Tuesday, November 07, 2006

Financial tsunami beyond regulation

When the financial regulators start getting concerned about what speculators are up to, it is time to take notice. The Financial Services Authority (FSA) recently expressed worries that some hedge funds were "testing the boundaries of acceptable practice concerning insider trading and market manipulation". Hedge funds engage in very high-risk speculative activity with other people’s money. They borrow against these funds to extend their operations. Now the FSA is sounding the alarm bells about the growth of so-called private equity markets. They use a mixture of funds and debt to provide financial backing to private companies. Private equity funds then restructure businesses, load it with debt, change the management, cut costs, take large dividends and then make a profitable exit by refloating the company on the stock market or selling it on. Firms currently in the firing line include Debenhams, United Biscuits, and the Automobile Association. As many as 20% of the UK workers are employed in companies saddled with private-equity investment. Many banks are also caught up as the speculators gamble in the private-equity markets which are beyond the reach of the regulators. Given rising interest rates "the default of a large, private equity-backed company, or a cluster of smaller such companies, seems inevitable". Risks are getting higher as private equity firms club together to do bigger deals. The FSA suggests that in "extreme circumstances" financial stability as a whole could be threatened. What all this reveals is that the FSA is running to catch up with a financial sector that is beyond control. Hedge funds and private equity markets operate in the shadows, away from the prying eyes of the financial authorities. This unregulated activity is an essential feature of capitalist financial markets. If it were ever to be regulated, the funds would simply move into other financial "vehicles" and areas of activity. In other word, the free market in finance will always outrun any attempt at regulation. However, as the FSA warns, any failure in these sectors could well bring down the entire financial system, including high street banks. Global capitalism has expanded over the last 30 years through the creation of mountains of debt, both personal and corporate. The wave of debt has built into a tsunami that is starting to engulf both companies and individuals in every country. No wonder the FSA is alarmed.

Gerry Gold, economics editor

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