`Light' hedge-fund rules OK, Bernanke says

April 12, 2007|By Bloomberg News

NEW YORK -- Federal Reserve Chairman Ben S. Bernanke said that a "light regulatory touch" on hedge funds is justified because of the incentives that investors and creditors have to monitor risks.

"Because hedge funds deal with highly sophisticated counterparties and investors, and because they have no claims on the federal safety net, the light regulatory touch seems largely justified," Bernanke said in a speech to the New York University School of Law's Global Economic Policy Forum. "Thus far, the market-based approach to the regulation of hedge funds seems to have worked well."

Bernanke said market-based incentives can complement government regulation to promote financial stability, a concept promoted by his predecessor, Alan Greenspan. Critics of the approach say it has spawned excesses.

"Public policy has been increasingly influenced by the insight that the market itself can often be used to achieve regulatory objectives," Bernanke said. "The invisible-hand approach to regulation aims to align the incentives of market participants with the objectives of the regulator."

Bernanke didn't comment on monetary policy or the economy. After he concluded his remarks, the central bank released minutes of its March 20-21 policy meeting, which said that further rate increases might be necessary to lower inflation. When it comes to commercial banks, prices on subordinated debt, whose holders would be the last in line in the event of failure, give regulators "useful information about the bank's riskiness," Bernanke said.

The Fed's approach is also endorsed by other federal regulators. The presidential working group on financial markets, in its report on hedge funds in February, endorsed a hands-off approach, relying on market pressures as the best way of dealing with risks. The group, including the Fed, Treasury and other regulators, undertook the study after hedge funds more than tripled in the past decade, to $1.4 trillion.

Bernanke said that one case where market discipline failed was Long Term Capital Management LP, a hedge fund that collapsed in 1998. He concluded that Congress was right to have avoided imposing a "much more intrusive regulatory regime" in the aftermath of the fund's demise.

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