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May 14, 2007
Hedge Funds Can Be Your Friends
Nationally renowned phony scandal purveyor John Solomon has been trying to stir up trouble about John Edwards' hedge fund ties. I wish people knew more about the particular hedge fund that Edwards was involved with -- Fortress Investment Group. Fortress is solidly Democrat-affiliated. From BusinessWeek in 2005:
During the 2004 Presidential campaign cycle, the employees political action committee of the company contributed $143,650 to Democratic candidates for Congress and the White House, including $4,000 to Edwards. They gave just $10,500 to Republicans running for federal office.
As the former research director of a dorm-room hedge fund (it was the sort of thing that kids started at Harvard during the tech bubble) I feel that I'm in good position to explain what hedge funds are and why we should have no serious problems with them.
Hedge funds are basically like mutual funds -- you give them your money and they manage it for you. The big difference is that they're allowed to pursue more complicated strategies than just buying stocks, like short-selling and playing with derivatives. Since the government doesn't want ordinary citizens blindly investing in funds that might be doing strange and risky things, hedge funds are only open to wealthy investors and institutions like banks and pension funds. A lot of hedge funds don't do anything especially risky, though -- they just pursue low-risk strategies that are too complex for mutual funds. Some use computer models to seek out incredibly complicated transactions that guarantee a small gain. In the end, they're just another company trying to find good places to park their investors' money, and they usually go about doing that in fairly inoffensive ways.
There are a broad range of forces in the corporate world that Democrats should be against. The health insurance industry traps us in an expensive and wasteful health care system that leaves tens of millions uninsured. All manner of corporations abuse illegal immigrant labor, paying immigrants miniscule wages for working under terrible conditions. Progressive policy goals involve fundamentally changing the way these businesses operate through health care reform and immigration reform.
But apart from some minor measures like increasing the capital gains tax (which won't substantially change the way hedge funds do business), there's no reason not to leave the hedge fund industry as it is. They fit nicely into the social democratic view of the economy that I think most American progressives hold -- maintain capitalism with some regulations, and tax the rich to pay for a safety net and whatever services markets can't efficiently provide.
May 14, 2007 | Permalink
Comments
Whatever Fortress does, the reason hedge funds exist is for the people with the $1 million+ to get into em is to escape regulation so they can insider trade. And the average investor can't get in em, no matter how risky they wanna be, b/c it's a sign of the 2 Americas our pal John Edwards talks about.
Posted by: Tim | May 14, 2007 1:25:48 AM
Insider trading regulations apply as much to hedge funds as anywhere else, Tim. What hedge funds can do that mutual funds can't is borrow lots of money and trade in various risky assets.
Posted by: Neil the Ethical Werewolf | May 14, 2007 1:37:50 AM
I came across your blog through a technorati search and I was wondering if you'd be interested in a link exchange with Immigration Orange. I'm always looking for different perspectives to interact with and value all viewpoints. Email me at beausset at fas dot harvard dot edu if you're interested.
Posted by: Kyle de Beausset | May 14, 2007 1:44:40 AM
Neil, what do you make of the off-shore tax shelter arrangement the hedge funds take advantage of? Edwards opposes that, and I suppose you do too? Does seem best to eliminate it, if possible.
Posted by: Sanpete | May 14, 2007 3:37:21 AM
You seem very certain that there is no reason highly secretive, lightly regulated entities that manage nearly a trillion dollars should be scrutinized.
Which fund do you work at again?
Posted by: look away | May 14, 2007 4:17:40 AM
Hedge what now?
Posted by: Jason | May 14, 2007 4:28:58 AM
Yeah, if there's a way we can crack down on offshore tax shelters, that's all to the good. I'm all for plugging tax loopholes.
Posted by: Neil the Ethical Werewolf | May 14, 2007 4:32:30 AM
Posted by: look away | May 14, 2007 1:17:40 AM
You seem very certain that there is no reason highly secretive, lightly regulated entities that manage nearly a trillion dollars should be scrutinized.Which fund do you work at again?
You'll need to put your quote for that, since I can't find it in what Neil wrote.
Neil did gloss over the negative side of derivatives, which is that derivatives can sometimes allow specific systematic risks like risks of a FX move or risk of a recession to be concentrated in a certain portfolio, held by those either unable to shift the risk, unable to detect the risk, or having unrealistically low expectations of the likelihood of that risk being realized.
If a hedge fund gets burned, it would normally be in the third group, because a hedge fund will be able to both assess the risk and to lay off a part of the risk.
But if the institutional investers with positions in hedge funds are doing so prudently, without being over-exposed to any single fund, then the only people at serious risk of getting burned are, essentially, millionaires with incomes of more than $200k annually. If they get burned because they were over-invested in a single hedge fund looking to get something for nothing, while Big Media will cry, I certainly won't.
Posted by: BruceMcF | May 14, 2007 7:31:22 AM
This whole thing has been a smear by righwingers.
In Media Matters last week, there is a good article on some of this.
The author says:
"Media portray wealthy candidates who advocate progressive economic proposals as out-of-touch hypocrites. Bizarrely, wealthy candidates who advocate conservative economic policies that would actually enrich themselves often escape similar scrutiny of their personal finances.
snip
"These rich men are trying to drive a wedge between the middle class and the poor (an electoral majority, in other words) and a candidate who would raise taxes on the rich in order to help the middle class and the poor."
http://mediamatters.org/items/200705120002
His work at Fortress has no impact on my view of John Edwards.
Posted by: Tom Wells | May 14, 2007 8:20:45 AM
Since the government doesn't want ordinary citizens blindly investing in funds that might be doing strange and risky things, hedge funds are only open to wealthy investors and institutions like banks and pension funds.
Well, good, because rich people never "blindly" invest in things that "might be strange and risky."
Since so much of America's wealth is being concentrated in the hereditary hands of a few, when will we drop the idea that wealth is a sign of innovation and wisdom? Paris Hilton is only the most visible heir/heiress running around doing stupid things.
Posted by: Stephen | May 14, 2007 8:36:49 AM
It should also be noted that Fortress is one of the publically trade Hedge Funds, so that it faces far more public reporting requirements than a closely held private fund.
Of course, the simplest approach is to consider the source ... this "gotcha" is courtesy of Solomon at the WaPo, who's a hack that writes lazy pseudo-attacks, invariably against Democrats.
When Solomon breaks a story, the first step of any responsible journalist would be to find out whether there is any story, and if not then report on Solomon engaging in another substance-free attack.
Posted by: BruceMcF | May 14, 2007 8:39:08 AM
Getting Solomon fired/ assigned anything other then presidential politics needs to be the progressive blogosphere's new issue.
He is a slander time bomb waiting to go off a month before the general election.
Posted by: ChrisB | May 14, 2007 9:03:41 AM
Posted by: Stephen | May 14, 2007 5:36:49 AM
Well, good, because rich people never "blindly" invest in things that "might be strange and risky."...
That's not the point. The point is that if they do, then tough titties. If hedge funds are preying on millionaires, who can perfectly well afford prudent third party advice that there is no such thing as something for nothing, well, big whoopdy do.
Posted by: BruceMcF | May 14, 2007 9:03:48 AM
Here's the point:
If it were a conservative candidate that had this history with this hedge fund, Neil would not be apologizing for John Edwards, but instead railing about the two Americas and the evils of Wall Street. However, since it's John Edwards that transgressed, he is willing to prostitute his belief system.
Posted by: Fred Jones | May 14, 2007 9:16:41 AM
Posted by: Fred Jones | May 14, 2007 6:16:41 AM
Here's the point:
If it were a conservative candidate that had this history with this hedge fund, Neil would not be apologizing for John Edwards, but instead railing about the two Americas and the evils of Wall Street. However, since it's John Edwards that transgressed, he is willing to prostitute his belief system.
Fred, you are projecting. If it was a Republican smeared in a lazy bit of gotcha reporting by a WaPo write, you would have defended the politician, but since it was a Democrat, you didn't.
If you imagine that John Edwards thinks that Wall Street is intrinsically evil, you are getting your information at second and third hand from biased sources. Wall Street was every bit as much part of the economic system in the 50's and 60's when the middle class was growing and poverty was declining.
Just as it is not money that is evil, but the love of money, it is not Wall Street that is evil, but public policies pandering to paper profits over productivity in the real world.
Oh, and alliteration too .... its not alliteration that's evil, but the love of alliteration.
Posted by: BruceMcF | May 14, 2007 9:24:31 AM
How about the ambulance chasers responses that he joined a hedge fund to "investigate poverty"? Do you numbskulls really buy that line of propaganda as well? I bet there is lot of poverty talk going on inside that hedge fund, right after discussing how they plan to customize the cabins of their private jets, but shortly before the seminars on buying that vacation home on the French Riviera.
Posted by: JBJB | May 14, 2007 9:28:11 AM
One tiny correction. You say, "The big difference [between hedge funds and mutual funds] is that they're allowed to pursue more complicated strategies than just buying stocks, like short-selling and playing with derivatives." Mutual funds are allowed to use derivatives and strategies related to them. They are just not allowed to make derivatives and securities lending strategies their main strategies. Also, I know you were using "just buying stocks" as a shorthand, but mutual funds invest in more than stocks. There are bond funds, money market funds, etc.
Finally, there has been debate in recent years about the need for and ways to regulate hedge funds in Congress and the SEC because hedge funds are affecting retail and non-wealthy investors like us as institutional investors like retirement plans and mutual funds have begun investing in hedge funds. (e.g., see the SEC's rule making on "Funds of Funds).
Posted by: Deedle | May 14, 2007 10:23:21 AM
JBJB, if you can show me one candidate that isn't wealthy, I'll begin to consider your statements regarding private jets and such.
Posted by: Ben | May 14, 2007 11:29:11 AM
Bruce, I actually had a few sentences on Long Term Capital Management in this post at one point, but then I took them out. Certainly, if people are making insane leveraged bets that can blow them up and take a lot of the market with them, that's a problem.
ChrisB, I'm willing to go on an off-and-on anti-Solomon crusade. "Slander Bomb" is a good nickname for him, unless anybody has anything better... suggestions, please?
Posted by: Neil the Ethical Werewolf | May 14, 2007 12:12:54 PM
Why is it conservatives think it is some sort of gotcha that Edwards is rich? Does it make his concern for the poor not credible? He isn't saying there shouldn't be rich people. He is saying we should do more to bring poor people up to the middle class.
I guess I also missed the part where Edwards proposed that taxes be increased on all rich guys except former Senators named John?
Posted by: Eric | May 14, 2007 2:02:55 PM
Neil, what do you mean by "insane leveraged bets that can blow them up and take a lot of the market with them"? Isn't that more or less what happened to Amaranth Advisors (probably getting the name wrong---the gas futures bet that wiped out a $6B hedge fund) last summer? As I recall, there wasn't any big repercussions in the rest of the market, and all that happened was that a lot of rich investors learned the downside of the risk-reward curve.
Posted by: Jack Roy | May 14, 2007 2:03:19 PM
Oh Eric, there's some sort of nonsense argument about the supposed hypocrisy in talking about two Americas while being rich himself. I guess if you're going to say that the economy as currently regulated has produced some unfair results you better be ready to give away all your money before you get into any kind of position to change the situation. I just can't believe anyone makes those arguments in anything approaching good faith, but they make them nonethesame.
Posted by: Ben | May 14, 2007 2:08:16 PM
Nonethesame? Holy not what I meant to say Batman! On second thought, I'm just going to start jamming words together at random. In the meantime though, let's all pretend I said all the same or maybe nevertheless.
Posted by: Ben | May 14, 2007 2:10:22 PM
Jack -- in 1998, Long Term Capital Management blew up and nearly caused a major financial crisis. Given how leveraged they were, there was a danger that their collapse might require them to unleash gigantic bond positions, throwing the market into chaos.
Posted by: Neil the Ethical Werewolf | May 14, 2007 2:13:27 PM
... If it was a Republican smeared in a lazy bit of gotcha reporting by a WaPo write, you would have defended the politician...
John Edwards, or anyone else that has worked for Wall Street, doesn't need defending.
Posted by: Fred Jones | May 14, 2007 2:54:09 PM
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