Are Capital Restrictions On Their Way to Becoming Respectable in Some Circles?

We’ve had (depending on when you define the starting point) at least two decades of a concerted push by the US towards more open capital markets (no doubt based not simply on the belief that the Anglo/Saxon model was superior, but also on the notion that US financial firms would come out on top).

Many orthodox economists will concede that restrictions on capital flows and trade can be beneficial for developing economies, but would not endorse them for mature ones. Yet the Panglossian faith in wide open capital markets airbrushes out a few inconvenient considerations. One is that the extensive historical dataset constructed by Carmen Reinhard and Kenneth Rogoff shows a strong correlation between high levels of cross border capital flows and bank crises. Two is that high levels of international money flows poses more than a wee problem of national sovereignity. How do nationaly based financial regimes regulate firms with global operations?

The Financial Times reports on a move afoot in the EU that will restrict investors in the EU from putting funds in private equity firms outside the EU, and also restricting the ability of foreign investors to buy European companies (frankly, as someone who has worked on more than a few cross border deals, a good business generally has no trouble finding domestic buyers. If local/regional players, who presumably have an information advantage by knowing the local market, won’t stump up for a particularly business, why should an offshore investor do better? Yes, there are always exceptions, but one needs to be plenty wary).

Reader Swedish Lex noted:

In parallel with the Greece/Goldman/default swaps/hedge fund vampire night dinners, etc., the EU is slowly advancing on the proposal to regulate hedge funds and private equity firms (and their managers).

The industry has spent vast recources over the past year in trying to water down the draft legislation, which was not entirely brilliant to start with. What seems to elude the industry is that all the bad press feeds back into the legislative process. Most of the 736 Members of the European Parliament had a vague understanding of this aspect of the financial industry to start with and, probably, believe that it has significantly contributed to the financial crisis. The very bad PR for hedge funds and over-leveraged and job slashing PE firms over the past weeks are hardly helping the industry.

What I find silly is that the Industry, in its efforts to convince the Parlamentarians, and the other relevant EU Institutions, are using the same bad old arguments like if you regulate in Europe, it will scare off investment and the pensions of ordinary people are jeopardized. Well yes, the EU does not welcome trashy short-term cancerogenus cash spreading from Cayman funds run by math nerds that design real nukes one day and their financial equivalent the next.

There will be a compromise in the end, but it is too early to say what it will be. Greece etc. could continue to have an interesting influence on the debate.

From the Financial Times:

Europe risks building a protectionist wall between itself and the global private equity industry if plans for a sweeping overhaul of regulation in the sector go ahead, some of the world’s biggest institutional investors have warned.

The warning from the International Limited Partners Association, representing 220 of the biggest pension funds, endowments and sovereign wealth funds, comes at a sensitive time with European Union lawmakers and member states close to agreeing new rules

Investors based in the EU could be barred from investing in private equity funds based outside the 27-country bloc, said the ILPA, whose members have more than $1,000bn (£667bn) invested in private equity worldwide.

In addition, the proposed regulation could “severely disturb” many of the world’s biggest private equity groups by depriving them of access to EU investors, while in turn reducing foreign investment into EU companies.

“Not only will EU investors have reduced access to non-EU private equity managers, there exists a real concern that the proposal will effectively close Europe off from the capital solutions . . . that comprise the global private equity industry,” it said.

Yves here. The chutzpah is breathtaking. Foreign firms are trying to bully EU officials? This is a great way to win friends and influence people. So what if they are severely disturbed? Europe functioned before there ever was a PE industry, and from what I can tell, its hotbed of innovation, the German Mittelstand, does not have much traffic with PE investors.

The idea that what is good for the private equity industry may not be good for the average citizen appears not to have occurred to these operators. Tone-deaf behavior like this ILPA letter is only good to feed the already high suspicions of about whether financiers have any social conscience.

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  1. attempter

    Many orthodox economists will concede that restrictions on capital flows and trade can be beneficial for developing economies, but would not endorse them for mature ones.

    They’ve had decades of enacting this and their neoliberal ideology in general. They’ve had decades for their promised “benefits” to materialize. So what has happened? Decades of wage and benefit erosion, job destruction, the dstruction of the safety net and all public amenities and spaces, the destruction of local and regional economies (the “ownership society” concept was never meant to apply to small business ownership; that proves what a scam it always was), and hijacking and destruction of the polity, and the most radical wealth concentration monopoly.

    We go back to basics: The measure of the health of any economy is how many good jobs it creates, and how equitably wealth is distributed. (That’s the only measure of economic “prosperity”. Debt bingeing is a scam.)

    Neoliberalism, like every other utopian ideology, promised that if it was given power it would bring this utopia.

    Stalinist fellow travellers used to say “you have to break eggs to make an omelette.” By the 50s the standard and correct retort to this was, “OK – so where’s the omelette?” Indeed Lenin had said that they needed to embark upon twenty years or so of state capitalism before the true worker-controlled system could be achieved. Twenty years was the “adverse scenario”.

    So by the 50s it was in fact well past time to ask where was the omelette.

    And so who today doesn’t know that the omelette promised by neoliberal globalism and financialization is just as spurious as the one promised by Bolshevik state capitalism?

    And who of integrity won’t say it’s now time to reject this vicious ideological lie and the vicious criminals who propagate it, free ourselves of them and their tyranny, and take back our economy?

  2. psychohistorian

    I think it is quite clear that financiers do not have a social conscience. We wouldn’t be in the mess we are in if they didn’t bow to the money god for their rich employers.

    Capital restrictions in and of themselves are not going to fix the social conscience issue. It will only force the rich to find back door ways to control and increase their ownership of the global economies and individual countries.

    The rich are still in control and increasing their grip on everyone and everything. There has been and will continue to be much blood on their hands as they maintain control.

    It is sad to see the dream of egalitarian America destroyed by the moneyed elite of the world.

  3. Siggy

    Being rich and being wealthy are not the same conditions. Not all of those who are rich understand the difference. Those that do comprehend the difference work to become wealthy.

    There are barriers to wealth. Some of the barriers are natural most are artificial. The artificial barriers are the artifice of the wealthy which has been constructed to prevent the dilution of their wealth by a cadre of unwashed nouveau riche. Which is to say that to be wealthy is to own the means of production and the fewer owners there are, the wealthier the wealthy are.

    Now, the keystone of production is capital. Labor is everywhere as are ideas and technocrats who can create a production process. It is also true that capital is money in its initial form. It is used to acquire the equipment, patents and things necessary to a production process that will be implemented by labor.

    Now, is it the rich or the wealthy who want to control the movement of money/capital? I think it is the wealthy. If there is a barrier to the movement of capital, that barrier tends to enhance the value of the capital in place until such time as the goods and services obtained from the in place production process is no longer competitive in terms of price and quality. Price and quality can be subsumed into utility.

    Now for a big leap, national living standards are very dependent on the dispersal of wealth throughout the population. Those nations that are benefited by a large number of wealthy individuals enjoy an economic advantage over those nations with smaller communities of the wealthy. The single most effective equalizer for the less wealthy is the exercise of labor arbitrage. Consider China.

    In its raw form, capital is amoral and without true national identity. It will find its application where the incomes it can earn are the greatest.

    Private equity firms exist in satisfaction of the needs of rich people seeking wealth and in the service of wealthy people who seek to preserve their wealth.

    Thus, restrictions on the movement of capital have limited hope for success. Whether capital stays or leaves will be determined by achievable rates of return to the investment in the means of any form of production.

    1. velobabe

      wealthy, rich give me freedom any day† had the first two, way over rated and boring. scared to death freedom is quickly becoming a luxury.

  4. DellaTerious

    ” … this ILPA letter is only good to feed the already high suspicions of about whether financiers have any social conscience.”

    I don’t understand quandaries like this one and so-called “Moral Hazard”. What Margaret Thatcher did with her admission that “There is no such thing as society…” was utter prostration to the needs of the Uber-Class: that they need not worry about such lower-class concepts as implied moral constraints on their actions that are placed there by a “social conscience”. If there’s no such thing as society, “VOILA!” There’s no need for a social conscience.

    Even a waiter at a hi-end restaurants catches enough bits of conversation to understand that the wealthy have a deeply ingrained and utter contempt for the human flotsam they consider the rest of us to be. Yet financial writers, even after these same power-hungry nak-ID and insatiable warlords plunder the economy unchallenged to the point of its destruction, still naively wonder how they can live with their “social conscience”.

    The entire framework of Monarchical government is to use that same separation of powers concept the founding fathers applied to the US government, by using religion as the social conscience enforcer. In exchange for having the Church bless the Sovereign with “Divine Right”, giving him legitimacy, the Monarch’s behavior vis-a-vis his subjects, is forced to demonstrate an (at least outward) manifestation of concern for their well-being, as enforced by the Church.

    Having replaced that concept with the “rule of Law”, which was then jettisoned by the Butsch administration, the rabid madness to which insatiable, purposely stoked, greed drives human beings to is now completely unchecked.

    If writers as intuitive, prescient and clear-sighted as yourself really believe that the Superclass has a social conscience, then we are truly in AIG territory: “All Is Gone”.

  5. Stelios Theoharidis

    Sounds pretty win-win to me. Seeing as quite a number of larger private equity firms, when there is surplus capital on the market, which is the case in these times of high inequality, are simply churning companies to present the illusion of adding value. They then float them or sell them off to the next sucker to legitimize the activity.

    I think there is value to be derrived by not having a superfluity of PE firms or VCs. There are only a certain amount of viable deals and after that point you get into this area where they buy firms and through additional acquisitions combine them with other firms by loading way to much debt onto the original company. After the PEs pay themselves off with fees, the new company has too large of a debt burden to survive and imploads, leaving a net job loss.

    I wouldn’t make the exact same suggestion for venture capitalists, as it is hard to acquire funding at that level. But, at a point of oversaturation we start to find a multiplicity of bad business ideas, like the many in the dotcom boom, and potential frauds getting finance.

    I can’t tell you what the happy median would be, but when you have a surplus of PE activity there is an inevitable misallocation of capital.

  6. CrocodileChuck

    PE musings: wonder what the returns on equity were for that Stuyvesant Town deal, Chrysler and what was formerly Texas Utilities* (TXU)? All these ‘deals’ have one thing in common-they were brokered in environments with excessively cheap capital. (the last wave coughed up the furballs of WorldCom and Enron)

    *prediction: this one won’t be able to roll its debt

  7. Gaucho

    capital controls are necessary in emerging markets, not as a rule, but just as a tool that can be used discretionally to offset the not-so-unusual investor over excitement with the “growth” story of emerging markets.
    I’m concerned about Brazil, billion dollar IPOs have become a common currency in the real estate sector. People with unlimited access to capital tend to do dumb things.

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