Home' Trinidad and Tobago Guardian : August 7th 2014 Contents BG28 | THE ECONOMIST
BUSINESS GUARDIAN www.guardian.co.tt AUGUST 2014 • WEEK ONE
Financial crises may seem a familiar
part of the economic cycle, but they
rarely repeat themselves exactly. In
the 1980s the locus was Latin Amer-
ica, in the late 1990s Russia and
southeast Asia, in 2007-2008 Amer-
ican housing and banks. Now some
worry that the next crisis could occur in the asset-
The industry manages US$87 trillion, making it
three-quarters the size of the banking sector. The
biggest fund manager, Blackrock, runs US$4.4 trillion
of assets, more than any bank has on its balance
sheet. After the crisis regulators tightened the rules
on banks, insisting that they hold more capital and
have sufficient liquidity to cope with short-term
pressures, but that may be a case of generals fighting
the last battle. In the absence of lending from banks,
many companies have turned to bonds, owned mainly
by fund managers, for credit.
Fund managers have caused problems in the past.
The 1998 collapse of Long-Term Capital Management,
a hedge fund run by some of the brightest minds on
Wall Street and in academia, led to a rescue instigated
by the Federal Reserve. Bear Stearns bailout of two
hedge funds it had been running contributed to its
collapse in 2008. In the same year a money-market
fund run by the Reserve group was forced to "break
the buck," imposing losses on investors, setting off
a run that prompted the Fed to provide a backstop
All this has made regulators nervous. In January
the Financial Stability Board, an international body
which tries to guard against financial crises, published
a consultation paper which asked whether fund man-
agers might need to be designated "systemically
important financial institutions" or SIFIs, a step that
would involve heavier regulation. A new report from
the Bank of England worries that pension funds and
insurance companies are no longer playing the sta-
bilizing role in markets that they used to, by taking
advantage of short-term market falls by buying assets
that look cheap. Instead t.ey may be amplifying the
cycle because of their need to meet more conservative
accounting and regulatory requirements.
The asset-management industry has marshaled
some powerful counter-arguments. First, managers
act as stewards of other people s capital, which is
held in separate accounts, with third parties acting
as custodians. Banks such as Lehman Brothers, in
contrast, were speculating on their own account.
Were a fund manager to go bankrupt, the assets
would simply be transferred to a competitor, with
no loss for the investors concerned. Hundreds of
mutual funds close each year, with minimal market
impact and without needing government rescue.
Second, the parallels with banks are inaccurate.
With the exception of hedge funds, asset managers
tend not to operate with borrowed money, or leverage.
The size of Blackrock s balance sheet is only US$8.7
billion, while HSBC s is nearly US$2.7 trillion, or
more than 300 times bigger. Fund managers thus are
far less vulnerable to sudden falls in asset prices than
banks proved to be in 2008.
Third, there is little evidence that mainstream asset
managers contribute to market panics. Retail investors
are less flighty than institutions. Many invest through
defined-contribution 401(k) plans, through which
they put a bit of money into the market every month.
This makes them indifferent to short-term fluctu-
ations. The Investment Company Institute, a trade
body, says that in the autumn of 2008, a low point
for stock markets, equity sales by mutual funds com-
prised only 6 per cent of total trading volume in New
Finally, designating fund managers as SIFIs would
have perverse consequences. The F.S.B. paper stated
that size was the key criterion, suggesting a threshold
of US$100 billion, which would capture 14 American
mutual funds. This may miss the point: Reserve
ranked only 81st among American asset managers
and 14th among those running money-market funds.
In any case, many big funds are low-cost trackers
such as Vanguard s 500 index fund, which allows
retail investors to get a broad exposure to the stock
market for fees of only 0.17 per cent a year. As one
of the consequences of being a SIFI, the fund might
be required to hold a capital reserve, the cost of which
would be passed on to retail investors. In addition
SIFIs could be required to support the orderly liq-
uidation fund, a bailout vehicle for other SIFIs. In
other words, when the next Lehman goes bust, small
investors in Vanguard might be on the hook.
As yet, no fund manager has been designated a
SIFI. However, Andy Haldane of the Bank of England
cautions that it may be prudent to do so.
"As any self-respecting asset manager would tell
us, past performance is no guide to the future," Hal-
dane says. "This is especially true in an industry as
large and as rapidly changing as asset management,
with asset portfolios becoming less liquid and more
correlated and investor behavior becoming more
fickle and run-prone."
A recent paper from the University of Chicago
concludes: "The absence of leverage may not be suf-
ficient to ensure that monetary policy can disregard
concerns for financial stability."
The worry is that herding among fund managers
might lead to a general sell-off, as happened with
mortgage securities in 2008. The fund-management
industry is becoming more concentrated, thanks to
the rise of passive funds that track an index. A category
known as exchange-traded funds has grown spec-
Assets or liabilities?
Continued on Page 29
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