Wilberne Persaud, Contributor

Persaud

In the USA today, highly talented and immensely experienced former financial regulators and financial journalists try publicly, to persuade government and free market capitalists that players in financial markets need more, not less regulation. The market does not self regulate. In the last twenty years, transparency of U.S. financial markets, which made it the envy of the world has given way to murkiness. Momentarily, in the wake of ENRON and Worldcom, this trend was arrested. But that did not last long.

One of the main reasons for this has been the phenomenal growth of hedge funds. A hedge fund is private, typically charges an investment fee and is not open to the public, but rather only to accredited investors. "Accredited" as defined in relevant rules includes wealthy individuals, corporations, endowments, retirement plans and the like-professionally managed operations.

The big picture

A wealthy individual would normally have a net worth of more than US$1 million. The definitional issue is complex, but need not deter us from a grasp of the big picture.

The main thing is that the fund is private, and does not have to disclose its operational mode, nor any of the other stuff normally taken for granted in say a mutual fund. They charge something like two per cent as fees and take about 20 per cent of the profits for managers and operators. Obviously, to do this they have to be super profit earners. There is also potential conflict of interest perhaps I should say intense conflict of interest.

These funds have grown to the trillions of dollars. And nobody knows what they are invested in. Why is this a problem? One simple way to understand this is to consider old time regulation and the subprime mortgage market and its worldwide impact. Past Bank inspectors and regulators who looked at the books of lenders would be able to evaluate collateral held, loan repayment schedules and performance in their assessment to determine the health of a loan portfolio. If they became convinced there were problems it was within their power to mandate provision for loan losses.

In the case of the sub prime mortgage this old style regulation does not exist. A mortgage is created by a loan originator. The originator does not hold the loan, collateral and all, for more than a few weeks or days. A set of mortgages are packaged and sold as a security. The security is rated by a private agency. This business is profitable because at the end of the chain there is some entity willing to buy the security. It may end up with UBS or Barclays or in a Hedge Fund. Retirement funds or the Yale University endowment may have bought into this Hedge Fund. Now no one knows the value of the security nor the level of risk associated with it.

Nobody knows

There is also conflict of interest. Whereas in the past a loan originator held that loan, literally knew the borrower, today nobody knows or cares. There is a loan servicing company that collects monthly payments and sends its relevant parts where they should go. The originator will not suffer if and when these loans go sour. And that is the immediate conflict of interest.

But there is another perhaps more menacing problem. The act of regulation is not meant merely to protect investors, the gullible and greedy-mostly from themselves. It is also meant to protect the system-the whole financial system.

The turmoil in world financial markets would not today exist were it not for this laxity in regulation. All private efforts so far have failed to cauterize the bleeding as credit markets tighten. The US Fed has now pulled one of the last few arrows out of its quiver, in its effort to assist. When banks cease lending to each other to cover short term needs, problems get worse. Interest rate cuts have gone so far but confidence has not yet returned. And Bloomberg news for yesterday noted "Treasury notes rose on speculation a Federal Reserve-led plan to revive credit markets crippled by defaulted subprime loans will do little to stem an economic slowdown."

Jamaica must consider these developments and take heed. Government's position seems to set out what appears to be a clear policy: post FINSAC, banks have deposit insurance, we have always known the stock market goes up and down with no guarantees, but should there be a collapse of non regulated investment schemes that do offer guaranteed returns, there shall be no bailout. It is not so long ago, a mere 10 years, that our insurance companies offered monthly guaranteed returns on certificates of deposit to pensioners which they then used for everyday living expenses. Whereas a Hedge Fund is not open to ordinary Jane and John Public, our unregulated investment schemes are not so restricted. Fallout is likely to create ripple and wave political and economic instability. These are outcomes perhaps too terrible to contemplate, or are they?

wilbe65@yahoo.com