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SEC and FBI bare teeth at hedge funds

by Open-Publishing - Thursday 28 September 2006
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Trade-Exchange Rates Governments USA

SEC and FBI bare teeth at hedge funds
By Ambrose Evans-Pritchard 
(Filed: 27/09/2006)

The US government is losing patience with hedge funds, signalling the end of glory days for an unregulated industry with $1,700bn to hand and the ability to operate with near total freedom across the globe.

The Securities and Exchange Commission (SEC) bared its fangs yesterday, launching a probe into Amaranth Advisors after it nearly collapsed this month when a lone trader lost $6bn betting on gas futures. The SEC said it would investigate whether Amaranth misled investors and would examine the role of banks in offering limitless credit.

Separately, the Federal Bureau of Investigations (FBI) said the hedge fund industry was spreading too fast beyond its natural niche as a rich-man’s toy, luring small savers in to risky investments.

"It is an emerging threat because of the dollar value and the number of institutions actively taking a look at this," said Chip Burrus, the FBI’s assistant director. "People that aren’t expecting to have this type of a risky investment in their portfolio end up taking a bath," he said.

Mr Burrus said the FBI was determined to uphold the integrity of markets and protect citizens who "just get fleeced left and right".

In softer tones, the US Federal Reserve also hinted at a crackdown, fretting that an ever greater share of the financial system was slipping beyond the oversight of regulators.

"We may have to revisit both the scope and the design of that framework," said Timothy Geithner, the New York Fed’s chief. Last week he warned that "the probability of systemic crisis may rise to levels that are unacceptably high", unless the authorities step in to reshape the market.

Mr Geithner, who is in charge of regulating US banks, has been beating the drum for months, fearing that the world’s $300,000bn derivatives market may be concentrating risk instead of dispersing it. He said the plethora of new tools had yet to be tested in a crisis and offered no defence against a financial earthquake. "They have not ended the tendency of markets to occasional periods of mania and panic. There are aspects of the latest changes in financial innovation that could increase systemic risk in some circumstances, by amplifying rather than dampening the movement in asset prices," he said.

The Fed now seems to singing from the same hymn book as the European Central Bank, which described hedge funds as a "major risk" to the global system in June. In a withering critique, it said the funds were clustered together on similar trades, raising the risk that speculators would capsize the ship as they rushed from one side of the deck to the other.

The ECB said the mimicking behaviour by the funds had "surpassed levels seen just before the near-collapse of Long Term Capital Management in 1998".

Glenn Stevens, head of Australia’s Reserve Bank, said he too was becoming alarmed by risk of dominoes falling as too many speculators scrambled to exit losing trades at the same time.

"It is under abnormal conditions, when liquidity in markets is under pressure, that the leverage employed by some of the funds will be at its most damaging."

A study by Greenwich Associates estimated that trades by hedge funds make up half the distressed debt market, 45pc of emerging market bonds, and up to a third of riskier corporate debt.

Amaranth is the biggest fund to go badly awry in recent years, but a clutch of smaller ones have come to grief, including Mother Rock LP and Bayou Management.

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2006/09/27/cnussec27.xml

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