By Edmund L. Andrews & Louise Story New York Times
WASHINGTON A wide-ranging plan by the Obama administration to overhaul the financial system by regulating hedge funds and private equity drew a mixed response on Capitol Hill and in the industry on Thursday.
The Treasury secretary Timothy F. Geithner outlined the plan before the House Financial Services Committee where he said the changes were needed to fix a badly flawed system that was exposed by the current financial crisis. Mr. Geithner in his opening statement called for comprehensive reform. Not modest repairs at the margin but new rules of the game."
Under the administration proposal hedge fund private equity and venture capital fund advisers would for the first time have to register with the Securities and Exchange Commission. They would be required to provide the government on a confidential basis information on how much they borrow to leverage their investments as well as information about their investors and trading partners. The S.E.C. would then share those reports with a new systemic risk regulator."
The issue of systemic risk was a major concern among private equity executives. Buyout firms have long argued that they do not pose nearly as much a risk as did securities firms like Lehman Brothers or hedge funds like Long-Term Capital Management arguing that the failure of a portfolio company would not endanger the broader economy.
Several people in private equity said that they are waiting to see more details on the Treasury Departments plan. While several big private equity firms are already registered as investment advisory firms many smaller firms are not.
Its an unprecedented opening of the kimono for the industry" one industry person said.
Douglas Lowenstein president of the Private Equity Council said the group would work to ensure that any legislation included the tools needed to to protect the American economy and taxpayers without imposing undue burdens on private equity firms seeking to make investments that create jobs and make companies more competitive."
Richard H. Baker chief executive of the Managed Funds Association the hedge fund industrys main lobbying group said that while the group supported the idea a systematic risk regulator the focus should be on preventing failures of market participants only when there is concern about the consequences to the broader financial system."
These are complex issues" Mr. Baker said and it is critical for policy makers to have a firm understanding of the implications of these proposals on financial markets before taking extraordinary action such as seizing the assets of non-bank financial institutions thought to be systemically relevant."
Hedge funds have generally not been implicated in the financial collapse a point Mr. Baker made in his testimony on Thursday.
One senior executive at a major investment firm said that the Treasury Department sought to include private equity and venture capital firms to avoid singling out hedge funds. Had it not done otherwise this person said many hedge fund firms would probably rush to claim that they are not in fact hedge funds.
John A. Paulson a hedge fund manager who made billions by betting against the housing market said in an interview on Tuesday that the main goal of any regulation of hedge funds should be to protect investors from frauds like the gigantic Ponzi scheme perpetrated by Bernard L. Madoff.
Were for anything that protects investors" Mr. Paulson said. While he acknowledged that some hedge funds might have relied too heavily on leverage to improve their returns he added that there hasnt been one problem at all to global systemic risk in the U.S. and abroad from a hedge fund."
Leon G. Cooperman a longtime hedge fund manger who runs Omega Advisors said Wednesday that new regulations were not needed and that he found the call for new rules to be mere finger-pointing.
Im already heavily regulated" Mr. Cooperman said saying that his fund was subject to oversight from the Security Exchange Commission the Commodity Futures Trading Commission the Fed and other organizations.
The truth of the matter is most major hedge funds are registered with the S.E.C. they are regulated with the C.F.T.C. and they are subject to Federal Reserve margin requirements" he said referring to the Feds rules that require all investors to set aside funds when buying securities on credit. The regulatory system is already in place. Let them enforce what they have."
During the committee chairman Representative Barney Frank Democrat of Massachusetts said it was clear that the government needed better options than say allowing a Lehman Brothers to fail or pumping billions of taxpayer dollars into a too-big-to-fail company like the American International Group.
We are looking for an alternative method to avoid those polar extremes" Mr. Frank said.
But Republican reaction at least initially was lukewarm at best. Representative Spencer T. Bachus of Alabama the ranking minority member said it was unacceptable" to have the government subsidize the cost of resolving" troubled institutions and that he hoped there would be more hearings to discuss the issue.
And Representative E. Scott Garrett a Republican from northern New Jersey said government authority to take over failing institutions needed to be carefully structured to avoid a lot of unintended consequences."
We could really end up doing a heck of a lot more harm than good" Mr. Garrett said. Forgive me if I am skeptical."
The plan outlined in broad strokes by Mr. Geithner would require Congressional approval. It would give the government new powers over systemically important" banks and other financial institutions that are so big that their collapse would jeopardize the economy as a whole.
Our hope is that we can work with Europeans on a global framework a global infrastructure which has appropriate global oversight so we dont have a balkanized system at the global level like we had at the national level" Mr. Geithner said.
The government would have the power to peer into the inner workings of companies that currently escape most federal supervision insurance companies like A.I.G. multibillion-dollar hedge funds like the Citadel Group and private equity firms like the Carlyle Group or Kohlberg Kravis & Roberts.
If regulators decided that a company had become too big to fail" as was the case with A.I.G. in September they would subject it to much stricter capital requirements than smaller rivals and much closer scrutiny of its borrowing levels and its trading partners or counterparties.
Where in the federal government should that power sit?" asked Representative David Scott Democrat of Georgia.
Mr. Geithner said it would be good to build on the model of the F.D.I.C." The Federal Deposit Insurance Corporation created during the Depression after a wave of bank failures insures customers deposits and can take over failing banks.
But the most striking new proposals and the ones that may provoke the most heated opposition from the industry would regulate so-called private pools of capital hedge funds private equity funds and venture capital funds and the gigantic market in financial derivatives including instruments like credit-default swaps the insurancelike instruments that allow investors to hedge against bond defaults.
There is likely to be an even bigger fight over the proposal to regulate financial derivative products. Some derivatives like stock options and interest rate futures are already regulated because they are traded on exchanges like the Chicago Board of Trade.
But the administration would regulate trading in more exotic derivatives that trade privately like the credit-default swaps that were used both to hedge against and to speculate on high-risk mortgage-backed securities. These more exotic products have been traded almost entirely in the informal over-the-counter market that lies outside regulatory scrutiny.
The administration would require that all standardized derivatives be traded through a regulated clearinghouse. Traders would be required to provide documentation on their collateral and borrowings. They would also be subject to new eligibility requirements and their trading and settlement practices would be subject to new standards.
But the proposals are all but certain to provoke criticism from all sides traders who say the rules are too intrusive and policy experts who say the approach is too vague.
