Policies to Avert Recurrence of Great Depression:

Necessity of Hedge Fund Regulation

(Why Hedge Funds are not Regulated?)

Sankarshan Acharya

April 23, 2007

Citizens for Development

How should hedge funds be regulated?

Only those types of regulations which will enhance stability and prosperity of the vast majority of American households should be enacted.

Why hedge funds need regulation? Avoiding Recurrence of the Great Depression.

The most prominent hedge funds are investment banks, brokerages and those run by principals (Board of Directors) of mutual fund companies. Hedge funds have pestilently and continually destroyed the prosperity of vast majority of American households.[1]  Hedge fund principals have designed and lobbied for enactment of policies that have been in place since pre-Great Depression era to wangle wealth from the vast majority.[2]  The unilateral, premeditated, lopsided wealth transfer policies-tacitly foisted by hedge funds on a society-may have enervated the middle-class. 

I hope and pray that any latent seething frustration, if brewing in middle-class America, does not destabilize society.[3]  Let’s first visualize the larger picture to see why we may be in an unstable predicament and how hedge funds may be responsible.  Of about $38 trillion debt owed by corporate firms, households and government, roughly about $4 trillion is lent by foreigners including China and Japan.  The net positive asset holders have thus created and extended a credit of $34 trillion as debt to the vast majority who are net borrowers.[4]  Pension fund savings that are held in the form of equity of highly leveraged companies, some of which like Enron and MCI-World Com have wiped out hundreds of billions of dollars.    

What makes households feel secure: growth in GDP or own net assets?

In general, households feel financially secure only when their net assets are positive and growing.  We do not know if the net asset of the vast majority of American households is growing.  It is because the government does not record data on net assets of individual households.  Net income of American households has become zero.  The net income will likely be very negative for the vast majority of households. 

The hedge fund managers, lawmakers, economists and everyone else with rational thinking considers net assets as the best gauze of their financial prosperity and security,[5] judging from their own actions to enhance their net worth.[6]  That is how they seem to measure the stability and prosperity of their own households.  I am sure every other household too tries to enhance its own financial stability and prosperity likewise.  Then a democratic government should measure net assets that every household considers paramount.  I have made a proposal to prominent U.S. Senators and President Bush to measure net assets of individual households as a barometer of social prosperity and stability.  America should lead the world to govern by truth disseminated to all citizens in its nonpareil democracy.  Growth in gross domestic product camouflages true prosperity, namely, net assets as judged by every household.[7]

What can trigger Great Depression?

Economic insecurity of a household stems from declining net assets and negative net income.  It may result from prolonged periods of unemployment or severe underemployment.  I define underemployment by zero or negative net income.  Economic insecurity of a vast majority over a prolonged period may lead to a recurrence of the Great Depression.  The prevailing belief that the Great Depression was due to high unemployment and credit squeeze has led to a policy of low unemployment through continual money injection.

Continual money injection may have already created severe underemployment. The Great Depression can recur if net assets deteriorate due to prolonged severe underemployment of a vast majority of households. The government cannot collect data on underemployment. But growth in net assets of households-data on which can be collected-subsumes the effects of unemployment and underemployment on the Great Depression. 

The current low unemployment statistics are not very useful and further money injection is futile if net assets of a vast majority of households have been declining due to severe underemployment.  A prolonged period of high unemployment (negative net income) deteriorated the net assets of a vast majority to cause the Great Depression.  A prolonged underemployment (negative net income) can also lead to decimation of net assets of the vast majority to trigger Great Depression.  Repeated money injections so far may have brought us to a stage at which any further injection is perhaps futile.

Treasury Secretary Paulson has said in the aftermath of the latest election verdict that net negative income of households has been lately buttressed by increases in the market values of stocks.  But this seems to be grossly incorrect.  It is because the vast majority that is languishing by negative net income has lost trillions of dollars of net assets due to the stock market debacle of 2000-2001.  As a result, they have little left over stocks to gain much from current market price appreciation to make up for massive losses they have suffered.  Any assertion that stock price appreciation is supplanting negative net incomes of the vast majority can be verified by only having the data on net assets of individual households. 

The Treasury Secretary should agree with my proposal for the government to collect data on net assets of individual households because (i) net assets are considered paramount by everyone in American democracy and (ii) policymakers need to know if the rising market price of stocks has been buttressing negative net incomes of the vast majority.  We cannot, of course, create the past data on net assets of individual households because they have not been documented.  But we should record such data now on for current and future policy directions. 

A deterioration in net assets of households and negative household income due to severe underemployment of the vast majority over a prolonged period may very likely lead to a recurrence of the Great Depression, despite nearly full employment effected by continual money injection.  The policy based on just the unemployment and inflation data is half-baked at best.  Prolonged severe underemployment amid low unemployment and low inflation can result in negative net incomes to decimate net assets of the vast majority for the Great Depression to recur.  

Declining net assets and negative net incomes (due to unemployment or underemployment) of the vast majority of households are true harbingers of a Great Depression.  Low unemployment, low inflation and growth in gross domestic product can mask the true harbingers of a Great Depression.  Current levels of high employment, low inflation and good GDP growth may not reveal deterioration of net assets due to prolonged periods of negative net incomes wrought by severe underemployment of the vast majority. 

Zero net income for the U.S. economy would only mean negative net income for the vast majority who are net borrowers of the $38 trillion credit in the system.  The current latent underemployment-indicated by the negative net income of the vast majority of households-is obviously due to unfettered money injection over the decades following the Great Depression.  A fear that credit tightening triggered the Great Depression has perhaps led to the prevailing policy wisdom for continual money injection during periods of economic weakness.  But continual money injection has perhaps brought us to severe underemployment or negative net income.  At the same time deterioration of net assets of the vast majority may be taking place irrespective of the monetary policy.  This shows that the current monetary policy may not safeguard against recurrence of the Great Depression. 

The only insurance against recurrence of the Great Depression is to arrest the deterioration of net assets of households of the vast majority, whether or not such deterioration is due to high unemployment or severe underemployment.  But to think of such insurance, we must first record periodically the data on net assets of individual households and monitor this statistic for the middle majority, say 75%.  We have to then pin down all major factors that can cause deterioration in net assets including unemployment and underemployment. 

Let’s suppose in the absence of data that net assets of a vast majority of households have deteriorated over some time.  This cannot be only due to a prolonged period of underemployment of the vast majority of households. The prime latent factor for deterioration of net assets of the vast majority is the current system of governance predicated on pre-Great Depression era policies that have been foisted by hedge funds to wangle wealth from a vast majority.  This system of governance basically recycles most of the created money to a few households. 

Despite benevolent intentions of money injection, the vast majority continues to be robbed because the prevailing system of governance may not be serving the best interests of the vast majority.  It is true that the vast majority wields voting power to change policies in a democracy.  But the current system of governance does not generate, let alone disseminate, information on net assets of individual households for the vast majority to propose rational amendments to existing policies. 

In spite of low unemployment, the vast majority is now facing the brunt of rising prices, declining net income and perhaps eroding net assets.  The problem facing the U.S. households is not due to China accumulating foreign currency reserves or the low value of yuan.[8]  The problem is the system of governance (policies) designed to rob the vast majority of American households. 

America has to rectify its current system of governance for the sake of prosperity and stability of a beautiful country and thereby lead the world for the betterment of humanity everywhere.  I salute great American leaders like President Lincoln who have correctly veered the destiny of a great nation.  I believe that the current leadership too on a bipartisan manner can visualize the real malaise in devising regulation of hedge funds.

What should be the hedge fund regulatory policies?

  1. Collect data on net assets of individual assets every year with tax returns.  The IRS already has the authority to collect such data when it wants.  Households have to provide such data to lenders at the time of borrowing.  If the vast majority of American households are required to provide such data, there should be no problem in collecting the same for all individual households in the country.

  1. Ban pre-Great Depression era short selling of financial securities, especially, in the instances where they breech the trust between customers and their brokerages and between mutual funds and the mutual fund company’s BOD-managed hedge funds. 

  1. Enforce that hedge funds including brokerages, investment banks and mutual fund companies report their long and short positions in all securities, especially those in which they have more than 1% of all the outstanding.  It is important that the brokerages, investment banks and mutual fund companies each consolidate their holdings across all hedge funds they manage directly and indirectly through affiliates in USA and other countries and islands to report their holdings on a consolidated basis.

  1. Mandate that market makers and their investment banks, brokerages and clearing houses report their and their affiliates’ positions in inventory accounts. 

  1. Close the currently bankrupt International Monetary Fund which has only served the best interests of major hedge funds by ruining economies around the world and thus causing undue consternation everywhere towards Americans. 

  1. Adopt safe banking proposed to the Congress. Before such safe banking law is enacted, banks should be required to maintain minimum capital based on consolidation across all subsidiaries including off balance sheet bankruptcy-remote entities like trusts, master trusts and conduits of the type that led to fiasco at Enron and MCI-WorldCom.[9]    

Sankarshan Acharya

Citizens for Development and Pro-Prosperity.Com

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[1] This is the view of someone who has taught finance, observed and participated in financial markets closely, derived optimal bank regulatory policies for the U.S. and proposed several capital market regulatory policies to the U.S. Congress.

[2]Mr. Robert Kiyosaki estimates that the vast majority of American households lost $7 to 9 trillion in last five years due to financial predators.

[3] My prayer is for Universal God.  The philosophy of Universal Religion and God may have already helped America and humanity.

[4] Many usurious wealth transfer schemes are outlined in my book, Prosperity: Optimal Governance, Banking, Financial Markets, Global Trading and Exchange Rate.” 

[5] We have the wisdom of Treasury Secretary Mr. Paulson who was the CEO of the most profitable hedge fund that Goldman Sachs is known as.

[6] Individual net worth maximization efforts may, however, harm a society and ultimately deteriorate net worth of every individual.

[7] Here is an example to see vividly how GDP growth is a false barometer of stability and prosperity of a nation.

[8] For more arguments on this issue, visit Pro-Prosperity.

[9] When I was on a mission from Federal Reserve (as an economist assigned to devise bank capital requirements based on public rating of bank assets, as required by the U.S. Congress) I had noticed at Citicorp that they had grossly abused the minimum bank capital requirement policy, which was based on my coauthored paper published in Journal of Finance.   

[10]Incidentally, the new US government initiative on immigration reform seems to dovetail with a proposal in my book, Prosperity.