Paulson Committee Backtracks

After standing firm on limiting (read: doing nothing) hedge fund regulation, the President’s Working Group on Financial Markets has apparently caved under international pressure...well, kind of. The Wall Street Journal reports that though earlier this year the group said current regulations were sufficient to prevent hedge funds from threatening the financial system’s stability, they will create two new advisory groups to develop voluntary "best practices" guidelines for investors in hedge funds and the managers that run them.

Apparently the pressure comes from German Chancellor Angela Merkel and French President Nicolas Sarkozy; neither of whom can be regarded as anti-capitalists. It remains to be seen whether the committee can whitewash their concerns as they have with U.S. investor advocates, given that the response will be to ask (politely I’m sure) hedge fund managers and investors to voluntarily adhere to meaningless guidelines on disclosure and due diligence.

Another issue the two subcommittees will discuss will be valuation, a lightening rod issue on Wall Street. Hedge funds love the mark-to-model method that allows them to use their own fuzzy math to determine the value of their portfolio, and consequently their 20 percent take of the returns. The more acceptable method is the mark-to-market, where a financial instrument’s value is based on the current market price.

When it comes to valuation methods, disclosures and due diligence, voluntary guidelines aren’t enough. Wall Street has been down this road before and it didn’t work. Stock analysts were supposed to adhere to best practices and we all know how that story ended. Already major hedge fund blow-ups have occurred, most notably at Bear Stearns which faces litigation, including several claims filed by Zamansky & Associates on behalf of investors. This trend is sure to continue so long as Wall Street is allowed to make up its own rules.