April 17, 2008--It's the Money, Stupid

And all along I thought it was the economy.

I naïvely thought that the reason hedge fund managers get special tax treatment was rationalized by the government because while having the potential to make lots of money for themselves and their investors, this income is not just of individual benefit but also helps lift the larger, macro economy.

In the language of tax lawyers, hedge funds are subject “to favorable treatment” by the U.S. Tax Code in order “to minimize the tax burden on investors.” This is because the income hedge fund managers generate is considered not to be personal income, which can be taxed up to 35 percent, but rather capital gains, or investment income, which has a top tax rate of just 15 percent.

In other words, it’s thought to trickle down.

Well guess what--it doesn't look as if it does.

To help understand this let's first take a quick look at what a few of last fiscal year's most successful hedge fund managers invested in. Were the investments that yielded each of them billions in personal income bets that would finance new business formation and thereby create thousands of new jobs for Americans, or Taiwanese and Indians for that matter? Did their investments help businesses expand or develop new products and services that would yield profits for shareholders and again lead to more hiring?

Let's check what John Paulson was up to to justify his $3.7 billion in income for 2007. Or James Simons and George Soros, each of whom earned almost $3.0 billion.

According to the New York Times (story linked below) how they deployed the money they controlled had very little effect on the larger economy. And though understanding some of this is far beyond my expertise, it looks to me like the fellas who made out best benefited greatly from the misfortunes of others. Particularly from those Americans who had sub-prime mortgages and who are now seeing their savings wiped out as the real estate bubble bursts.

To many in the hedge fund world it was like shooting fish in a barrel. There was so much of this kind of money lying around to be scooped up at bargain basement prices that that funky liberal philanthropist, George Soros, who made most of his initial billions by manipulating the British Pound, came out of retirement to get in on the action. His Madallion Fund rose 73 a nifty percent last year.

In 2005 Mr. Paulson’s began betting that various kinds of sub-prime mortgages would decline in value and set up two funds to take advantage of this. One returned nearly 600 percent last year and the other “just” 350 percent—all because of the good news for Paulson and company that this sector of the mortgage economy imploded.

He lives modestly in his $15 million apartment on New York’s Upper Eastside. George Soros has given away some of his billions to various good causes. But others in the Billion-A-Year Bottom-Feeders Club have been buying even larger apartments, Hamptons mansions, super-yachts, and fueling the market for Modern Master paintings. Hedge fund managers were perceived to have bid up to record levels last year prices on assorted Picassos and Warhols and Johns.

I’m not an economist but I do not see how any of these staggering profits have been of benefit to anyone other than the hedge funds’ investors. Few trickle-down jobs are created through the sale of $30 million coops or at auctions at Sotheby. And fewer still when folks get tossed out of their homes and onto the street.