These hedges need trimming

Are hedge funds a financial service or a racket?

By MSN Money Partner May 30, 2013 11:51AM

House of bills © Tetra images /Tetra images/Getty ImagesBy Sam Pizzigati, OtherWords

 

They're hunkering down at SAC Capital, the hedge fund empire of billionaire Steven A. Cohen. Federal prosecutors have been picking off SAC's second bananas one by one, plea bargaining for information that brings them ever closer to Cohen.

 

SAC coughed up $616 million in March, without admitting guilt, to settle a federal civil suit charging the hedge fund with insider trading. A defiant Cohen then went out and plopped down $155 million for a Picasso and $60 million more for a new Hamptons manse, just to show how little he'd miss the $616 million.

 

Now the feds are chasing Cohen on criminal charges, and SAC has announced the hedge fund will no longer cooperate with government requests for information.

 

The information already public has considerably dimmed the "financial genius" aura around Cohen. The 30% annual returns his hedge fund has averaged, Vanity Fair details, rest on a gusher of insider tips that the fund spends millions to keep flowing.

 

Whether prosecutors can prove all this in court remains to be seen. But the hedge fund industry's recurring response to scandal -- "every industry has a few rotten apples" -- is wearing thin.

 

We're no longer "talking simply about the occasional corrupt individual," notes federal prosecutor Preet Bharara. We're "talking about something verging on a corrupt business model."

 

That's certainly the view of Les Leopold, the veteran labor analyst. Leopold's 2009 book, "The Looting of America," zeroed in on America's big banks and how their chase after fortune crashed an entire economy. His new book, "How to Make a Million Dollars an Hour," refines that story -- by adding hedge funds into the mix.

 

Hedge funds only started gaining traction in America 30 years ago when wealth started seriously concentrating at America's economic summit. Financial industry insiders quickly realized they could make millions managing all the cash the titans of America's new Gilded Age had sloshing around in their pockets. All they had to do: promise -- and deliver -- high investment returns to wealthy investors.

 

Hedge funds made the perfect vehicle for generating these high returns. Like mutual funds, hedge funds take in money from investors and charge a fee for their investing know-how. Unlike mutual funds, hedge funds face little regulation since they only service a narrow market: deep pockets with at least $1 million to invest.

 

Hedge funds can do virtually whatever they please with the money those deep pockets hand them. They can lay bets on anything.

 

The danger in all this wagering? Imagine how you would feel, Leopold asks, if total strangers could buy insurance on your home -- and collect a windfall if your home burned down. Total strangers with a motive for torching your house? What could be more terrifying?

 

Well, strangers can't buy insurance on our homes. Insurance industry regulations prevent that. But hedge funds can bet on assets they don't own. They can bet against a company's share price or a nation's currency or a mortgage-backed security.

 

The rewards if the bets pan out? In 2010, Leopold calculates, America's top 10 hedge fund managers averaged $842,788 per hour.

 

Rewards this outrageous give power-suits at hedge funds an irresistible incentive to behave outrageously. And they do. They connive to create investment securities certain to fail and then lay bets anticipating the failure. They plant rumors to rig markets. They exploit high-tech wizardry to buy and dump stocks, Leopold explains, "in nanoseconds, fleecing slower buyers and sellers."

 

Hedge funds, in short, operate as a "drain on our economy."

 

Imposing a tiny tax on every financial transaction, says Leopold, would help plug that drain, and the European Union is actually making some promising moves toward this taxation. In Washington, meanwhile, neither the White House nor Congress has so far displayed much interest in following suit.

 

Our financial apples are still rotting.

 

OtherWords columnist Sam Pizzigati is an Institute for Policy Studies associate fellow.

 

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