One potential option for hedge fund regulation

ZH has closely been covering and providing commentary on the publicly released details of Geithner's "New Rules of the Game"; a couple of posts by Rick Bookstaber (here and here) make a convincing case for the most effective way to limit future market risk. Basically, much of the criticism leveled against the risk management industry has typically been lazy accusations that risk managers still believe that markets follow a normal distribution/don't understand fat tail risk. Given that even college juniors looking for internships can recite Taleb in their sleep, it seems unlikely at this point that this is the major knowledge gap in our system. Rick goes on to point out that for more effective risk management, we need to get beyond the "hey, be careful, something may happen" mode of thinking, into something more actionable.

The proposal therefore is a central body that has access to all the exposures of banks, large funds and other systemically important players. By seeing the positions and correlations, this central body could hypothetically spot seemingly uncorrelated unwinds ahead of time and provide guidance on how to avoid it.

ZH thinks this is a great idea in theory but has reservations about practical implementation. Basically, the architect of this system is facing a trade off between asking for increasingly proprietary trade positions from banks and hedge funds, and the ability of the central body to pull out these correlations. Given that this central body is likely to be a federal agency, paying federal salaries and benefits, it's unlikely that they will be drawing the brightest minds who are capable of coming up with innovative ways to see correlation links between extremely disparate asset classes across disparate market players from limited trade information. The other option is to legislate mandatory position reporting that is much more detailed than hedge funds are even considering right now; basically, to make it easier for the not-as-smart-as-if-they-were-being-paid-more regulatory employees to see the linkages.

This could see some pretty drastic moves by hedge funds and even internal proprietary bank desks to do as much as possible to evade the reporting standards. The publicly stated reason of course would be that these super secret hedge funds do not want to divulge their highly proprietary and ridiculously complex trade strategies. The cynics among us might argue that they simply don't want to be unveiled as glorified vol sellers and/or leveraged mutual funds.

In summary, it seems reasonable that Geithner & Co. have something similar in mind to what Rick mentions as a way to improve regulation going forward but there are three options to consider:

1) Pay more to get smart people into these regulatory jobs and face the music as politicians moan about those overpaid regulatory guys.

2) Impose extremely high position reporting standards to make it easier to find the hidden correlations in our markets and watch the hedge fund industry duck and weave to avoid this.

3) Do neither 1 or 2 and hope and pray that next time we'll get lucky. Sphere: Related Content

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Geithner pushes for increased regulation

In a move to avert the next crisis, Geithner & Co. are seizing the political initiative and populist momentum to call for "New Rules of the Game"; i.e. more regulation. Looking past the rhetoric, it's interesting to assess each leg of the proposal independently.

- make it mandatory for "large" hedge fund, private equity firms and venture capital firms to register with the SEC, new disclosure requirements and potential inspections

First, it will be interesting to see what gets defined as "large". The specific number will give some indication of what the administration's true motives are; if the number is legitimately high to prevent a LTCM-type unwind vs. a generic $1B AUM limit to cover every mom and pop corner store in Greenwich to simply rattle the cages. 

The disclosure requirements are going to require beefier compliance departments for (insert household fund name here) but the end result will be minimal, especially to the industry leaders which tend to hold themselves to higher audit standards. For example, the mega funds with a strong institutional base are already used to a detailed level of scrutiny of their operation. 

- these same "large" pools of capital may be ordered to raise capital or limit leverage

This has the potential to really screw over some funds - it's all dependent on what "large pools of capital" is defined as, and what the target capitalization levels are set at. If the administration's philosophy is purely to prevent systemic risks, this shouldn't pose a serious damper to returns but Zero Hedge has a sneaking suspicion that some asset classes are going to be severely curtailed.

-would require a central clearinghouse for derivatives

Great move. The initial transition period will be more than offset by a lower probability of a Lehman London type scenario. 

-new rules to require banks to build up capital during boom times for the slumps

Great in theory, but I'm short this idea being executed well. How do you define boom times, slump, adequate capital, and over/undercapitalized? It's foolish to think that banks won't figure out some way around this in 6 months to increase returns on capital.

- future plans to generally police fraud more effectively, plug gaps in regulation and collaborate with international counterparts on tax evasion and leverage rules

More details are really needed - there are a bunch of simple, logical actions that the government could take but that is far from a given.

As a final note, it's important to realize that this is far from getting passed. ZH is reasonably sure something to this effect will get passed but keep in mind that Congress will attempt to amend this to ride the populist wave as much as possible. This could result in additional, poorly thought out legislation, including curbs on compensation; we'll be watching this very closely.

Sphere: Related Content

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Seeking donations: Media coach for Geithner

Seriously, this guy needs a muzzle. Obama's public support for his embattled SecTreas seems misplaced after Geithner publicly expressed his openness for the Chinese and Russian proposal to strip the USD of "reserve currency status". The dollar got mauled across every single currency pair before Tim was able to issue a correction that promptly caused a reversal.

A lot of day traders just got completely demolished, getting stopped out on the long side before getting whipsawed by Tim's clarification. Even the hint of the dollar losing reserve status would be disastrous, especially in light of the newly announced PPIP and other programs. Sphere: Related Content

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Sir Stanford Owes Over $100 Million In Taxes, Wants To Be Considered For Treasury Secretary Post

Failed fugitive and successful criminal mastermind Allen Stanford, together with his wife Susan, who may or may not be the "girlfriend" he was with during his Virginia capture, owes the U.S. $104.2 million in back taxes, more than double the previously reported amount of $56 million, according to tax liens filed on Texas and Florida properties. Stanford had previous IRS tax issues in 1997, when he lost a tax court case in which he was found guilty for not filing a 1990 tax return and owed $442,000 in taxes related to his ownership of Guardian International Bank, a bank he had set up in the British West Indies. Hilariously, Stanford claimed he failed to file tax returns because records were destroyed by hurricane Hugo in 1989, yet that had not prevented him from filing a 1989 tax return.

Stanford, who believes the best defense is an offense so retarded your enemy's brain turns to mush, sued preemptively the IRS to contest the agency's contention that he and his wife "itemized deductions improperly, wrongly classified capital gains as losses, and attempted to carry forward more than $4.1 million in net operating losses in violation of tax laws."

If Sir Stanford had not ended up getting all caught up in running some small time Ponz, he would definitely have been the number one contender for the position of Secretary of the Treasury. Sphere: Related Content

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