By Ian Morley*
Banks are about as popular as politicians and estate agents. Not liked, but considered too important to fail and too important to upset. In teenage parlance they get a lot of verbal but not much action.
In stark contrast, hedge funds are increasingly being accused as possibly the perpetrators and certainly the catalysts of the crime. And what was the crime? To let everyone know that the party was well and truly over. How was the crime committed? By shorting the banks and mortgage companies to deflate and thereby demonstrate that they were castles in the air. The answer seems to be shoot the messenger!
Can anyone recall a time when the ceo, cfo or chairman of a listed company ever announced its share price was unsustainable and recommended that investors sell? Yet it is the unlimited rise of prices, unchecked by such sober messages, that ultimately leads to the inevitable falls and far greater destruction of wealth than a few hedge funds shorting some stock.
But perfectly sensible people will tell you that the shorting of stocks in general and bank stocks in particular is probably unethical and ought to be illegal. This ignores all evidence to the contrary: that prices fell more after the short-selling ban was imposed and that hedge funds shorted at the top of the market not at the bottom. Hedge funds should have been praised for raising the alarm-not chastised for ringing the alarm bell of excess and greed.
The world of hedge funds is Darwinian. There are no bailouts for us. The good will prosper while the poor and mediocre fail.
Sensible dialogue leading to intelligent regulation seems to have been jettisoned by the latest EU daft (sorry, draft) directive that is seen as being inspired by prejudice and possibly breaches international agreements on free trade. It will add billions in burdensome costs just after the expensive and mostly useless MiFID implementation and credit meltdown, and could transfer regulation from the FSA direct to the EU, even though 80% of the entire European hedge fund business resides in London.
The new mantras of liquidity, transparency, managed accounts and tougher regulation will probably prove to be palliative rather than curative. Managed accounts cost more and, unless legally segregated, the danger of rehypothication-an arcane term for grabbing assets that don’t belong to you-will still apply unless they are very carefully and expensively constructed.
Liquidity is fine, but not if you want to have exposure to small-caps, emerging markets, distressed, and so on. Transparency will allow more quantitative risk to be measured but that is not the point. The risk was obvious before; it’s what you do about it that matters. And as we know, most investors remained in denial until they ran out of money. They then sold their good assets to meet the margin call on their bad assets.
So, as anthropology teaches us, those who survive are better equipped for the future and, as the study of subsidies teaches us, those subsidised tend to remain weak and unlikely to change their bad ways. Guess which one is the banks and which the hedge funds?
The fact that we should all be a bit more humble and transparent is a given. The old days of “give us your money and we will manage it” have been replaced by a genuine rather than superficial environment of listening and learning. Offering investment solutions rather than just selling investment products is the way the good alternative providers will go because they must to survive. The banks have no need to change and therefore won’t. Why should they when we are collectively subsidising them out of bankruptcy?

*Ian Morley is the founder of Wentworth Hall Consultancy in London. A prominent figure in the hedge fund industry, he has advised the Bank of England and was the first chairman of the Alternative Investment Management Association.