European level. Since then various proposals have been circulated. Norton Rose has an excellent overview of the evolution of this EU regulation attempt. There was heavy opposition by outside EU hedge fund groups against a provision on marketing non-EU funds. The initial draft proposed a complete ban on AIFMs marketing non-EU domiciled products.
The provisions on marketing non-EU funds have provoked the most press comment on the AIFM Directive to date. In what appears to be a blatantly protectionist measure, though still does not go nearly far enough for certain Member States, the initial draft proposed a complete ban on AIFMs marketing non-EU domiciled products.
In the latest version Article 35 permits the marketing of an AIF domiciled in a third country to professional investors domiciled in a Member State if that country has entered into an agreement based on Article 26 of the OECD Model Tax Convention with the Member State on whose territory the AIF shall be marketed. However, this right to market AIFs to professional investors only becomes effective three years after the transposition period.
For good reasons hedge fund professionals outside the EU see this as a heavy protectionist measure.
Overall, it is questionable whether hedge funds even pose a major systemic risk to the financial sector. No hedge fund had to be bailed out by a government during the financial crisis. Furthermore, hedge funds have been crucial when certain industrial conglomerates had to be saved from bankruptcy. A prominent example is the Swiss conglomerate OC Oerlikon which has been saved from bankruptcy by a numer of hedge funds and banks lately.
It is highly questionable whether the new EU directive is an effective measure to prevent systemic risk. Robert Preston from BBC dealt with this question in a recent blog entry in an intelligent manner. Here is the core of his arguments:
First, the actual harm that hedge funds and private equity may have wreaked in the creation and course of the credit crunch could probably be much better tackled not by regulating them directly, but by new restrictions on the banks that service them and take credit from them, and on the financial markets where they trade.
There are five kinds of harm that hedge funds and private equity may have caused, all of which are fixable without a directive that imposes new direct constraints on hedge funds and private equity:
1) Some financial institutions, such as Bear Stearns and Lehman Brothers, became dangerously dependent on short term credit provided by hedge funds. But that's fixable by imposing tough new requirements on such investment banks to raise much more longer-term finance that can't be withdrawn on a whim.
2) Many believe that hedge funds have destabilised banks such as HBOS and even entire economies, such as Greece, disproportionately to the fundamental weakness of such banks and economies, by their ruthless financial speculation that such banks and economies were heading for the knackers. Now, to be clear, that hypothesis is by no means proven. Some would say that in such cases hedge funds are the public-spirited early warning system (please don't shoot your computer). But if you think that it's wrong to allow the mafia to take out an insurance policy on your house that delivers the mob a profit when your house burns down, which is how some would see naked CDS shorts on bank debt or government bonds, then ban those insurance policies, prohibit naked CDS shorts. But that's product regulation, not regulation of institutions such as hedge funds.
3) Hedge funds have provided a market for some of the newfangled financial products, such as CDO squareds and cubeds, that decimated the balance sheets of banks. But if you don't like the toxic new products, regulate their development or the extent to which banks can load up their balance sheets with them.
4) Banks have suffered big losses on their loans to businesses acquired by private equity firms. But that is eminently sortable by constraining banks' ability to lend to over-indebted companies and institutions.
5) Finally, the massive rewards earned by the partners in some hedge funds and private equity firms helped to encourage the spread of a pernicious short-term bonus culture in banks. But let's be clear about this. First of all most hedge fund and private-equity partners are at least putting some of their own money at risk (although some would say nowhere near enough), which almost never happens in banks. More germanely, hedge funds and private equity surely can't be held accountable for the abuse of their remuneration system by other institutions.
Here is the conclusion of the authors of the Financial Services Authority report on hedge fund riks:
"Surveying managers of hedge funds and some of their key bank counterparts helps to inform our supervisory work and improve our understanding of any systemic risks that might arise through the activities of hedge funds. The results from this survey work were mostly in line with our expectations. The HFACS data suggests that on 31 October 2009 major hedge funds did not pose a potentially destabilising credit counterparty risk across the surveyed banks. HFS data shows a relatively low level of ‘leverage’ under our various measures and suggests a contained level of risk from hedge funds at that time. While our analysis revealed no clear evidence to suggest that, from the banks and hedge fund managers surveyed, any individual fund posed a significant systemic risk to the financial system at the time, this position could change and future surveys will be an important tool in identifying emerging risks. It is also notable that the Alternative Investment Fund Managers Directive, which is currently under negotiation in Europe, may at some point in the future require national supervisory authorities such as the FSA to collect certain data from alternative investment fund management sectors, including hedge funds.We hope that our work in this area can contribute to the ongoing debate about the Directive. Our intention is to repeat these surveys at six monthly intervals and build a time series of data that will help us monitor trends in hedge funds as they relate to systemic risk. Discussions are taking place within the Financial Stability Board and IOSCO to ensure consistency in the timing and content of systemic risk data collection for hedge funds and we hope our work will help inform that process. A consistent and proportionate global approach will help deliver G20 commitments of better coordination between regulators and, through improved data sharing, the clearer identification of global risks."
This is a good piece which has been published by Robert Reich 20 years ago in the NYT:
An ideal private equity model combines both types of entrepreneurs.
Private equity deal-makers, those kings of corporate buyouts, made billions for themselves when times were good. But some of their biggest investors, public pension funds, are still waiting for the hefty rewards they were promised.
The nation’s 10 largest public pension funds have paid private equity firms more than $17 billion in fees since 2000, according to a new analysis conducted for The New York Times, as the funds flocked to these so-called alternative investments in hopes of reaping market-beating returns.
But few big public funds ended up collecting the 20 to 30 percent returns that private equity managers often held out to attract pension money, a review of the funds’ performance shows. read the whole article in the New York Times
Here is some return data extracted from the article
"Private equity owes its explosive growth largely to America’s pension funds. Buyout funds raised $200 million in 1980 and $200 billion in 2007. According to Prequin, a financial data provider, public pension funds were the biggest contributors over that period and now have $115.9 billion invested in private equity.
But these investments have not worked out as well as many had hoped. According to data from the Wilshire Trust Universe Comparison Service, the median returns for public pension funds with assets greater than $5 billion were negative 18.8 percent over one year, negative 2.8 percent over three years, and 2.4 percent over five years."
Dissecting the China Puzzle: Asymmetric Liberalization and Cost Distortion, Huang Yiping, China Center for Economic Research, Peking University, and China Economy and Business Program, Crawford School of Economics and Government, Australian National University, March 2010
Find here a chinese view on the reasons for trade imbalances: They see the exchange rate as only one of several major causes:
"Repressed costs of labor, capital, land and resources artificially raise profits of production, increase returns to investment and improve international competitiveness of Chinese products. This is why economic growth is strong, but investment and exports are even stronger. These distortions also contribute to the global imbalances by boosting Chinafs current account surpluses and capital outflows in forms of foreign exchange reserves. We estimate factor cost distortions for 2000]2009 to gauge the likely magnitudes and cross]year patterns. They provide a reasonable explanation of the movement in economic imbalances."
Here is an excerpt:
"There are three fundamental issues that US policymakers should focus on: domestic demand in China, China’s trade with the rest of the world, and exchange rates.
With respect to domestic demand in China, there is rather clear evidence that, if anything, it is currently too strong, and certainly not at a level to justify accusations that China is not doing its “bit” for the world economy. For about 13 years we have used our own proprietary gross domestic product indicator for China, the so-called Goldman Sachs China Activity index. At the moment, this is growing at an annual rate of more than 14 per cent. Indeed, and somewhat ironically, it is likely that if Washington and others could keep quiet, Chinese policymakers would probably be more eager to do things to ease the inflationary pressures arising from this growth, including introducing more flexibility to the exchange rate."
This is an interesting working paper by CRESC about the reaction of major European countries on the financial crisis:
Here is part of the conclusion:
"The national responses to the crisis reviewed above can be summarised as follows: in the UK, a liberal market capitalism, the expected consensus among elites to maintain the status quo of the financial industry is not completely guaranteed, with proposals of sectoral restructuring being floated by senior technocrats; on the other end of the spectrum, in Germany, banks were deeply affected by the crisis and both remedial actions to address the crisis and the policies advocated to fix the system were very similar to the US’s solutions, the paragon liberal market economy. Social partners, such as unions, were not as involved in the process while financiers were credited with two important policies involving tax payer money. In France, the relatively low impact of the crisis on the national financial system has given the government a window to advocate a moral capitalism that mirrors the French system."
The Wall Street Journal reports that Greece paid a stiff premium to raise €5bn on Monday, signalling that the EU announcement last week of a possible rescue package has done little to lower the troubled country's high cost of borrowing. Compared with Greece's two previous bond issues in 2010, demand was relatively subdued. read more
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