So it is Barack Obama vs Wall Street, and both sides are pulling no punches. But while Obama has singled out the banks, hedge funds are seriously threatened too. Here’s Obama:
My resolve to reform the system is only strengthened when I see a return to old practices at some of the very firms fighting reform; and when I see record profits at some of the very firms claiming that they cannot lend more to small business, cannot keep credit card rates low, and cannot refund taxpayers for the bailout. It is exactly this kind of irresponsibility that makes clear reform is necessary.
Banks which have Federally-insured deposits or access to cheap Federal Reserve funds (such as Goldman Sachs) will be banned from trading for their own account or owning hedge funds or private equity, while those choosing to become pure investment banks will have a ceiling on assets.
According to the White House announcement the proposal would:
1. Limit the Scope-The President and his economic team will work with Congress to ensure that no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit.
2. Limit the Size- The President also announced a new proposal to limit the consolidation of our financial sector. The President’s proposal will place broader limits on the excessive growth of the market share of liabilities at the largest financial firms, to supplement existing caps on the market share of deposits.
This is great news for the hedge funds: they will face less competition from the banks, which do much the same thing with their own money, often on a larger scale. But it is also terrible news: the banks will have to dump holdings in huge numbers of hedge funds, including some of the world’s biggest. On top of that, they won’t be able to buy any more, removing the most common exit route for hedge fund managers wanting to cash in. For private equity this does not seem so serious, although the big private equity groups will benefit from the lack of competition from all the banks’ PE arms.
There appears to be worse news for the denizens of Greenwich, Connecticut and Londons’ Mayfair. According to the Wall Street Journal’s story:
Under the proposed rule, commercial banks would be prohibited from owning, investing in or advising hedge funds or private equity firms. Bank regulators would not be simply given the discretion to enforce such rules. They would be required to do so.
Apart from the problems of dumping their hedge fund stakes – of which there are hundreds, notably JP Morgan’s Highbridge, Morgan Stanley’s FrontPoint and Goldman Sachs Asset Management – a ban on “advising” hedge funds would appear to kill much of the lucrative banking business of prime broking, servicing hedge funds (assuming the WSJ isn’t just mixing up “advising” and the ban on being a “sponsor” of a fund, whatever that means).
If lending money to hedge funds can survive as a non-advisory, purely automated business, it could be good news for the biggest funds which can do much of the work in-house, by driving down the price of loans even further.
But for the small and mid-sized hedge funds, having no prime broker to hold their hands and introduce them to potential investors will require a major culture change, or a move onto a hedge fund platform.