Tags: Asness | AEI | Dodd-Frank | crisis

Hedge Fund Whale Decries Regulation, Cronyism

By    |   Friday, 10 May 2013 12:43 PM

On May 9, the American Enterprise Institute (AEI) staged an hour-long interview of one of its distinguished board members, financier Cliff Asness, by Arthur Brooks, the president of AEI. The event was part of a project at AEI called the Culture of Competition CEO Series.

Asness, former managing director and director of quantitative research for the asset management division of Goldman Sachs, is a co-founder of AQR Capital Management, an $80 billion enterprise. Asness has a Ph.D. from the University of Chicago and has published articles in leading academic journals that have received critical acclaim.

The premise of the interview, stated briefly on the website, is that Asness charged in a 2010 Wall Street Journal op-ed, which triggered thousands of comments, that the Dodd-Frank Act was "perfectly designed to create the largest and most powerful crony system in history," ... one that "will itself select for, reward and enforce corruption."

The purpose of the interview was to consider whether that prediction was "overblown or prescient," whether firms are "cozying up to Washington" and how a principled, free-market financier should interact with decision makers in Washington.

In response to an invitation sent to regular attendees at AEI events, I made a fruitless effort to point out that the corrupt regulatory regime of which Asness speaks has been in place for decades and was hardly the creature of Dodd-Frank. Therefore, the prediction could hardly have been prescient. The decision makers in Washington respond to the contributions and demands of clients based primarily in the financial capital, which is Wall Street.

The following are some excerpts from the interview:

Q (Brooks): What is the Dodd-Frank Act?
A (Asness): It is a collection of many different things. Mostly it pulls every idea off the table that's been around and jams them all together — Financial Stability Oversight Council (FSOC) members, like experts wearing robes, with untold access to data, it has resolution authority to circumvent bankruptcy law, it's the Consumer Financial Protection Bureau (CFPB), it deals with moving derivatives to exchanges. Basically, it is four or five giant experimental bureaucracies. Laymen can't get their heads around it, because it's an amorphous beast, a left-leaning wish list of regulation.

Q: There's a consensus that markets were wrong and bureaucrats can get it right. Why should an average American care at all?
A: I'm a natural pessimist. People should be as fired up about this as about Obamacare. I don't think people will go to the barricades, but every single thing will cost more and be less efficient, but costs are very diffuse, like sand in the gears.

I think we have made the cost of another crisis more, not less, although the chance is always small. Someone who got 2008 right could have gone bankrupt by being early. The idea that the FSOC can fix it is not only wrong, but they can't affect the future without taking actions that will impede growth, like taking away the punchbowl, as with monetary policy. Everyone laughed at Greenspan, who was a cynic before he changed his mind.

To the extent that people think someone has their back, markets are less stable. Bernie Madoff was registered with the Securities and Exchange Commission (SEC). I've had SEC audits. They're very good at telling honest people how to do things better, but not at finding true fraud. The FSOC might make people less vigilant and the magnitude of the next disaster worse.

Regarding the resolution trust, people should care about the rule of law. They can take over your business without recourse. It's hard to get sympathy for bankers. The CFPB is supposed to make things safe, but I prefer a world where we all know it's risky. Your back can never be covered everywhere. Social studies show that when traffic lights and guard rails were taken out in the Netherlands, there were fewer accidents.

Q: So who was hurt most by the 2008 crisis — fat cats or the poor?
A: As a fat cat, another crisis would result in another bailout, and Dodd-Frank has done nothing to make that less likely. Crises will be more likely, cost more and you'll still be on the hook. Dodd-Frank hasn't changed that. Also, there's less access to credit. People need food, clothing, shelter and healthcare to survive, but to thrive, they need credit, energy and communications.

Q: Is Dodd-Frank part of that?
A: It's more general than Dodd-Frank. Implementation is trickling in. There's reluctance to lend, because we're sending banks mixed messages, because CEOs will be made to do the walk of shame if there's ever a bad loan. Banks won't make loans at tiny spreads when they're getting interest on reserves. An air of uncertainty is never good. The grand experiment and mixed signals by government are collectively killing credit.

Q: Regulation is hurting the poor as an unintended consequence of the bureaucratic state, but it's helping rich people through cronyism.
A: It's helping undeserving rich people. Cronyism is competition through government advantage. You have to do something nice for the government first. It can be defensive or offensive, by hurting competitors, imposing taxes on others. We already had that with government contracts. We have more cronyism because we have more government. Markets are self-correcting, but government isn't.

Q: Can you give some outrageous examples from Dodd-Frank?
A: A lot isn't written down, so we don't know. They haven't written rules; they've granted powers. It's harder to say no to politicians asking for money, so some will give. The costs are passed on to consumers.

Q: You're most worried about amorphous pools of money to create new agencies. France is largely run by socialist bureaucrats. Is that what you're talking about?
A: It's even in the United Kingdom, as in "Yes, Minister." The United States has the State Department, which has grown organically, but Dodd-Frank is a giant leap. The CFPB is designed to be permanent, with little oversight. It's like a bomb that you can't defuse. Cancers build their own blood supplies. I don't want to be on the wrong side of these institutions. I don't know why I'm talking here.

Sample audience questions:

Q: Do Wall Street people understand what they've done?
A: I'll defend some of them, because I'm not sure what they should do. These aren't terrible people; they think they have a good product.

Q: Are some worse than others?
A: It is said that small business is better, but I don't agree with the glorification of small business, because their objective is to get big. Cronyism creates advantages for bigger entities. Our industry never had interaction with Washington before. Mostly we're just trying to comply.

Q: What would you have done in 2008?
A: I would have done the bailout rather than take the small risk of a depression worse than the Great Depression. We bailed out Long-Term Capital Management, and now that seems quaint and moronic. Individual companies have been bailed out in the name of preserving jobs and for political benefit. To be credible in ending bailouts, you have to actually fail to bail someone out, and the government has to stop creating bubbles.

(I would observe that these are the musings of someone who has not processed the fact that the damage to the financial sector that Asness decries is self-inflicted, but Wall Street has adopted the strategy of presenting itself as the victim of zealous regulators, most of whom have done their best to serve the industry, now bent on preventing bankers from creating jobs.)

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On May 9, the American Enterprise Institute (AEI) staged an hour-long interview of one of its distinguished board members, financier Cliff Asness, by Arthur Brooks, the president of AEI. The event was part of a project at AEI called the Culture of Competition CEO Series.
Friday, 10 May 2013 12:43 PM
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