Thursday, April 9, 2009

Regulatory Reform Likely to Give Passes to PEU's & SWF's

America's shadow banking system included investment banks, hedge funds, private equity underwriters (PEU's) and foreign sovereign wealth funds (SWF's). After Lehman Brothers imploded, investment banks disappeared. All ran to the safe harbor of commercial banking, already regulated. That leaves hedge funds, private equity and sovereign wealth funds as candidates for regulation. Bloomberg reported:

Bernanke and Geithner also called for stronger regulation to constrain the risks taken by firms that could endanger the financial system.
Yet, signs point to hedge funds as the only new group under a regulatory umbrella. Do SWF's and PEU's not pose a systemic risk? Knowledge @ Wharton reported in December 2007:

Writing in the Financial Times last July, former Treasury Secretary and Harvard president Lawrence Summers noted that government shareholders may not always have the same interests as ordinary shareholders. "The logic of the capitalist system depends on shareholders causing companies to act so as to maximize the value of their shares," he wrote. "It is far from obvious that this will over time be the only motivation of governments as shareholders. They may want to see their national companies compete effectively, or to extract technology or to achieve influence."

Governments of target, or "host," countries could find themselves in awkward situations, he said. "What about the day when a country joins some 'coalition of the willing' and asks the U.S. president to support a tax break for a company in which it has invested? Or when a decision has to be made to bail out a company, much of whose debt is held by an ally's central bank?"

Given his stated concerns, wouldn't Larry Summers, now President Obama's Chief Economist, put SWF's under some kind of review structure? Is it because he wants them to pony up funds for public-private partnerships? Will taxpayer backed profits help make up for past U.S. financial pain?

What about PEU's? While their investors are wealthy, that doesn't mean no capital calls. Should a few get skittish, like Wall Street the week of September 15, 2008, a PEU run could occur. The Carlyle Group made $681.3 million of capital calls on Calpers, the huge pension fund in 2008. What if Calpers said no and asked for its investment back? Crater time, or do other options exist?

Regulation is about more than the risk of a PEU run. Many private equity firms have a wide variety of investment funds. Insider information from one arm could turn into profits for another. Basic, ethical oversight is warranted.