How Citadel and the Fed Crossed Paths Before the Hedge Fund Hired Ben Bernanke – Real Time Economics

Former Federal Reserve Chairman Ben Bernanke will serve as a senior adviser to Citadel, a Chicago-based hedge fund.
Alex Brandon/Associated Press

The news that former Federal Reserve Chairman Ben Bernanke will become a senior adviser to Citadel, the Chicago-based hedge fund, has renewed attention on the tendency of former regulators and economic policy makers to move to financial institutions once leaving office.

The story, first reported by the New York Times, included a brief interview with the former Fed chairman:

Mr. Bernanke said he was sensitive to the public’s anxieties about the “revolving door” between Wall Street and Washington and chose to go to Citadel, in part, because it “is not regulated by the Federal Reserve and I won’t be doing lobbying of any sort.”

It’s true that as a hedge fund, Citadel is not directly regulated by the central bank. But what about those public concerns? Here’s a quick tour of the news archives from recent years, about whether or not the Fed and Citadel ever have any interest in each others’ doings.

 

In March 2008, the investment bank Bear Stearns Cos. was teetering on the brink of collapse. To help prevent the firm’s disorderly implosion, the Fed arranged for a cash infusion, via J.P. Morgan Chase & Co., to keep Bear Stearns afloat. While the Fed’s loan was keeping the flailing bank alive, the hunt was on for a potential buyer. From the Wall Street Journal story on March 15, 2008:

The Fed, not J.P. Morgan, is bearing the risk of the loan. It is the first time since the Great Depression that the Fed has lent in this fashion to any entity other than a bank.

Some Wall Street executives said they thought Bear was likely to be sold, in whole or piecemeal, in a matter of days, to prevent it from going under. Bear, the fifth-largest investment bank, said it has retained investment bank Lazard to weigh alternatives. Those alternatives “can run the gamut,” Bear Chief Executive Alan Schwartz said in a conference call.

Possible buyers, according to a person close to Bear, include J.P. Morgan and hedge fund Citadel Investment Group.

J.P. Morgan ended up absorbing Bear Stearns, rather than Citadel. But by October 2008, as the financial crisis spread, the Fed’s regulators were growing concerned about risks that could come from hedge funds. From The Wall Street Journal’s October 25, 2008, story:

Federal officials are closely monitoring large hedge funds, wary of a shakeout in the industry and the risk that market woes could trigger hidden, systemic problems from the largely unregulated sector.

In recent days, examiners with the Federal Reserve questioned Wall Street counterparties in at least two instances about their exposure to debt and other holdings of Citadel Investment Group and Sankaty Advisors LLC, the credit-investment affiliate of private-equity firm Bain Capital, said people familiar with the matter.

In December of 2008, Fortune magazine reported that rumors about the Federal Reserve’s interactions with Citadel’s chief executive Ken Griffin were damaging the company:

Then there was the most damaging rumor of all: Griffin had been holding “secret meetings” with the Federal Reserve, looking for a bailout.

In January 2009, the New York Times followed up on the rumors about Citadel and reported this:

Federal Reserve officials did in fact check up on Citadel. But since last spring, such inquiries have become routine at all large financial institutions. The other rumors were unfounded.

As part of its efforts to recover from the financial crisis, Citadel launched an investment banking unit in May 2009. In a 2010 Bloomberg News story on Citadel’s efforts to build the bank, the financial-services analyst Richard Bove noted that Citadel may benefit from avoiding the Fed’s regulatory scrutiny.

“An unregulated company coming into this sector has a real good shot,” said Bove. Citadel Securities, unlike Goldman and Morgan Stanley, isn’t overseen as a bank holding company by the Federal Reserve Board, he said.

(Ultimately, Citadel unloaded this line of business to Wells Fargo.)

In July 2010, the Dodd-Frank financial regulatory overhaul was signed into law. Even before the bill was finally passed, hedge funds were poaching employees from Wall Street’s banks, because of the coming legislation. From the Wall Street Journal’s June 3, 2010, story:

The competition is on to scoop up Wall Street traders and portfolio managers increasingly unnerved by the likelihood of sweeping new financial regulation.
Since political momentum began building earlier this year to limit trading for profit at Wall Street firms, traders have been exploring their options, and some have already left. Outside the banks, private investment funds looking for skilled traders have been gearing up for a hot talent market.

The story noted Citadel as a beneficiary of the trend:

Citadel Investment Group, the Chicago hedge-fund firm, has attracted more than a dozen portfolio managers to its second seeding platform for equities managers, called Surveyor, launched this year. Managers who recently joined the firm include Daniel Chai, who previously traded health-care stocks for UBS AG, people familiar with the firm say. Citadel’s Pioneer Path seeding program, started in 2008, also has grown.

Last year, the Fed raised questions about a bank practice that helped hedge fund reduce their taxes on dividends. From the Wall Street Journal’s September 28, 2014, story:

Large banks generate more than $1 billion a year in revenue by helping hedge funds and other clients reduce taxes through a complicated trading strategy that has drawn criticism from U.S. authorities.

The story noted Citadel was a firm that used this practice:

Citadel, Lansdowne Partners Ltd. and Och-Ziff Capital Management Group LLC are among the firms that have benefited from dividend-arbitrage trades, as well as banks that work as custodians of pension-fund assets.

The Dodd-Frank Act also gave the central bank the responsibility for regulating systemically-important financial institutions. No hedge fund has been so designated, but as pointed out by Nick Bunker of the Washington Center for Equitable Growth, at least one hedge fund in the past was a clear example of a systemic risk. Joseph Lawler of the Washington Examiner noted that this means that Citadel could potentially fall under the Fed’s regulatory scrutiny.

In fact, in a 2006 speech on whether hedge funds are systemically risky, Mr. Bernanke noted that following the collapse of the hedge fund Long-Term Capital Management, top regulators considered  directly regulating hedge funds, though decided against it. The central bank’s thinking has continued to evolve on the topic. In April of 2014, San Francisco Fed research said that a new method of measuring financial risk “suggests that hedge funds may have been central in generating systemic risk during the crisis” and that “there is a growing recognition that hedge funds are systemically important.”

 


 


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16 April 2015 | 6:45 pm – Source: blogs.wsj.com

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