German Finance Minister Against Offshore And Hedge Funds

by Jeremy Hetherington-Gore, Tax-News.com, London

08 February 2002

Writing in London's Financial Times, German Finance Minister Hans Eichel has launched an attack on tax havens and hedge funds as contributing to global financial instability. These tired old allegations are long past their sell-by date, and it's particularly alarming to see such economically illiterate statements coming from the mouth of the finance minister of the world's third largest economy.

"Offshore financial centres (OFCs)" says our hero, "are potentially de-stabilising because they often have poor supervisory regimes and can conceal financial transactions and their risks. They should be made to comply with international standards."

That's a different issue. No-one is denying that banking centres should have best-of-breed controls against money-laundering and criminal activity, although there are doubts about their efficacy, and the facts are that large countries like the US, UK and Germany host far more illicit activity than smaller ones. But why does the German minister persist in confusing money-laundering with instability? Criminal money is no more unstable than Mr Eichel's own savings; if anything, criminals are likely to be even more conservative in investing their money than a cabinet minister. Disraeli notoriously spent years close to bankruptcy after taking a bath in financial futures.

Some progress has been made. Two years ago, the Financial Stability Forum, an initiative launched by the Group of Seven finance ministers and central bank governors, published a list classifying 42 OFCs in terms of their level of supervision and willingness to co-operate. That encouraged a number of OFCs to overhaul their practices. In addition, the International Monetary Fund is providing OFCs with technical assistance via a programme expected to end next year.

"Hedge funds are another potential threat to financial stability," continues the article. "Anyone who doubts it should remember the near-collapse of Long Term Capital Management, the US hedge fund, in 1998. Carelessness in granting credit to hedge funds and other highly leveraged institutions, coupled with inadequate risk assessments, had enabled some hedge funds to concentrate large positions in individual markets whose abrupt liquidation would have triggered market disruptions."

The LTCM debacle was remarkable for the ease with which the US financial system accommodated a crisis, and there was never any systemic risk. Many people and companies lost money, but so what? That is the nature of free markets; people are free to lose as well as gain. For an example of systemic risk, Mr Eichel should instead remember Herstatt - the German bank which failed after having made traditional investments in the construction sector, and which nearly did bring down the world-wide banking system. 'Herstatt risk' to this day is the term used by bankers to describe the danger of a global inter-bank meltdown - and it's got nothing to do with hedge funds or offshore.

Far from being unstable, hedge fund trading is the opposite. By often acting in a contrary fashion, short trading and other favourite hedge fund techniques act to smooth out market instability, not worsen it.

Says Mr Eichel: "As hedge funds are not subject to any restrictions on their investments, they are able to respond very rapidly and flexibly to changing conditions and also to engage in short-selling, which in times of market turmoil can lead to a general price collapse. The reactions of financial markets to the events of September 11 gave a clear indication of the risks involved. In view of this, the German government has included in its draft of a fourth Financial Market Promotion Act a clause enabling short-selling of shares to be temporarily banned in Germany. Given the interdependence of financial systems it should be possible to co-ordinate appropriate measures at the international level between the supervisory authorities in big financial markets."

Yawn. And the next step no doubt will be to have a Tobin tax to pay for it all. The sooner this fatuous proposal is buried and forgotten, the better.

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