December 24, 2005
Nocera: The Champion of Feel Good-Regulation
Whenever I pick up the New York Times and see a column by Joseph Nocera I know that I will get a traditional dose of the need for "feel-good regulation." The column will contain a fuzzy, well-intended discussion of the the need for expanded federal regulation of the business and investment community, a community that is habitually misbehaving. "Feel-good regulation" makes proponents feel better because they believe they are addressing a social problem; the effectiveness of the regulation is secondary to the warm feeling proponents have when regulation is aimed at the rich and powerful. Fuzzy thinking on effects is tolerated; critics are dismissed as pawns of the powerful. Today's column , "Offering Up an Even Dozen of Odds and Ends," is more of the same.
Take one example: Nocera again defends the need for hedge fund regulation because they are, horrors, "secret." "Secrecy is the Achilles heel of the hedge fund industry. It's scary that nobody knows what hedge funds are doing..." He is incorrect on several levels. First, hedge fund investors know what hedge funds are doing; they are sophisticated investors and keep track of their money. Hedge fund managers must communicate with hedge fund investors and hedge fund investors money is "hot"-- investors can and do withdraw funds at the drop of a hat. Some managers lie of course but their investors watch, discover and pull their money out. Second, some secrecy by hedge funds makes imminent business sense: hedge fund trading strategies -- researched, designed and market tested -- are valuable and the value disappears once they become public knowledge. Other traders will free ride off the success of the strategy until the strategy no longer works. Why spent capital to develop a strategy if you have to tell everyone else what it is once it makes money? Unless hedge fund managers inherently lie to their own investors there is no need to force them to publicly file or declare their trading strategies. Forcing them to reveal their strategies will mean that hedge fund managers underinvest in developing strategies unless they can avoid the regulation (move to the Canary Islands or require a two year lock in of investments). In short, secrecy is sometimes bad and sometimes not. It is bad when, for example, CEOs use techniques to obscure the true nature of their salary from their shareholders. Old tricks include options and perks; the new trick (in yesterday's WSJ) is the tax "gross-up", the company pays an executives tax bill. This is bad; CEOs are hiding their total pay package from their investors. If CEOs believe that the deserve such salary payments then why do they hide them? They should be able to justify them on the merits.
The fuzzy thinking is in not discriminating the CEO pay package problem (too much secrecy) and the hedge fund problem (some secrecy is necessary to the business).
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