Opinion | Too-Big-To-Fail Government

Are hedge fund billionaires Carl Icahn and Ken Griffin too big to fail? No, but that’s not stopping the Biden Administration from teeing up hedge funds to designate as systemically important institutions. As government expands, so does the taxpayer backstop.

The Securities and Exchange Commission last week finalized two rules to augment the agency’s power over private markets. One will regulate hedge funds that trade Treasurys as dealers similar to large banks. The other will require hedge funds to report granular information about their strategies and counter-parties, among other things.

Chair Gary Gensler says private funds have “evolved” since Democrats passed the 2010 Dodd-Frank Act. Hedge funds in particular have become major intermediaries in the $27 trillion Treasury market. His putative worry is that hiccups in the Treasury market and problems at so-called shadow banks could ripple through the financial system.

“Private funds today are ever more interconnected with the broader capital markets” and “nearly have tripled in size in the last decade to approximately $26 trillion in gross assets,” Mr. Gensler says. “This compares with the U.S. commercial banking industry of approximately $23 trillion.” But whose fault is it that private funds have swelled?

Burdensome Dodd-Frank regulations caused banks to retreat from some markets. Capital standards also limit their ability to buy the flood of Treasurys that are financing a gusher of government spending as the Federal Reserve shrinks its balance sheet.

Hedge funds have filled the vacuum left by banks and provided liquidity in the Treasury market. As the Financial Stability Oversight Council (FSOC) noted last autumn, “the Treasury market has continued to show resilience, even when liquidity conditions were most challenged during the regional banking concerns in March 2023.”

FSOC nonetheless fretted that the “growth of Treasury debt outstanding could make the Treasury market more vulnerable to shocks,” especially if private funds pull back or have to liquidate positions under stress. In other words, ballooning U.S. debt may be creating systemic financial risks.

But rather than exhort Congress to cut spending, Biden regulators are seeking to deem hedge funds “systemically important” like too-big-to-fail banks. Hedge funds’ growing size and leverage could “increase systemic risks by potentially magnifying losses in a market downturn,” FSOC warned.

Enter Mr. Gensler, whose new rule will require private funds to register with the commission as “dealers” if they provide liquidity to the Treasury market on a more than “incidental” basis. Dealers under federal securities laws are subject to extensive capital and reporting requirements.

The rule eviscerates the long-held distinction between dealers and traders—namely, that dealers have customers. “Doing so runs counter to the statute, as the Commission and market participants have read it for decades,” Commissioner Hester Peirce noted in a dissent. Compliance costs could cause some funds to withdraw from the Treasury market, reducing liquidity.

The SEC is also requiring hedge funds—regardless of whether they trade Treasurys—to report loads more data so FSOC can assess their systemic risk. The manifest goal is to use the data to justify designating hedge funds as too-big-to-fail and subject them to bank-style regulation. Talk about a moral hazard. Does Mr. Gensler really think taxpayers should be standing behind Mr. Griffin’s Citadel?