Inequality.org

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How Many Rotting Apples Do Our Hedges Hide?

High-profile prosecutions only hint at the crime and ethical misbehavior rampant in America’s most rewarding high-finance suites.

leopold-bookThey’re hunkering down at SAC Capital, the hedge fund empire billionaire Steven Cohen has spent over two decades building. Federal prosecutors have been picking off SAC’s current and former second bananas one by one, plea bargaining for information that brings them ever closer to Cohen.

This past March SAC coughed up $616 million, 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 — on an “unconditional” basis — with government requests for information.

The information already out in public has considerably dimmed Cohen’s “financial genius” aura. The astounding 30 percent annual returns his SAC has been averaging, a vivid Vanity Fair chronicle details this month, rest on a gusher of insider tips that SAC spends hundreds of millions to keep flowing.

Whether prosecutors can prove all this, in a court of law, remains to be seen. But the hedge fund industry’s recurring response to scandal — “every industry has a few rotten apples” — is wearing thin. The hedge fund universe, one Harvard Business Review commentary observes, has become a “crimogenic” environment that encourages those enmeshed in it “to ignore legal and ethical rules.”

We’re no longer “talking simply about the occasional corrupt individual,” adds Preet Bharara, the hard-charging federal prosecutor going after Steven Cohen. We’re “talking about something verging on a corrupt business model.”

The hedge fund industry’s recurring response to scandal — ‘every industry has a few rotten apples’ — is wearing thin.

That’s certainly the view of Les Leopold, the veteran labor educator who has made demystifying America’s financial order his own personal mission ever since the 2008 Great Recession meltdown threw millions of Americans out of work and wiped out the life savings of millions more.

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: Why Hedge Funds Get Away with Siphoning Off America’s Wealth, refines that story.

Hedge funds, argues Leopold, have played a much larger role in our ongoing economic woes than analysts have generally acknowledged. That doesn’t surprise Leopold — and shouldn’t surprise us. Hedge funds, after all, operate in the shadows, behind layers of secrecy that outsiders rarely get to penetrate.

In fact, most Americans would have a hard time even defining “hedge fund.” Again, no surprise here either. Hedge funds have only been around, in a serious way, the last 30 years. They started gaining traction in the 1980s as wealth started concentrating at America’s economic summit.

Financial industry insiders saw a fabulous new market in this concentration. They could make millions — billions — managing all the cash the titans of America’s new Gilded Age had sloshing in their pockets. All they had to do: promise — and deliver — high investment returns to wealthy investors.

Hedge funds made the perfect vehicle. 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 precious little federal regulation, since they don’t service the general public, only deep pockets with at least $1 million to invest.

How you would feel if total strangers could buy insurance on your home — and collect a windfall if your home burned down?

With regulators seldom looking over their shoulders, hedge fund managers can do virtually anything they please with the money deep pockets hand them. They can buy stocks, just like mutual funds, and hope they appreciate in value. They can buy up companies, like private equity firms, and hope to make a killing on a resale. And they can lay bets — on anything.

Leopold has a useful metaphor for exposing the dangers in all this wagering. Imagine how you would feel, he 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, total 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 wade into exotic speculative markets and bet against a company’s share price or a nation’s currency or a mortgage-backed security.

The rewards if the bets pan out? Amazingly huge. In 2010, Leopold calculates, the hedge fund industry’s top ten earners averaged $842,788 per hour.

Rewards this outrageous give power suits at hedge funds an irresistible incentive to behave outrageously. And they do, as Leopold makes plain.

These suits 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 “in nanoseconds, fleecing slower buyers and sellers,” and, in the process, “pocketing a hidden sales tax on our mutual funds, pension funds, and 401(k)s.”

Hedge funds, in short, operate as a “drain on our economy and society.” We need to plug the drain. Imposing a tiny tax on every financial transaction would be one step. Such a levy, says Leopold, could put about $150 billion a year of “downward pressure” on the “inflated incomes” of our financial elites.

Sign up for To MuchThe European Union is actually making some promising moves to taxing financial transactions. In Washington, meanwhile, neither the White House nor Congress has so far displayed any interest in following suit.

Our financial apples are still rotting.

Sam Pizzigati also edits Too Much, the online weekly on excess and inequality.

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  • Lafayette

    A DARWINIAN ECONOMY

    The battle for Social Justice has been largely won in Europe, but has only begun in the US. Americans have little notion of the concept, which has long since been a foundation stone of what European’s call Social Democracy.

    In fact, in Wikipedia, I cannot even make a suggestion of the socioeconomic nature of Social Justice – because I cannot “reference” the source. Unless, of course, I reference myself – which is inadmissible.

    Here is my definition: Social Justice = The primary qualitative feature of any socioeconomic collective in which egalitarian principals merge with public solidarity to insure that the basic human right to well-being is attained by the maximum number of a nation’s citizens. It is often crudely but visually best expressed economically by the Gini Coefficient. (See Gini Coefficient here: http://en.wikipedia.org/wiki/File:Gini_since_WWII.svg )

    Note that the highest coefficient (which means highest inequality) of any modern democracy is that of the US. Note also that most European countries are a full 10 points below that of the US.

    And why does America not know about Social Justice? Perhaps we can blame the McCarthy Era which succeeded, if at nothing else, at least to give the word “social” an evil connotation. As in “Socialism”.

    In fact, Socialism still adheres to the notion that the state (meaning national government) must own some public services, whereas Social Democracy simply means that the state assures the provision of such services that serve a Public Purpose (by also employing private enterprise).

    Which, in most countries, means they serve the needs of those who find themselves in the lower levels of Maslow’s Hierarchy of Needs. Those needs, defined in the early 1940s by a psychologist, can be seen here: http://en.wikipedia.org/wiki/Maslow's_hierarchy_of_needs . Assuring those needs is not Mission Impossible, unless a nation is fixated uniquely on the accumulation of Wealth. Which makes it a Darwinian Economy of winners and losers, where winners have all or most of the privileges.

    When America’s progressives will be able to convince the grassroots of inequality in terms of the above notions, perhaps politically can arise a will to reform fundamentally our nation. Where, unfortunately, we continue to adulate those who “made it”. And all others are just Road-kill on the Highway of Life …

    • Johnny Dollar

      Definition of paragraph three = gibberish. You should be able to look that up in almost any dictionary.

      Unfortunately, the rest of the ramble is no better.

  • Johnny Dollar

    If you don’t like hedge funds, don’t invest in one. Pretty simple. Why should savers be penalized with a financial transaction tax? (By the way they already are.) A financial transaction is no different than any other transaction. What’s next? Taxing rent payments perhaps?

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