Dow Jones Newswires

U.S. Rep. Leach Disappointed By BIS
Hedge-Fund Proposals

Dow Jones Newswires

WASHINGTON -- The chairman of the House Banking Committee on Friday
criticized recommendations made by an international panel of central bankers
on the regulation of hedge funds, saying the proposals were too soft on the
industry.

Rep. Jim Leach, an Iowa Republican, said in a statement that much of the
recommendations by the Basel Committee on Banking Supervision "are simply
common good sense." But he said the panel should have recommended that
governments refuse to bail out troubled hedge funds.

"I was disappointed...not to find in the report the most obvious
recommendation: that there should be no public bailouts if hedge funds fail," he
said. "Just as intrusive government regulation can be counterproductive, so
bailouts can be socially debilitating. They present moral hazards that should be
rebuffed in advance of any alleged emergency."

The Basel Committee, working under the Bank for International Settlements,
recommended Thursday that banks that lend to hedge funds be made the
primary instrument of their regulation. It urged banks to be more careful in
extending loans to such funds, and to insist that the funds be more candid in
disclosing the extent of their investment risks.

The committee also said that hedge funds may need to be directly regulated by
tougher methods, such as licensing, if indirect regulation proves insufficient. But
it said such forms of regulation would "clearly extend beyond the competency
of bank supervisors and would require a political initiative."

That's because many hedge funds choose to register in small countries where
regulation is weak, putting themselves out of the reach of regulators in the larger
countries where they do most of their business. For example, the U.S. hedge
fund Long-Term Capital Management L.P., which the Federal Reserve helped
rescue in September, is registered in the Cayman Islands but its principal offices
are in Greenwich, Conn.

"I was disappointed that the report did not deal more forcefully with the
off-shore regulation problem," Leach said. "Whenever a hedge fund is
registered in an off-shore domicile, it distances itself from the aegis of U.S. law
and regulation. Since regulation in certain off-shore jurisdictions is generally
weak...banks should be directed to be more conservative in lending to funds
organized in regulatory havens."

Leach also complained that the panel ignored the anti-trust implications of
hedge-funds owned by a group of big financial institutions. Long-Term Capital,
for example, is now largely owned by a consortium of big U.S. banks that
arranged a $3.6 billion bailout of the company at the behest of the Fed. Leach
said that ownership arrangement "would appear to be an umbrage to a
competitive market system, and governmental bodies have an obligation to
review it."

He said: "While the Basel Committee's study is a good beginning, it should be
understood that if bank loans to a hedge fund are backed by 5% core capital,
as they are in many money center banks, and the hedge fund then uses the
borrowed money to leverage its capital more than 25 times, bank funds
implicitly become leveraged 500-fold to purchase financial instruments that may
themselves be leveraged still further."

"This extraordinary leveraging is even more troubling if a self-dealing situation
develops where banks or their officers are also investors in a particular hedge
fund," Leach said.

   -By Joseph Rebello; 202-862-9279; e-mail: joseph.rebello@dowjones.com