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Hedge Fund Managers To Congress: Go Ahead, Regulate Us

What a difference two years and a financial crisis make. When Congress last floated the idea of regulating the hedge fund industry in 2006, proposing a bill that would have forced them to register with the Securities and Exchange Commission, the industry revolted and the bill died in committee. But on Thursday, in the face of growing economic tumult and an incoming pro-regulation Democratic administration, top hedge fund managers signaled they are now willing to deal on the thorny issue of oversight.

Testifying before a congressional oversight committee, fund managers Philip A. Falcone, Kenneth C. Griffin, John Paulson, James Simons, and George Soros agreed that hedge funds may require increased government regulation. Even minor regulation or increases in transparency would be a big change for the hedge fund industry. "Currently, hedge funds are virtually unregulated," said Henry Waxman (D-Calif.), who chairs the House Committee on Oversight and Government Reform, which held the hearing. (Mother Jones also covered Waxman's previous hearings on Lehman Brothers, AIG, credit rating agencies, and federal regulators.) The 1998 rescue of Long-Term Capital Management (LTCM) demonstrated that the failure of just one highly leveraged, unregulated fund could require government intervention. Because LTCM was considered "too interconnected to fail," the Clinton administration arranged for a bailout of the fund by Wall Street banks. Most of the committee members (and, naturally, the hedge fund managers) believe that hedge funds were not the cause of the financial crisis. But with the economy already in dire straits, members of Congress are determined that the hedge fund industry not produce another LTCM. "In our prior hearings, we have focused on what went wrong in the past," Waxman said. "Today's hearing lets us ask what could go wrong in the future so we can prevent damage before it occurs." With President-elect Barack Obama entering office in January, the writing is already on the wall when it comes to increased regulation of the financial sector. By demonstrating their willingness to accept some increased regulation, the hedge fund managers who testified on Thursday made the imposition of new rules on their funds' behavior almost inevitable.

Why would the most successful people in an industry that previously opposed government regulation suddenly change course? The hedge fund managers may have simply remembered the old Washington saying that "If you're not at the table, you're on the menu." With the markets in chaos and Congress desperate to take action, the no-way-no-how position the hedge fund industry originally took toward regulation is not likely to be well received. By accepting the need for modest regulation and slightly increased transparency, the hedge fund managers were showing they were willing to negotiate.

The fund managers have a lot at stake. Not only do these five men make some $5 billion a year collectively, but they also receive favorable tax treatment on some of their income. In a practice known as "carry," or carried interest, some of the cut that hedge fund managers take of their firms' profits is taxed as capital gains, rather than normal income. In theory, this is allowed because hedge funds are investment partnerships. (Long term capital gains are taxed at 15 percent and exempt from payroll tax.) According to Joseph Bankman, a professor of law and business who testified before the managers, "A fund manager who in 2007 earned $80 million paid tax at a lower average rate than a high school principal who earned $80,000."

Last year, legislation passed the house that attempted to correct this alleged loophole, but stalled in the Senate after fierce lobbying from hedge fund and private equity executives. The tax treatment of carried interest was brought up in Thursday's hearing, but in general the proceedings were remarkably non-confrontational. The hedge fund managers probably didn't want to appear uncooperative in the face of a national crisis, and the committee members may have been reluctant to anger five billionaires who have showered politicians (mostly Democrats) with nearly $400,000 in campaign contributions this election cycle alone.

The pace of congressional hearings investigating the financial crisis and the bailout doesn't seem likely to let up anytime soon. A House hearing on Friday will feature testimony from Neel Kashkari, the 35-year-old former Goldman Sachs banker who is in charge of overseeing the bailout. Check back for our coverage.

Photo from flickr user Artemuestra used under a Creative Commons license.

Comments

Seems to me this asswipe doesn't have time to check stories before he fires a broadside on his weenie blog. Go fuck yourself and get a job.

Posted by: Phillip Pulliam on 11/13/08 at 4:55 PM Respond

Phillip, as someone who is reading the blog entry who is not entirely familiar with the hedge fund industry, I urge you to clarify what you have said. If you have information that conflicts with what the author has posted, I would be interested in hearing those comments rather than the insults you posted, which seem irellevant without any substance to back up their virulence.

Posted by: rhfarmer on 11/14/08 at 4:12 AM Respond

Brilliant and cogent criticism, Phillip. This sort of commentary would put you at the top in kindergarten.

Posted by: John on 11/14/08 at 5:18 AM Respond

Phil, as someone who works at a multi-billion dollar investment firm which invests in a variety of hedge funds, I don't see anything particularly egregious in the article posted. Would you care to share your critique?

Posted by: ehboy on 11/14/08 at 9:16 AM Respond

How about taxing everyone at the same rate and call all income, "income". Perhaps that collective rate could be lowered for all of us.

Posted by: Mikie on 11/15/08 at 2:46 AM Respond

I have friends who think that the whole idea of Capitalism is to make money and they seem to add -by any means possible. I have a problem with that. It would make robbing banks a Capitalistic endeavor and believe me, the Hedgefunders and Corporate CEO's who give themselves huge bonuses by manipulation of loans and Market trends are nothing but Bank robbers! White collar Bankrobbers but Bank robbers none the less! The job of lawmakers is to plug holes in the system-Lou Dobbs called them ratholes. I tend to agree!

Posted by: Mr. Independent on 11/15/08 at 6:29 AM Respond

Most world economies have gone from Manufacturing, Producing and Innovation to pushing money and paper around on Wallstreet and that in my opinion is why we are in the mess we are in today..

There are two exceptions to this rule in China and India who have continued to manufacture and produce product which they sell to the world which has forgotten about Manufacturing and Production of products..The only production left in the USA is the manufacture of Military weapons..Could it be that the USA is afraid of what would happen if they lost this production and that is why they continue their wars in Iraq and Afganistan..

Wallstreet and other world markets did very well until greed and corruption showed them for what they are..Crooks..

It was then that it was noticed that Manufacturing and Production had moved to China and India where the big corporations in order to help their bottom line on wallsteet had shipped them..

Now China and India are sitting pretty while we have a recession..

Posted by: doober on 11/16/08 at 12:52 AM Respond