Keenan Mayo

If you’ve spent the last 5, 10, or 20 years enjoying the fruits of a blissfully unregulated financial system that created wealth for its adepts but nothing for the American people, then surely you’re steamed at the big regulatory overhaul that passed in Congress this summer. But there’s still something you can do: move over from the stringently monitored world of banking to the somewhat less monitored world of hedge funds. We spoke to an actual big-shot hedge-fund manager to pick up tips on how you too can start the rogue finance shop of your dreams.

Step 1: Create a hedge-fund team!

The bare essentials to get your new fund going: two junior analysts, a junior trader, and a chief financial officer. When you “spin off” from your current bank, it’s crucial to steal away some crack subordinates. A big selling point to potential investors is that you have a well-oiled, cohesive unit with a history of “crushing it.” Actual big-shot hedge-fund manager’s tip: “Choose people who have a nose for ferreting out opportunities, but who are not willing to cut your guts out and try to replace you. You need junior-level people.”

Step 2. Name your fund!

Let’s face it: aggressive, testosterone-redolent names (e.g., Hungry Wolf Capital, Thor Hammer Fund, Tomahawk Capital Management) are as passé as Meatpacking District mega-restaurants and conspicuous luxury boxes at the stadium. Come off as attuned to the times with something gentle and/or arboreal (e.g., Sassafras Group, Bending Birch Asset Management, Larchwood Partners). Actual big-shot hedge-fund manager’s tip: “The goal is to project sturdiness without rapaciousness. You don’t want to be Three-Headed-Dog-Guarding-the-Gates-of-Hades Capital. And you don’t want to use your own name. Typically, guys use streets and towns from their childhoods. Or a tree, to convey strength and deep roots.”

Step 3. Hire a law firm!

You’ll need a good firm to incorporate your fund—first in Delaware, and then offshore in either the Caymans or the British Virgin Islands. But beware of big, sprawling, white-shoe corporate law firms that overcharge. Instead, go with the specialists who do this thing all the time. Actual big-shot hedge-fund manager’s tip: “The Coke and Pepsi of the business are Schulte, Roth & Zabel and Akin, Gump, Strauss, Hauer & Feld. Avoid the high-tone and really big firms. They are too expensive and they don’t know what they’re talking about with funds. They’re too busy billing Pfizer millions upon millions to file their 10-K forms.”

Step 4. Get that anchor capital!

You need your first assets under management (A.U.M.) to get your fund off the ground. But you most likely don’t have deep pockets yourself, and that damned Madoff has discredited the formerly effective inscrutable-Zen-warrior passive-aggressive approach to investor solicitation. So your best bet is to find a “seeder” to put up the anchor capital. Warning: This can be excruciating. Actual big-shot hedge-fund manager’s tip: “The nasty world of seed investing is one step up from human trafficking. They try to own a piece of you: ‘I’ll give you $25 million, but I own 40 percent of your company.’ It’s similar to the ‘pimp-and-ho’ model: they put the money into you, and you’ve gotta go work the street. One of the best seeders is a company called Reservoir.”

Step 5. Get a prime broker!

When you buy a stock, that transaction needs to be recorded somewhere. Your prime broker is like your custodian. It clears your trades for you. Walk around to Goldman Sachs, Morgan Stanley, or Deutsche Bank—or maybe Bank of America. Actual big-shot hedge-fund manager’s tip: “Probably Goldman is still the best. Remember: When you start, you’re walking upright but weighed down by the seeder, the prime broker, and your own team—they’ll all want equity, of course—and it’s a real slog. But once you’ve got your seed and your documents in order, you’re ready for business.”

Step 6. Check into your very own hedge-fund hotel!

Even though you’re going rogue, you still need a proper office to look respectable and legit. And guess what? The very same investment houses that serve as prime brokers almost invariably have unused office suites—“hedge-fund hotels”—that are just waiting to have their reception areas emblazoned with your fund’s logo. Actual big-shot hedge-fund manager’s tip: “They might provide you with low-cost rent. There are lots of little hedge funds trying to make their start, and the brokers will agree to a month-to-month lease.”

Step 7. Hire a good P.R. person!

It’s a long road to your first billion. But when you get there, watch your back! Actual big-shot hedge-fund manager’s tip: “When you have over a billion dollars at least, that’s when people start shooting at you. There’s so much Schadenfreude out there that you’ll need Schadenfreude-defense. But remember—that’s way down the line.”
Once you’ve successfully navigated all these steps, celebrate in pre-2008 style: build a Suffolk County house that eats up 90 percent of your lot’s footprint; marry that yoga instructor; or, best yet, exploit every campaign-finance loophole to underwrite a slate of candidates who will repeal the Obama-nomics overhaul bill of 2010.

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T

he recent Dodd-Frank financial reform legislation takes important steps toward stabilizing the financial sector, but it may have created a false sense of security. There is a large and worrisome vulnerability to bank runs that the legislation did not address, and we are not as safe as we could be from another financial panic.

The problem is not the traditional type of bank runs your grandparents might have told you about. Rather, modern bank runs occur in the shadow banking system. The shadow banking system includes major investment banks, money market mutual funds such as Fidelity, Vanguard and Schwab, and securities dealers such as those that can be found at JP Morgan, Bank of America and Citigroup.

These banks, which control trillions of dollars in assets – money market mutual funds alone were worth $3.8 trillion in 2008 — serve as intermediaries between borrowers and lenders, and hence function like traditional banks, but they are not subject to the regulations that exist in the traditional sector to protect against problems such as bank runs.

A bank run within the shadow banking sector was at the heart of the 2008 financial meltdown that led to one of the worst recessions in U.S. history, and it’s a problem that could happen again if we don’t take steps to prevent it. Shadow banks manage 401(k)s, insurance policies, pension funds and other consumer investments, and problems in this sector can devastate retirement, education and other investments that consumers rely upon for security.

Why Bank Runs are a Problem in the Shadow Banking Sector
Bank runs occur when there are real or imagined worries about the ability of a bank to repay its depositors. In the traditional banking sector, deposit insurance solves the bank run problem, but it can create other problems in the process. In particular, deposit insurance gives banks protection on the downside, and hence gives them an incentive to take on too much risk. Because of this, traditional banks are subject to strict regulation to limit the amount of risk they can carry.

Shadow banks are also vulnerable to bank runs and other problems. The cataclysmic problems at Bear Stearns and Lehman Brothers are prime examples of this, but they weren’t subjected to the same regulation as traditional banks. In fact, these types of banks have hardly been regulated at all. Why is this?

Industry leaders and lobbyists have argued that more regulation would make them less competitive, and prevent them from delivering returns on investments. However, the economic argument that market discipline will force shadow banks to self-regulate has had more influence on policy. The idea is that monitoring by depositors worried about losses will prevent the accumulation of excessive risk. And if problems occur anyway, the monitoring will ensure that the banks hold enough high quality financial assets in reserve to prevent bank runs, and in any case the problems will be confined to the few banks causing the trouble.

But there are three problems with this argument. First, large shadow banks have an implicit government guarantee due to their too-big-to-fail status, and this gives them the incentive to assume too much risk despite the monitoring.

Second, an informational market failure created by lack of transparency and highly complicated financial assets makes it impossible for investors to monitor the quality of the loans, investments, and the financial assets held as reserves. Prior to the financial meltdown, investors relied upon the ratings agencies to do the monitoring for them, but that turned out to be a mistake. Many of the assets held in the shadow banking system turned out to be much riskier than their rating suggested, and when that fact was revealed, a bank run followed.

Third, banks were far more interconnected than regulators realized. They held too few high quality reserves to prevent bank runs, and the problems were not confined to the financial sector. 

By MARK THOMA, The Fiscal Times

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