 The Preposterous Reality:
25 Hedge Fund Managers Are Worth
680,000 Teachers
(Who Teach 13
Million Students)
By Les Leopold, AlterNet
Posted on April 10, 2010
What work do we value most?
In 2009, the worst economic year for working
people since the Great Depression, the top 25 hedge fund managers
walked off with an average of $1 billion each. With the money
those 25 people “earned,” we
could have hired 658,000 entry level teachers. (They make about
$38,000 a year, including benefits.) Those educators could have
brought along over 13 million young people, assuming a class size
of 20. That’s some value.
Apparently the 25 hedge managers did something that is even more
valued in our society. But how valuable was it, really? To assess
that, we need to answer a few basic questions:
1. What do hedge managers do?
They run funds into which very rich people put money to make
even more money. Hedge fund managers move the money around
in very risky ways to get the most enormous yields possible.
(Wealthy investors believe they are entitled to double digit
and even triple digit returns.)
Because hedge funds are considered playthings
for the rich, who presumably are fully aware of all the risks,
they are exempt from most financial regulations. (We’ll
soon see if the financial reform bill now moving through the
Senate changes this in any substantial way.)
The wealthy will have placed an estimated $2
trillion into hedge funds by the end of this year. (That’s
about $6,500 for every man, woman and child in the U.S.)
2. Where does all that hedge fund money come from?
It’s mostly excess cash the super-rich have in hand now that
their tax rates have dramatically declined. In the 1970s the marginal
rate on those with incomes above $3 million (in today’s dollars)
was 70 percent. Today, the effective rate on the 400 richest Americans
is 16 percent, according to the most recent IRS data.
The wonderful thing about putting your money
in a hedge fund (or managing one) is that the income you get
from it is not taxed as income (say, officially at the rate
of 35 percent). Instead, it is treated as a business investment,
something that’s good
for the economy and that we need to encourage through a low tax — a “capital
gain.” The tax rate on capital gains is 15 percent. This
is one reason that Warren Buffett can say that he pays a smaller
percentage in taxes than his secretary.
 3. How do hedge funds make money?
Some hedge fund managers use computerized modeling to decide where
to invest or to make investments automatically. Other managers
claim they just make good judgment calls. They also make enormous
bets using lots of leverage and deploy an arsenal of derivatives.
It’s a dicey business, but it’s not supposed to put the
larger system at risk… until it does. In the late 1990s,
the hedge fund known as Long Term Capital Management, run by the
brightest bulbs in the financial universe (including a couple of
Nobel laureates), found itself with over $100 billion in assets
but only $4 billion in capital. When that upside down pyramid began
to crumble, the effect was systemic. So systemic that the Federal
Reserve, fearing a major meltdown of the financial markets, forced
Wall Street banks and investment houses to bail out the fund’s
investors. Some economists argue that risky gambling by hedge funds
did not cause the current crisis. But no one has conducted an impartial
investigation into that question.
The $1 billion each those 25 hedge fund managers
netted (for themselves) was impressive — but doing it in the year 2009 was also slap
in the face of struggling Americans. That’s because hedge
funds would have earned little or no money at all in 2009 had the
government not bailed out the financial sector with trillions in
loans, asset guarantees and other forms of financial assistance.
It was, in effect, a generous gift from we the taxpayers. Much
of that money was “earned” by betting that the government
would not let the financial sector collapse. Smart bet.
In principle hedge funds would do little harm
if they were not implicitly backstopped by the taxpayer in
this way. Here’s how one sage
financial expert put it to me recently:
Personally, I do not care whether hedge funds and other pools of
unregulated funds gamble in opaque derivatives rated by incompetent
ratings agencies. But I do want them to fail when their bets go
bad. Nor do I want them to be rescued in the event of a run to
liquidity. If they are leveraged and cannot come up with cash,
they should fail. It will be painful for their creditors. So be
it, the more pain, the better. That is the downside to private
property. Greed is good, but must be balanced by the fear of failure.
Without failure there is no fear.
On the other hand, I want to have a protected
and closely regulated portion of the financial sector for
those who do not want to take excessive risks. And any institution
that bets with “house
money”–that is, that has access to the Fed in the case
of a liquidity problem and to the Treasury in the case of insolvency–must
be constrained. That is the direction that true reform ought to
take.
4. Do hedge funds create real value that is essential for our economy
and our society?
Here’s a test: Imagine what would happen if they disappeared
entirely. People working at the 8,000 or so hedge funds — a
relatively small number of people — would lose their jobs.
But it’s unlikely that the national or world economy would
suffer at all. The wealthy would simply move their money to other
investments. They might even decide to make longer term investments
that would be used to produce real goods and services.
But wait, aren’t these piles of money a valuable source of
funds for investment in the real economy? Don’t hedge funds
make our markets work more efficiently? By betting against overvalued
currencies and bogus balance sheets of toxic-chocked banks, don’t
hedge funds police the bad guys? Aren’t they the essential
glue for rebuilding America?
If any of those good things happen, they’re
an accidental byproduct. The real job of hedge funds is to
allow very rich people to make more money as quickly as possible,
preferably without tying up the cash for too long. Use hedge
fund money for a leveraged buyout that can be flipped quickly
for big profits? Sure. Use it to speculate on the value of
currency or to make a quick dash in and out of a credit default
swap? You betcha.
If we step back and look at the big game, we
can see that hedge funds are hard at work skimming profits
from the financial sector, which in turn is living off the
largess of the American taxpayer. It’s
all part of the great financialization of the U.S. economy that
began in earnest when the financial sector was deregulated in the
late 1970s. Over the years, financial sector profits have risen
to nearly 40 percent of all corporate profits. And sadly, it’s
not because financial firms helped our economy grow. It’s
because they figured out how to run a very profitable casino for
the wealthy. And then hedge funds came along and figured out how
to skim the skim from those casinos.
5. So how can 25 hedge
fund managers be “worth” $658,000
new teachers?
They aren’t. And I bet the leading hedge
managers themselves would admit it.
But our economic system isn’t rewarding real value. While the
hedge fund 25 are living large, teachers everywhere are getting
the axe. Why the layoffs? Because state and local governments aren’t
collecting enough taxes — not since Wall Street investors
crashed the economy.
In our New Jersey town, we are laying off 85
teachers. Instead we ought to be hiring 85 more to reduce
class size and improve support programs for those students
who desperately need them. It’s
obscene that we’re shoveling money to the super-rich even
as we force teachers to join the ranks of the unemployed. Already
29 million Americans are without work or forced to work only part-time.
How to tame these runaway paydays? Just institute
a financial transaction tax or a windfall profits tax. The
fix is technically simple but politically complex. It’s going to take a lot of political
will — over a long period of time — to reorder our
most basic economic values.
In the meantime, try explaining to your kids why school programs
are being cut while 25 shrewd gamblers
are living like Pharaohs. |
