McCreevy Holds Hedge Funds Blameless in Market Crisis

While some people want to demonize hedge funds, they are not the cause of the current difficulties in the market, EU Commissioner for the Internal Market Charlie McCreevy told the European Parliament. Rather, he said the present crisis has its roots in poor quality lending, compounded by the securitization of the loans in off balance sheet vehicles.

Many hedge funds have been particularly active in the structured credit markets and incurred losses, conceded the commissioner, but that is the way markets go. Sophisticated players in hedge funds know that financial markets function on risk.

But, in his view, the crucial fact is that hedge fund failures did not spill over into the wider financial system. Investment fund rules under the UCITS Directive have held up. Reaffirming the European Commission’s light touch financial regulation, the commissioner said the prudential framework and bank risk controls in place have prevented hedge fund failures from triggering wider systemic disruption.

The transfer of mortgage loans and their risks to other parties through securitization has been at the center of the crisis, said the commissioner. These risks have sometimes returned to the originating bank when their financial vehicles could not sell off or finance the bank-originated securities.

He vowed that the Commission will examine the mechanisms at play, including the role of special purpose vehicles, and their relevance for banks. The problems of valuation of complex securitized products and clearing mechanisms in stressed markets will also be analyzed. The market crisis has also highlighted the importance of reputational and liquidity risk as important drivers to properly assess the risk exposures of banks to complex securitized transactions.

The commissioner also criticized credit rating agencies for being too slow in downgrading their ratings for structured finance backed up by sub-prime lending. He is also concerned about the potential conflicts of interest of the rating agencies. The conflict arises because they act as advisors to banks on how to structure their offerings to get the best mix of ratings, while also providing ratings widely relied upon by investors. Another concern is the importance of the ratings for the calculation of banks' capital requirements.