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The Biggest Buying the Big


The keynote speech at the Monte Carlo Hedge Fund Conference (I gave a lowly speech on such mundane things as the markets and the role derivatives play and will play) was about how hedge funds will be positioned in the future.

The speech was given by the head of a large bank's fund of fund business. She suggested that hedge funds should be positioned as a cog in the wheel of a large bank. In other words, large banks should control the allocation of money to hedge funds for two primary reasons. First, hedge funds should be opportunistic and as part of a sophisticated portfolio controlled by an experienced manager of funds, this can be achieved more readily. Secondly, it is just simply safer when a large fiduciary controls the ultimate un-sophisticated investor.

Rhetoric is a wonderful thing: it can take a good idea and position it to cause harm. What sounds plausible is in fact dangerous. Surely hedge funds should be opportunistic, but they can be such without a big bank telling them to be.

The speaker was prescient. J.P. Morgan Chase (JPM:NYSE) announced this morning that they are buying Highbridge, probably the largest convertible bond hedge fund in existence. Congratulations to my old friend Henry Zwieca.

But that is where the happiness ends for me and the concern begins. When the government repealed Glass-Steagle, it seems we have been on a relentless course for banks to control just about everything financial. Hedge funds were the counter trend: control of the intermediary system through hedge fund development was becoming fragmented. As you know, I viewed this as a positive: less leverage and less monopolistic control. No more.

Lured by the incentive fees of the hedge fund business (which are coming down as we speak), JPM, itself the master of the derivative world, could not resist adding another quiver to its already massive array of derivative risk.

Fragmentation of markets is a good thing is it not? Why do we espouse a monopolistic structure in the financial system but abhor it in manufacturing? It seems to me that the risks in the financial system should be dispersed among as many participants as possible not concentrated for a few "experienced" nobles to decide "the fate of the world".

And "too big to fail" loses its meaning when there is no one left that is bigger.
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