So the big financial system overhaul bill has finally passed. It seems like legislators, lobbyists and lawyers have been working on this thing forever. In reality they have been working on it in one form or another pretty much since someone taped that two dollar bill to the revolving door at Bear Stearns.
A lot of friends who are not in the financial industry have asked me what I think of the legislation. As if I’ve read all 2,300 pages. Most of the people who just voted on the bill haven’t even read all 2,300 pages â€¦ or even one-tenth of that. But I still offer my quick take, which is that it’s a large and complicated bill designed to try to rein in a large and complicated industry, the excesses of which over the years caused large and complicated economic problems.
It is going to be years before we understand the full effect of this legislation. Some winners and losers are easy to pick out. Others will take some time. One big winner for sure is lawyers. This bill is going to create a lot of work for lawyers and compliance departments, figuring out what the bill actually says and how to implement specific provisions firm-by-firm. Some law firms may create entire departments just to figure out which pieces of this affect their clients and how.
For hedge funds, the new rules mean registration, and higher compliance costs. But administrators, prime brokers and accounting firms are already developing and deploying middle- and back-office systems designed to automate many of the compliance functions that will be required by greater regulatory oversight. In the end, the new rules will probably not be a large barrier to entry, even for an industry that could probably use a slightly bigger one. Financial regulation reform will not result in the dismantling of the hedge fund industry as we know it, nor will it likely affect returns.
Even the supposedly greater regulatory oversight to which hedge funds will be subject may in reality never materialize. Subjecting hedge funds to more regulation will only be effective insofar as the regulators can handle the added workload. In recent years there has been little to suggest the SEC is equipped to identify, understand or address the kinds of risks that forced the global financial system to its kneesâ€”including counterparty risk and leverage.
And subjecting the hedge fund industry to greater regulatory scrutiny, while it may help discourage the kind of outright fraud we’ve seen, it won’t totally prevent it. Nothing will. You can’t legislate morals.
As we choke down and digest this thing over the coming months and years, one thing that will stick in my craw is how financial regulatory reform is a shining example of the way the American legislative system works. What I mean by that is this is a bill that was written by lobbyists, not legislators. The whole lobbying process is distasteful to me, but I harbor no illusions about why it exists: the complexity and nuances of many aspects of the world todayâ€”finance, health care, energy policy, to name threeâ€”are beyond the ability of most elected officials to comprehend.
That’s not necessarily meant to be a knock on politicians. They are, after all, politicians; they are not bankers, doctors or energy experts. But they are also not like everyday people. Many members of Congress may not know what a gallon of milk costs at the store and are years removed from calculating how much gas to put in the car to make it to work the rest of the week while still having enough money left over to buy food, pay the rent and shop for clothes for the kids. Put simply, politicians are not equipped to understand the complexities on either end of most legislation. Enter the lobbyists. Banking lobbyists, environmental lobbyists, organized labor lobbyists, gun lobbyists, tax lobbyists, abused spouse lobbyists, renters’ rights lobbyists, auto safety lobbyists, auto industry lobbyistsâ€¦. All have a story to tell, a change to suggest, a meal or trip to pay for.
I was talking the other day with an executive at a hedge fund administration firm. The conversation inevitably came around to financial regulation. He said he was in favor of financial regulation that gave investors confidence. The old way of doing business wasn’t sustainable, he said. I was dismayed, but not surprised, when he told me nobody connected to drafting financial regulatory reform had ever asked him what he thought might be needed, nor had they asked anyone he knew. Industry lobbying groupsâ€”the Managed Funds Association, in particularâ€”had spoken on behalf of the industry.
Apparently the lobbying is only just beginning, even now that the bill is about to become law. Regulators themselves appear to be the next targets as they determine how to implement this new rule book they’ve been given.
Although the banks and others may complain about the additional costs of complying with these new rules, they’re not going to be the ones ultimately paying for it. They’ll pass those costs on to their customers and clients.
Which it could be argued is a fair thing to do. We as consumers have benefitted from the financial wizardry that led to credit default swaps and collateralized debt obligations and we should probably be responsible for paying to make sure things don’t get out of hand again.
Not that this legislation will necessarily do that. When it’s all sorted out, it probably will have some positive effects, but only if its implementation is carried out by intelligent, competent people of integrity. Like the Zen master says, “We’ll see.”