Top hedge fund executives testified about the financial crisis before the House Committee on Oversight and Government Reform today, summarized by the FT. The execs didn’t fight the need for regulation but warned against excessive regulation. Standard, and justified, fare for market participants. It’s always the same thing with financial regulation: you need enough regulation to provide transparency and fairness, but too much regulation limits innovation and just pushes market activity to other regions.
Most notable were two hedge fund managers. First was Philip Falcone, co-founder of Harbinger Capital highlighting his childhood in Minnesota where his dad earned $14,000 a year:
“It is important for the committee and the public to know that not everyone who runs a hedge fund was born on 5th Avenue – that is the beauty of America,” he said. He added: “This is not a case where management takes huge bonuses or stock options while the company is failing.”
Second was Kenneth Griffin, founder of Citadel Investment Group, a hedge fund that is now also developing an exchange for credit default swaps along with the Chicago Mercantile Exchange. Below is his full testimony or here’s a video for non-readers. He was the smartest guy in that room, or perhaps any room. Amidst the worst financial crisis since the 1930s, his firm is now poised to take spread on the $55 trillion market for credit default swaps.
Mr. Chairman and Distinguished Members of the Committee, my name is Kenneth Griffin, and I am the Founder and CEO of Citadel Investment Group. Thank you for the opportunity to address this Committee. Today, our nation is working through the worst financial crisis since the 1930s. It is imperative that we, as a society, continue to take actions to mitigate the impact of the credit crisis on our broader economy, in the hopes of keeping Americans employed and productive. I appreciate your leadership on this important undertaking.
I am proud that in the 18 years since I founded Citadel, it has grown into a financial institution of great strength and capability, with a team of over 1,400 talented individuals. Citadel manages approximately $15 billion of investment capital for a broad array of institutional investors, endowments, high-net-worth individuals and Citadel’s employees. Citadel’s Capital Markets division plays an important role in our nation’s financial markets. Citadel is the largest market maker of options in the US, executing approximately 30% of all equity options trades daily. In addition, Citadel accounts for nearly 10% of the daily trading volume of US equities.
All businesses take risk. In some industries, we refer to risk taking as “research and development.” At financial institutions, we often take risk by investing in securities. However, we have all seen the consequences of taking imprudent risk. Failures to understand and manage risk can be severe, as we have seen far too often in recent weeks.
Although the financial crisis has affected virtually every participant in the financial markets, including Citadel, I believe that Citadel’s consistent and constant focus on risk management has been a critical asset in successfully navigating this financial crisis and will continue to serve us well in the years to come.
In this crisis, the concept of “too interconnected to fail” has clearly replaced the concept of “too big to fail.” The rapid growth in the use of derivatives has created an opaque market whose outstanding notional value is measured in the hundreds of trillions of dollars. As a result, there is great concern about the systemic effects of the failure of anyone financial institution.
In the area of credit default swaps, for example, there is an estimated 55 trillion dollars of outstanding notional contracts between market participants. This number is almost four times the GOP of our country.
The creation of central clearing houses to act as intermediaries and guarantors of financial derivatives such as credit default swaps represents a straightforward solution to the issues inherent in today’s opaque over-the-counter market. Of greatest importance, such a clearing house will dramatically reduce systematic risk — allowing us to step away from the “too interconnected to fail” paradigm. Numerous other benefits will accrue to our economy. Regulators, for example, will have far greater transparency into this vast and important market.
In recent months, Citadel and the CME Group have partnered in building such a clearing house for credit default swaps. Our solution is an example of how industry in cooperation with regulators can solve complex market problems. I believe, and have said before, that our financial markets work best when they are competitive, fair, transparent and stable.
Proper regulation is critical. But the best regulation is created with an eye toward unleashing opportunities, not limiting possibilities. To achieve this, Congress, regulators and industry must all work together. Our markets are complex and they must be well understood if they are to be well regulated. We must solve the serious issues we face but in a way that does not stifle the best innovative qualities of our financial markets. I thank the Committee for holding this hearing today and I look forward to answering your questions.