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Harvard Business School Professor Explains Hedge Fund Greed Machine
We asked Harvard Business School Professor Robin Greenwood about new regulations of the financial services industry, the future of hedge funds, and what Wall Street will look like in five years.
BT: What types of new financial services regulations are most likely to be enacted in the coming months?
RG: The biggest regulatory problem facing the financial markets today is that we don’t have a good system for shutting down financial institutions without having significant spillovers on the rest of the system. There are too many firms that are “too big to fail.” The contracts between financial institutions have been so complex that we don’t know what would happen if we extinguished one of these institutions. Nor do we have a good system for dealing with such a bankruptcy. The fear of what might happen has made the government unwilling to make tough decisions, and has led us to spend significant taxpayer dollars to avoid the unknown. Citigroup is the canonical example.
Part of the regulation is sure to focus on simple technical issues such as trade disclosure and trade clearing. These are important. Consider the following. Suppose that bank A owes bank B $100 who in turn owes bank C $100. If B were to go bankrupt, in theory we would roll over bank A’s claim directly to bank C. In practice, however, we haven’t set up any mechanisms to do this. In a worst case scenario the bankruptcy of bank B causes bank C to file for bankruptcy before it has time to recover its claim on bank A. Thus, we can expect that the government will push for more centralized exchange (and the disclosure that goes along with this) of opaque financial products, which are currently traded in over-the-counter markets.
There are likely to be other regulations dealing with leverage requirements, short sales, securitization, and possibly even executive compensation. I have mixed feelings about these. I think we have seen plenty of evidence that the private sector cannot enforce sensible leverage on itself: bank leverage increased dramatically in the past decade, with devastating effects when banks’ investments lost money. But one worries that if the incentives to take high leverage persist then institutions from abroad with lower capital requirements will step in where constrained institutions cannot. Thus, one always worries that the effects will be to drive business abroad without actually having any effect on systemic risk.
BT: How should the hedge fund industry respond?
RG: The hedge fund industry has been one of the survivors of this mess. Running a hedge fund is likely to get more expensive in the coming years, with additional disclosure requirements. Hedge funds will spend more time explaining or justifying what they do, rather than actually doing it. There are two implications. First, I worry that they will have insufficient flexibility for performing their main function, which is to be the smart money that keeps prices efficient. Second, one or two-person hedge funds such as were common in the past decade are sure to decline relative to the mega-hedge funds, as the legal and compliance costs are likely to rise. These mega-hedge-funds will look more like traditional asset managers— with client service professionals, a compliance team, global offices, etc. But this is a trend of consolidation that would have happened anyway. To me, the biggest unresolved question is, what will happen to fees?
BT: What do you think the hedge fund managers most want to know from the administration?
RG: The Obama tax plan for 2010 calls for hedge fund managers to pay ordinary income tax on “carried interest,” which previously has been taxed at the lower capital gains tax rate. This will more than double the tax rate on these earnings. I suspect that for most hedge fund managers, future tax policy remains the biggest question mark.
BT: How will the operations of Wall Street be different in five years?
RG: Wall Street will be smaller, and it should be. Finance should return to its rightful place in the economic system: a lubricant that greases the wheels of real economic activity, rather than an end in itself. Paul Krugman has argued that the business of finance during the 1930s, ‘40s, and ‘50s was essentially a boring business, and never more than 4 percent of GDP. Our financial system became out of whack during the past decade: nearly all of my best students went to Wall Street rather than starting or running companies. Financial Services commanded nearly 8 percent of GDP in 2007, and an even greater share of corporate profits. In some ways, the crisis is an important reality check for our economy. But it is turning out to be very costly and having large negative effects on non-finance businesses that rely on the credit markets to do business.
About Robin Greenwood:
Harvard Business School Professor Robin Greenwood investigates the effects of investor demand on asset prices, as well as the implications of investor demand for corporate financing and investment. He now teaches a new course on behavioral finance and value investing.
Ever since we've had the technology, we've looked to the stars in search of alien life. It's assumed that we're looking because we want to find other life in the universe, but what if we're looking to make sure there isn't any?
Here's an equation, and a rather distressing one at that: N = R* × fP × ne × f1 × fi × fc × L. It's the Drake equation, and it describes the number of alien civilizations in our galaxy with whom we might be able to communicate. Its terms correspond to values such as the fraction of stars with planets, the fraction of planets on which life could emerge, the fraction of planets that can support intelligent life, and so on. Using conservative estimates, the minimum result of this equation is 20. There ought to be 20 intelligent alien civilizations in the Milky Way that we can contact and who can contact us. But there aren't any.
Frequent shopping for single items adds to our carbon footprint.
- A new study shows e-commerce sites like Amazon leave larger greenhouse gas footprints than retail stores.
- Ordering online from retail stores has an even smaller footprint than going to the store yourself.
- Greening efforts by major e-commerce sites won't curb wasteful consumer habits. Consolidating online orders can make a difference.
A pile of recycled cardboard sits on the ground at Recology's Recycle Central on January 4, 2018 in San Francisco, California.
Photo by Justin Sullivan/Getty Images<p>A large part of the reason is speed. In a competitive market, pure players use the equation, <em>speed + convenience</em>, to drive adoption. This is especially relevant to the "last mile" GHG footprint: the distance between the distribution center and the consumer.</p><p>Interestingly, the smallest GHG footprint occurs when you order directly from a physical store—even smaller than going there yourself. Pure players, such as Amazon, are the greatest offenders. Variables like geographic location matter; the team looked at shopping in the UK, the US, China, and the Netherlands. </p><p>Sadegh Shahmohammadi, a PhD student at the Netherlands' Radboud University and corresponding author of the paper, <a href="https://www.cnn.com/2020/02/26/tech/greenhouse-gas-emissions-retail/index.html" target="_blank">says</a> the above "pattern holds true in countries where people mostly drive. It really depends on the country and consumer behavior there."</p><p>The researchers write that this year-and-a-half long study pushes back on previous research that claims online shopping to be better in terms of GHG footprints.</p><p style="margin-left: 20px;">"They have, however, compared the GHG emissions per shopping event and did not consider the link between the retail channels and the basket size, which leads to a different conclusion than that of the current study."</p><p>Online retail is where convenience trumps environment: people tend to order one item at a time when shopping on pure player sites, whereas they stock up on multiple items when visiting a store. Consumers will sometimes order a number of separate items over the course of a week rather than making one trip to purchase everything they need. </p><p>While greening efforts by online retailers are important, until a shift in consumer attitude changes, the current carbon footprint will be a hard obstacle to overcome. Amazon is trying to have it both ways—carbon-free and convenience addicted—and the math isn't adding up. If you need to order things, do it online, but try to consolidate your purchases as much as possible.</p><p>--</p><p><em>Stay in touch with Derek on <a href="http://www.twitter.com/derekberes" target="_blank">Twitter</a>, <a href="https://www.facebook.com/DerekBeresdotcom" target="_blank">Facebook</a> and <a href="https://derekberes.substack.com/" target="_blank">Substack</a>. His next book is</em> "<em>Hero's Dose: The Case For Psychedelics in Ritual and Therapy."</em></p>
Chronic irregular sleep in children was associated with psychotic experiences in adolescence, according to a recent study out of the University of Birmingham's School of Psychology.