MAY 2010                                                                                                                                         Download PDF Version

The Fifth Labour

Hercules’s fifth labour was the cleaning of the Augean stables. This seemingly impossible task he completed in a day by diverting two nearby rivers to run through the stables and get rid of thirty years of built up waste. I have often thought back to this story having hoped and expected a similar torrent to sweep through the financial world in reaction to the recent crisis.

A Lost Opportunity
Angela Merkel apparently ‘spooked’ the markets recently with her ban on naked short selling. This seems like an easy target, no one likes shorters benefitting from company’s pain, and, in Germany, the short squeeze on Volkswagen in 2009 is still fondly remembered. While I would agree that shorting some financial institutions should be banned since this can become a self-fulfilling death spiral, in general I tend to think that shorting acts as a benefit to the market, re-setting share prices to correct levels of value. I would also argue that there is merit in the reinstatement of the ‘uptick rule’ in the US which disallows the shorting of stock except on an uptick of price. However, this is hardly the great cleansing of the system that many would have wanted.

If Merkel wanted to punish the shorters then surely Hedge Funds in general would have been the better target. It looks as if Hedge Funds are going to emerge from the 2008-2009 period with their reputations fairly much intact although there have been some infamous disaster stories in the sector. The strong bounce back in markets has allowed the basic structure of the industry to remain intact. In particular the 1+20% fee structure which in no way aligns the investor with the manager. We would not necessarily argue for a reduction of fees but it would have been a good chance to alter the terms at which the performance fees crystallise; for instance if the performance fee became payable once the investor redeemed (or at an agreed date in the future) then interests would be better aligned.

The trouble is that Hedge Fund investors are generally discrete and diverse and do not talk to each other about these issues, and would be unlikely to form into a united front.

Moral Hazard
A much more serious issue is the moral hazard related to the bail-out of the big banks. The short-term risk-taking and excessive bonuses enjoyed by the senior executives needs regulating. Fundamental reform is required to prohibit banks gambling and taking misunderstood risks.

Therefore we hope that it is not too late for the politicians to grasp fully the nettle of financial reform and regulation. However, if they did read the Hercules story they will know that Augeas, having asked for the cleaning of his stables, was killed by Hercules for not fulfilling his side of the deal; many politicians will be mindful of the same electoral fate.

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