April 8, 2014 / 12:01 PM / 5 years ago

COLUMN-Funds too lame rather than too big to fail: James Saft

(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

April 8 (Reuters) - It isn’t true that the asset management industry is too big to fail but it may well be that it is too lame to be tolerated.

Noting the rocketing growth of the global asset management industry, which is on track to more than quadruple in size by 2050 to $400 trillion, Bank of England executive director for financial stability Andy Haldane argued that funds may require closer and tighter supervision by regulators.

“Their size means that distress at an asset manager could aggravate frictions in financial markets, for example through forced asset fire sales,” Haldane said in a speech last week in London.

"It is possible to identify a set of market-wide conventions or regulatory practices which have the potential to drive common behaviour among asset managers and their institutional client base. These have the potential to turn idiosyncratic market frictions into systemic market failures." (here)

The idea that asset managers are too big to fail, that their sheer size makes them a particular threat, is at best unproven, as Haldane acknowledges. Not only do asset managers employ far less leverage than banks, they mostly play with other people’s money, making those that flame out more a source of private grief than public strife.

And though there have been notable instances of large asset managers causing market distress and malfunction, there is little doubt that they are not immune to the consequences of their actions in the same way as the very largest banks.

As a thought experiment, imagine an asset manager which had made as egregious a series of mistakes and miscalculations as has Citigroup over the past 15 years or so. You can’t, because such an institution would have ceased to exist, several times over. Or at best, sunk into insignificance.

Citibank was bailed out by the U.S. government in November 2008 with the government taking a 36 percent equity stake, a $45 billion credit line and a guarantee covering losses of more than $300 billion.

This is not at all to say that asset managers don’t represent a threat, of sorts; much less that they do a good job allocating capital in a way which helps the economy and secures retirements. Quite the opposite, in many ways.

Asset managers, and their clients, tend to chase returns, exacerbating market mispricings like the ones which brought on the last two recessions and which now threaten a third.

I’d argue that this is mostly the result of a mix of human frailty, self-serving career management by fund mangers and poorly thought-through existing regulation producing perverse results.


One of the prime dangers caused by asset management is herding, the phenomenon whereby many managers all behave the same way at the same time. The mania for Internet stocks in the late 1990s is an excellent example, as may well be the current vogue for social media companies.

Why does herding among asset managers happen? Because managers don’t only manage your money, they manage their careers. If a bubble in a particular sector is driving strong market performance, the typical manager sits it out at her own peril.

It is easy to get fired if you lag the market, even for very sensible reasons.

The irony, of course, is that central bankers are well aware of this phenomenon and use it themselves as a tool by which to effect policy. Narayana Kocherlakota, President of the Federal Reserve Bank of Minneapolis, argued as much a year ago, maintaining that very low rates may have to persist for quite a long time for the Fed to reach its aims.

“For a considerable period of time, the FOMC may only be able to achieve its macroeconomic objectives in association with signs of instability in financial markets.”

It wouldn’t change human nature, but if we want better asset management, therefore, perhaps we ought to have better central banking. Standing as we are on what may be the brink of another bout of market instability, this is an important point.

Haldane also details the rather monumental error made by many pension funds during the most recent downturn.

While prudent fund management dictates that when you have a crash you ought, if you can afford it, to buy a bit more of what just went down the most and sell a bit of what didn’t, we saw quite the opposite. Pension funds which were well funded, which had enough money to meet their obligations, cut their equity holdings sharply, while those without enough tended to increase theirs.

The well funded were cutting risk while the relatively needy were taking it on. That’s not doing a good job, either for the economy or for savers.

Reform seems much needed, but it will take a profound change in the approach of central bankers if it is to do much good. (At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft) (Editing by James Dalgleish)

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