Tuesday, March 06, 2007

Disclosure Not Answer to Hedge Fund Transparency Says NY Fed CEO

By James Hamilton, J.D., LL.M.


While acknowledging the enduring appeal of the call for more pubic disclosure of hedge funds’ risk profile and actual positions, NY Fed President Timothy Geithner said that such disclosure may provide false comfort and is in some ways unachievable. In his view, the potential gains from a disclosure regime of this type would be limited compared with the cost of trying to put such a regime in place on the global scale that would be necessary to make it effective. His remarks were delivered at a seminar sponsored by the Global Association of Risk Professionals in NYC. The Wall Street Journal recently described Mr. Geithner as the Fed’s ``go-to man’’ for financial crises with a ``bully pulpit,’’ but who cannot appear to be invading the turf of other domestic or international regulators.

The disclosure urged by some policymakers is of two distinct kinds. The first is information that would make it easier to evaluate the overall risk profile of major hedge funds and their counterparties, and thereby judge their vulnerability to a sharp movement in asset prices. The second is information about the actual positions of individual funds or institutions, which would make it easier to identify concentrated exposures to specific risk factors, and thereby assess more accurately the potential impact of the failure of a major fund or institutions on the markets.

While admitting that there are a number of crude measures of overall risk profile that, if disclosed, would give counterparties information they do not now typically get about the risk of failure of the hedge fund, the senior official cautioned that these would be lagging indicators carrying with them the risk of providing false comfort in some circumstances and excessive concern in others.

The central banker also acknowledged the enduring appeal of the second type of disclosure being proposed, which is information on the actual positions of major hedge funds. But this transparency is unachievable, he explained, because there is no feasible way to try to capture in real time the rapidly changing exposures of different institutions to different risks in any meaningful fashion.

But he promised that the Fed will continue to explore ways in which the provision of greater information to counterparties and to the markets more generally could help reduce vulnerability to financial crises. For now, though, the practical limitations on achieving greater transparency through disclosure underscore the importance of strengthening the robustness of the shock absorbers in the financial system.

In his view, the most sensible thing to do is to improve the capacity of the core of the financial system to handle adversity, which requires improving the strength of the capital and liquidity cushions, as well as the market infrastructure. In this regard, he said that the Fed is encouraging a global initiative for more sophisticated and conservative management of credit exposures in OTC derivatives and structured financial products, as well as of exposures to hedge funds.