Tuesday, January 27, 2009

Hedge fund reform to bring investors to their senses

Professor Sol Picciotto, a senior adviser to TJN, has co-written a letter that appears in the Financial Times. We are delighted to reproduce it in full.

Hedge fund reform to bring investors to their senses
January 26
From Prof Sol Picciotto and Prof David I. Campbell.

Sir, Current debates about rules for hedge funds (“Hedge funds move to limit rules burden”, January 19) are tackling the problem at the wrong end. There should indeed be no need to regulate hedge funds, provided that they invested only their own money, were subject to normal rules of disclosure, and their income was properly taxed. Then they would actually be private funds, rather than funds that exist only because of special treatment by public authorities.

We believe that hedge funds greatly contribute to undesirable levels of speculation and hence instability, rather than to what is supposed to be their true purpose, knowledgeable investment. Their deleterious effects could be greatly reduced or eliminated by two significant, but obvious, reforms.

First, any bank that is backed by the taxpayer (via the lender of last resort guarantee) should be prohibited from lending to hedge funds. This would greatly reduce those funds’ leverage, and therefore their excessive risk-taking.

Second, hedge funds’ returns should be properly and fully taxed as income, and the Inland Revenue should vigorously attack their use of tax havens for tax avoidance and evasion, to which a blind eye has been turned for too long.

Deprived of these substantial public subsidies, hedge fund investors would be risking only their own money. They should, of course, be at perfect liberty to do this.

However, once deprived of the public subsidy that has underpinned seemingly unending and high returns, we would expect that enough investors would come to their senses to change the ridiculous governance structures that allow fund managers to profit enormously from the upside and lose nothing on the downside. If not, so much the worse for those investors.

Sol Picciotto,
Emeritus Professor of Law,
Lancaster University, UK

David I. Campbell,
Professor of Law,
University of Durham, UK

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