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Guest Post: David Brooks' Big Wet Kiss To Hedge Fund Managers
Submitted by David Fiderer
After he read a book that he didn't understand, David Brooks came up
with another crackpot distortion of capitalism. This time, he finds a
sharp contrast between bankers and hedge fund managers, whom he lumps
together all other business entrepreneurs. In his latest column he writes:
The smooth operators at the big banks were playing with
other people's money, so they borrowed up to 30 times their investors'
capital. The hedge fund guys usually had their own money in their fund,
so they typically borrowed only one or two times their capital.The social butterflies at the banks got swept up in the popular
enthusiasms. The contrarians at the hedge funds made money betting
against them. The well-connected bankers knew they'd get bailed out if
anything went wrong. The solitary hedge fund guys knew they were on
their own and regarded their trades with paranoid anxiety.
Because they weren't playing with other people's money, hedge fund
managers were more careful than the big banks? How fatuous is Brooks'
analysis? Let's count the ways:
1. Hedge fund managers are insulated from investment losses
and from taxes, whereas bankers are not.
As anyone who reads The Wall Street Journal knows, hedge
fund managers get rich because of the "Heads-I-win-tails-I-don't-lose"
fee structure paid by their investors. Typically, they charge a 2%
management fee, plus they take 20% of all profits. The fund manager only shares
in the profits, not the losses. So his primary incentive is to seek a
big short-term upside, rather than to limit downside risk. When a hedge
fund manager puts his own money into a fund, he benefits primarily from
the leverage of other investor contributions, rather than from external
debt. And when a fund manager collects his no-risk fees, he doesn't pay
taxes the way ordinary Americans do. Those fees, which take out 20% of
the fund's profits, are considered capital
gains rather than ordinary income, which is quite a trick, since
the theory behind lower rates on capital gains is that money was put at
risk.
A hedge fund manager who takes spectacular losses can start over by
launching a new fund right away, whereas a bank executive who screws up
usually gets fired. At best, Brooks' claim that, "well-connected bankers
knew they'd get bailed out if anything went wrong," is grossly
misleading. Banks that got bailed out also got dismantled. Bear Stearns,
Wachovia, and Washington Mutual no longer exist. AIG is being broken
up and Merrill is a shadow of its former self. The one possible
exception is Citibank, which was forced to sell Salomon Smith Barney.
Moral hazard remains a huge issue, and the senior executives who failed
to properly manage their banks walked away rich. But these guys were
also fiercely driven and committed staying on top, which is why they
never thought, "I'm well-connected so I'll get bailed out." Instead,
their common failure in judgment was to accept bogus triple-A ratings on
mortgage securities at face value
2. Hedge funds made money by exploiting secrecy, whereas
banks were regulated.
The largest hedge fund in the world was run by Bernie Madoff. Many other hedge funds invested
almost exclusively in the Madoff Fund. Clearly, these feeder fund
managers, and other sophisticated investors, were clueless. The Madoff
scam thrived because the entire hedge fund industry, which dominated many credit markets, had operated in
secrecy. The funds that offered the skimpiest financial disclosures were
able to snare investors who treated due diligence as a joke. This
complete lack of transparency gave hedge funds large incentives and
opportunities to manipulate markets and to trade on inside information. Amarenth and Centaurus exploited that secrecy to
manipulate natural gas markets. In a prequel to the financial crisis of
September 2008, a single hedge fund, LTCM, brought Wall Street to its
knees.
Commercial banks are subject to a lot of regulatory oversight. Again,
the banks failed, and the regulators failed to provide effective
oversight, primarily for one simple reason: They all relied on bogus
triple-A ratings for toxic mortgage securities. They saw the rating and
disregarded the need for substantive due diligence or analysis on those
investments. John Paulson, and other "contrarian" hedge fund managers
whom Brooks' exalts, had figured out the triple-A scam and got rich by
creating, and then shorting, new toxic assets designed to fail.
3. Because they are black boxes, hedge funds borrow in the
repo market, whereas bank leverage is a consequence of Bush-era
cronyism.
Brooks insinuates that hedge funds had two times leverage because
their managers were cautious. Not true. Banks would only lend to them on
an overnight basis, while they held marketable securities as
collateral, because a hedge fund's financial position can change
instantaneously. Investment grew their leverage, to 30 times equity,
because a Bush-era crony, S.E.C. Chairman Chris Cox, gutted regulatory oversight of investment banks.
Over the objections of a unanimous commission investigating the subject,
Cox decided that investment banks could opt in or out for "voluntary
oversight" whenever they felt like it.
All of this segues into Brooks' real agenda, which is to pervert
history. He wants us to equate the Bush Administration's refusal to
enforce the law, and its wholesale emasculation of regulatory
institutions, with a creeping socialism. He wants to us to believe that
the bank profits are caused by government regulation, which stifles
those engines for growth in the real economy, hedge funds. He calls
bankers "princes" and hedge fund managers "grinders":
The princes can thrive while the government intervenes in
the private sector. They've got the lobbyists and the connections. The
grinds, needless to say, don't. Over the past decade, professionals --
lawyers, regulators and legislators -- have inserted themselves into
more and more economic realms. The princes are perfectly at home amid
these tax breaks, low-interest loans and public-private partnerships.
They went to the same schools as the professionals and speak the same
language. The grinds try to stay far away and regard the interlocking
network of corporate-government schmoozing with undisguised contempt.
For the record, banks are making lots of money because of
low-interest rates and reduced competition, two offshoots of the Bush
financial crisis, and because financial reform has yet to pass. As for
those hedge fund managers who show disdain for Washington lobbyists,
check out this. There's a reason the book touted by Brooks
is titled, More Money Than God.
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Brooks is a tool. Nuff said.
What he said.
+10^10
Definition of a tool:
A person who writes something like this:
"I remember distinctly an image of--we were sitting on his couches, and I was looking at his pant leg and his perfectly creased pant, and I’m thinking, a) he’s going to be president and b) he’ll be a very good president.”
Well done, AssFire.
This time, he finds a sharp contrast between bankers and hedge fund managers, whom he lumps together all other business entrepreneurs
Whats the big deal?
In the book "The Partership: The Making of Goldman Sachs" the auther repeatedly(100 times) , comingles the the word "clients" demands or investments with GS investments.
You cant tell whicjh is which. Is why I thinl anytime, the investment, has a bad PR, like subprime, they will state it was their clients demanding this investment.
But otherwise it was GS investment.
Comingle, comingle...
Hello Black Rock..
I can smell you a mile away.
51% GS 49& Morgan.
You guys must have meet in line ,
getting your "retail banking " licence down at the fed window.
Where did we arrive at the very odd idea that if a journalist just hangs around in the business long enough, then they somehow (through osmosis I guess) become qualified to have a weekly column in which they bloviate on subjects they have exactly zero personal experience in?
The journalist-turned-columnist is no more valuable than your uncle Ernie offering his opinions on foreign affairs from the couch at a family reunion.
Needless to say, I don't read any of them.
Agreed. A phd in economics should be required.
</sarcasm>
In some quarters it is called tenure.
In Brooks case, I think it's the spittle that forms in the corner of his mouth when he appears on TV. So, they allow him to write nonsense just for the entertainment spectacle of his TV exposure.
Just a hunch.
Its called "Soros , Theory of Reflexitivity.
A lonely philosiphy , named Soros has been trying to convince us for decades of his theory, almost but miles away from Einsteins theroy.
Its been going on for decades, but know its most obvious.
The medias job is to create that "mis bias, or misperception" that Soros refers too in his theory.
Oil market in 2008 is a perfect example, but fort another piece.
Amen
Brooks, the new-age Renaissance man; able to demonstrate stunning incompetence in multiple fields.
Brooks exists to soften the rather repugnant features of the Neocon fantasy.
Brooks has been losing it for a while now. He's been wrong on so many major themes, political, economic and now this foray into financial market analysis, its hard to know where to begin. His columns are a reminder of what Tyler has mentioned numerous times before, and what this site is all about; namely the failure of the main stream media to explain to the US populous what's really happening in global financial markets, corporate board rooms and official Washington.
If Brooks was intellectually curious he would review the archives of this site and he'd realize how naive his views are.
Populace n. The human inhabitants of a place
Populous adj. The state or condition of having numerous people
I'm just trying to point out the correct word. Your post was insightful.
Never let facts get in the way of your story. Hedge fund LTCM was leveraged a little more than 2 times - try 25 to 1.
I mostly agree with Fiderer here but I'd like to point out that at least in this financial crisis hedge funds or at least independent hedge funds weren't much of a problem. A few did well, a bunch blew up and capital reallocated itself accordingly. No LTCM type hedge fund posed a systemic risk to "the system" or required a bailout or taxpayer money. Some were even forced by Obama to "share the burden" and take what they were given instead of what they were legally entitled to in the Chrysler bankruptcy.
The Madoff fund was obviously the biggest hedge fund disaster of this era but that was a plain vanilla fraud story of a shark picking off dumb money while our regulator heroes had their thumbs in their asses...and just like failed HF managers I think those regulators will continue to stay in the business and move onto bigger and better things.
I feel genuinely sorry for whatever widows, orphans etc. were ripped off via two+ degrees of separation from the guy who was actually running their money. But lots of fancy people placed (begged to place) their money with Madoff simply because other fancy people had placed their money with Madoff. How many degrees of separation was Kevin Bacon from the due dilly on Madoff before he wrote a check one wonders? I have zero sympathy for those people and don't think that kind of hubristic, snobbish stupidity should be regulated.
But but...it's Bush's fault.
I thought Chicago "inherited" the need for government to take over every remaining productive activity to prevent the problems it caused from happening yet again...
madoff wasn't a hedge fund. Initially, he ran those accounts through his b/d. It wasn't until he was flagged by the Helen Keller types at the SEC that he suddenly morphed into a hedge fund. He falsified brokerage statements. Heck, he didn't use leverage or bizarre strategies that masked risk, he flat-out stole money.
Hey that's a low blow, pal. Helen Keller would have figured out what Madoff was up to on her coffee break.
"A hedge fund manager who takes spectacular losses can start over by launching a new fund right away, whereas a bank executive who screws up usually gets fired"
Well, Sallie Krawcheck was the CFO of Citicorpse who helped architect the largest bank collapse in world history. And yet by getting fired before the final collapse, enormous expense on PR agents and a great look, she managed to land on her two feet at Bank(ruptcy) of America
Sounds like an ultimate capitalist to me, survival of the fittest.
The top capitalists change the rules to make his hand a winning one.
I didn't junk you but I disagree. There are crooks and thieveseverywhere. When they get authority they use it to steal what they can. Are you implying that under socialism, marxism or communism no one is taking more than their fair share? Capitalism isn't evil, evil people are evil. And they come in every shape, size, race, religion, sex and sexual orientation.
David Brooks is the one of the top reasons that I stopped reading newspaper op/ed sections many years ago. He has always presented idiotic ideas cloaked in bloviation...why any newspaper continues to carry his column is beyond comprehension...Oh wait, he is writing exactly what the newspaper owners want to read!
David Brooks has his own agenda to promote. He glosses over reality to present an alternate version of reality to serve his masters. I don't care how erudite it sounds, it is the same cesspool.
Did Brooks happen to comment on how perfectly creased the hedge fund managers pants were?
And remember, Brooks is the "House Conservative" for the NY Times - boggles the mind what the editorial discussions at Pravda on the Hudson must be like.
Don't you think you're being a little tough on Pravda there, doc?
"A hedge fund manager who takes spectacular losses can start over by launching a new fund right away..."
Yeah, because closing a hedge fund and starting over doesn't hurt your reputation at all, amiright?!
"For the record, banks are making lots of money because of low-interest rates and reduced competition, two offshoots of the Bush financial crisis,..."
Holy shit, you can't possibly subscribe to this line of thought! Low-interest rates are the cause, not the symptom. I wish had a good cartoon of a horse pushing a cart right about now.
Clarification: The current low interest rate policy is a response to the financial crisis and the collapse of home prices. But you are correct, Greenspan's low interest rate policy helped create the housing bubble.
"Low-interest rates are the cause, not the symptom."
Ding ding...give that man a cigar.
http://www.youtube.com/watch?v=KUDpc04r_QM
David Brooks.... hmm, David Brooks.
Oh, this David Brooks:
http://www.seedsofdoubt.com/zendaba/images/brooks_ho2.jpg
Have you no shame? What the hell am I gonna do after seeing that?
Where's Muir when ya need him? ;-)
The real problem with people talking about bank leverage is that they don't really understand who is at risk on a lot of "bank balance sheet leverage." VIEs, ABCPs (with or without funding guarantees), Prime brokerage stock lending and bond repo (where the prime broker intermediates the borrowing/lending between its clients and the Street) all go on balance sheet. That kind of business requires no real equity per se because it is a pass-through. The equity required is one to deal with the margin inadequacy in the event counterparty default, but even in the Great Panic of '08, it was not the HFs which collapsed which caused banks problems with their equity. In many cases, HFs collapsed because they were forced to sell in a declining market precisely because their PB was doing its job in assessing a Termination Event, or by seizing assets in place of margin.
The comment about banks growing their leverage to 30x equity because Cox gutted regulatory oversight is misplaced. They grew their leverage to 30x equity because there were customers who wanted to give them money to do it. And because there was no rule about gross balance sheet leverage ratios, and it was/is a lot easier to create an on-balance sheet SPC structure than an off-balance sheet one (even when you are neither lending to it, nor owning any of the net economic risk of the securities issued by the SPC), balance sheets ballooned.
None of this, however, refutes the idea that Brooks has almost no idea what he is talking about.
Sorry I disagree with this article and believe what Brooks is selling to an extent. Hedge fund mangers have their net worht in their funds and the amount of leverage used applies to all participants in the fund, including the hedge fund manager.
Yes, there are funds that use excessive leverage, but the managers are ok with that. That is on each hedge fund manager as well as their clients.
Brooks is spot on IMO.
i dont like the guy either. he is friends with a bunch of neo cons.
This is a joke: no one here could go toe to toe with Brooks for 2 minutes in discussing policy.
This is true, although hedge funds in their sector tend to have more leverage as a rule. At least, that was true while they were conv arb. It became ridiculous once they started doing market-directional crap. Concepts like leverage or notional principal are only relevant with context; 10x leverage on arbing the merger between, say, BA and Iberia is nowhere near as scary as 10x leverage on the equity tranches of 2006 vintage subprime ARM CDOs. Or, more simply, if you buy a plain call with leverage, the most you can lose is the premium and the cost of borrowing. If you write it with leverage, losses can make you insolvent. AIG resembles the latter, something of a dumpster for Wall Street's derivative risk, and the cost to those poor traders is retention bonuses.
I'd posit that hedge funds played it safer than commercial banks, which effectively had egregious leverage in the riskiest, most directional housing market bets, especially if you bring some of the paper vehicles back on the balance sheet. (Also, the bailout of LTCM—basically the FRBNY calling their buddies and demanding that they arrange a private bailout—looks pretty awesome relative to AIG, the GSEs, Citi and Merrill.)
I don't doubt whether this has happened, but do you have some examples? Remember, O'Neal got a golden parachute, Fuld and Thompson (Wachovia) still have lucrative jobs, Congress has granted Pandit carte blanche for acing their dog and pony show, and just generally i-bankers still got their bonuses even if their firms would have failed absent government intervention.
First off, he ran an "investment advisory business." The important distinction is that he managed the accounts in-house instead of holding them through GS, JPM or other prime brokers. In other words, just verifying the assets would go a long way to rooting out crooks like him, and there are fixes for that. What's the fix for the government put granted to TBTF institutions? It sure ain't FinReg. Second of all, Madoff didn't cost me a penny (aside from those going to the SEC for non-enforcement), but you better believe the cost of propping up GS's bonus structure is being billed forward.
Also, I don't understand the singular focus on Bush. Yes, he did a terrible job, but neither Clinton before him nor Obama after have shown anything but deference to i-banks. Glass-Steagall came during Clinton, Dems have always prevented reform of FRM and FNMA, Madoff's Ponzi scheme started during Clinton (and he was a Democratic donor), etc. Both parties need to be blamed, period.
I've always found NYT's financial reporting as bad at best, and criminally inaccurate (cf. Gretchen Morgenson) at worst, but at least superficially I agree with Mallaby's argument: hedge funds have provided less corruptible and more effective risk management, and many of the mechanisms for managing its flaws (e.g. basic transparency and progressive taxation) are simple compared to fixing the FRB-SEC-FDIC-OCC-OTC-FHA-NCUA-FFIEC regulatory behemoth.
And when a fund manager collects his no-risk fees, he doesn't pay taxes the way ordinary Americans do. Those fees, which take out 20% of the fund's profits, are considered capital gains rather than ordinary income, which is quite a trick, since the theory behind lower rates on capital gains is that money was put at risk
A hedge fund manager who takes spectacular losses can start over by launching a new fund right away, whereas a bank executive who screws up usually gets fired
Almost complete and utter BS. Yes it is true that some'hedge funds' which aren't actually hedge funds at all and are llc's or other partnerships can try the carried interest trick (which is probably going to get legislated away) in things like real estate investments, the vast, vast majority of hedge fund managers collect their income as fully taxable.
Anyone here including the author is welcome to try and start a hedge fund and raise millions/billions of dollars and collect that 2 and 20. Go for it. News Flash ... It ain't that easy...
This reminds me of sitting at a bar listening to a bunch of 28 handicappers critiquing Tiger Wood's golf swing.
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