Shoot the messenger

Meanwhile, a consortium of Wall Street institutions has taken over the regulatory functions of the Federal Reserve, and particularly the powers of the Chairman, as well as the President’s Economic Recovery Advisory Board, and will be dictating US financial regulatory policy in future. Some government departments will be spun out to avoid dangerous and destabilizing concentrations of political and regulatory power. Politicians and bureaucrats will be punitively taxed as punishment for their past misdeeds.

That concludes today’s alternative reality resolution of the Global Financial Crisis. But I hope you get the point. This is a mirror image of the current EU and US regulatory initiatives around hedge funds, private equity, bank proprietary trading desks, and the other financial sins that so conspicuously did *not* get us into our current mess.

Governments are busily attempting to punish the markets and economic mechanisms that exposed their own faults and failings. The Volcker Rule, the EU Directive on Alternative Investment Fund Managers, the new Congressional jobs creation package that incidentally hikes tax rates on fund managers’ profits, all amount to the most concerted assault on the current international operating norms for GPs that private equity has seen in decades, or perhaps ever.

And why? It’s become a matter of cliché that hedge funds and the much-reviled “vultures” of private equity did little or nothing to create the GFC, and the spiraling sovereign debt crisis in Europe. Lax regulatory oversight in the US absolutely was a major contributor to the GFC; but even the eyes-wide-shut attitude of the Bush-era regulators pales in comparison to the dereliction at German state government level, or in Athens or Madrid.

Western governments may have been still looking at the last macro debacle, the Asian Financial Crisis of 1997, when speculative money flows arguably did help exacerbate the situation. But no one else seems to have detected any such thing happening this time round. The public markets, as reflectors and transmitters of economic reality, have every reason to move on the current situation in Europe; but if anything, they have been comparatively restrained.

Yet the politicians have made a direct, spurious equation between the crisis and independent funds. The original thinking behind the EU Directive was formulated prior to the crisis under Denmark’s Poul Nyrup Rasmussen, and the GFC gave a convenient cover for implementing it. Pressure from Berlin to enact the EU Directive has been explicitly linked to German public anger over the Greek bailout. And in the most sublimely ridiculous epitome of Western leaders living in denial, Greek Prime Minister George Papandreou has threatened to sue US investment banks for supposedly creating his country’s crisis. Western politicians’ response to reality calling is to shoot the messenger.

If private equity has done nothing to deserve this, it may have to live with the consequences nonetheless. Amendments to the EU Directive may blunt some of its worst and silliest provisions. Vigorous lobbying in Congress may tone down the fund management tax provisions in the package now under discussion. Even the Volcker Rule has yet to see the statute book. But some modified form of all these proposals will likely be exercising some kind of influence on private equity’s operating environment in the years and decades ahead.

No one is claiming GPs are saints. They may occasionally be culpable; they are almost certainly all operating within highly commercial and well-financed businesses, with compensation structures and incentives designed around self-interest. But their management of public money from pension funds and other investors is well-policed and directly accountable to LPs; and their role in industrial revitalization and job creation surely outweighs any talk of asset-stripping vultures.

Above all, they are far less culpable, and far more accountable, than the politicians and bureaucrats now bearing down on them. But the politicians have the enviable privilege of being able to set the rules – to blame somebody else.

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