Large funds pose systemic risk to the US and global financial system
Recent reports report that the Justice Department’s top antitrust lawyer, Jonathan Kanter, plans to examine the practice of large private equity funds to “bundle” competing firms to create monopolies and oligopolies.
It might be a good idea on the antitrust front, but let’s take a step back and look at the risk front.
In 1995, a young trader from Singapore named Nick Leeson, who was supposed to be doing low-profit, high-volume arbitrage trades on the Nikkei, approved his own trades. When it entered a short overlap of Nikkei and Singapore trading, the Kobe earthquake cratered markets in the region, causing Leeson’s trade to fail catastrophically. To hide it, Leeson entered into a number of risky deals that ultimately drove his employer, Barings Bank – chartered in 1764 – into bankruptcy with losses of $1.4 billion.
Just 13 years later, another young trader, Jérôme Kerviel, engaged in unauthorized transactions that cost Société Générale some 4.9 billion euros ($7.2 billion). Then, in the same year 2008, Bernie Madoff became the biggest financial fraudster in history, defrauding investors of up to $65 billion.
Today, the world’s largest private equity fund, BlackRock, controls more than $10 trillion (yes, it’s with a “T”) in investment assets. That’s nearly half of US GDP. That’s about a third more than annual federal spending. That’s about 10% of the total value of the entire US stock market in 2020. That’s a massive amount of money. By comparison, Berkshire Hathaway and Warren Buffet’s KKR are valued at less than half a trillion dollars. Most other funds, although worth hundreds of billions, are veritable pikemen by comparison.
These funds have enormous influence. Annual letters from financiers like Larry Fink and Warren Buffett make national headlines and are scrutinized by both Wall Street and Washington, and make policy decisions based on them. Nonetheless, these huge funds somehow manage to escape the definition of a “systemically important financial institution,” or SIFI.
A SIFI, in simple terms, is a non-banking entity which, if it were in “significant financial deficit – or the nature, scope, size, scale, concentration, interdependence or combination of its activities” , could pose a threat to the United States. financial stability.” In other words, SIFIs are those deemed “too big to fail” by regulators. They emerged after the 2008 financial crisis as part of the sweeping Dodd-Frank Wall Reform Act Street and Consumer Protection (Public Law 111-203) which became law in 2010.
Since then, the Financial Stability Supervisory Board has designated – and revoked – a number of SIFIs, including insurance companies, finance companies and other non-bank entities.
But these large investment entities that, simply by their statements, can influence not only the markets, but also social and government policy, have none of the government oversight of a SIFI.
When the Bernie Madoff scam was finally uncovered after decades of wrongdoing, Cornell University determined that in addition to Madoff’s own victims, people who knew his victims or were near where they found had withdrawn some $363 billion in investment funds.
Now imagine if a fund the size of BlackRock – or even a tenth of its size – were to have a rogue trader like Nick Leeson if even a trillion dollar fund were to be exposed as a Ponzi scheme.
The markets would crater. Pension funds and popular institutions would hedge in the same way as when Madoff was exposed, but it would be several orders of magnitude above Bernie Madoff, who was relatively small. Not only would the markets spit, but it could take years – decades – to regain public confidence. The ensuing financial catastrophe could even create an existential threat to the republic.
Putting aside for a moment the enormous political clout of a fund like BlackRock, or even some of its smaller competitors – which should not be dismissed as the political heavyweight that it would be – the Common sense would dictate the need to oversee some of these funds.
I am of course not so naive to believe that a failure of these funds could be avoided by closer government oversight. The SEC missed obvious inconsistencies that should have exposed the scam, and failed to even act when a concerned citizen pointed them out. But the idea that there’s a “cop on the beat” might deter bad actors.
Congress, take action! Earn funds with $1 trillion or more under SIFI management.
The opinions expressed in this article are the opinions of the author and do not necessarily reflect the opinions of The Epoch Times.