Nothing beats a presidential campaign for bringing out the most creative combination of facts, misrepresentations, smart analysis and outright lies about people, countries, industries or ideas that the public appears to loathe. And 2016 is no exception on a lot of fronts. We could take trade, immigrants, taxation, Mexico or Wall Street.
But let’s focus on a subset of that last group: hedge funds.
Hillary Clinton, the likely Democratic nominee for president, puts hedge fund managers in the same category as Wall Street and Fortune 500 CEOs.
“Prosperity can’t be just for CEOs and hedge fund managers. Democracy can’t be just for billionaires and corporations,” Clinton said in one of her inaugural speeches as a candidate. She went on to castigate Republican attempts to repeal regulations passed in the wake of the 2008 financial crisis. She made the remarks in New York City, about 9 miles away from Wall Street.
For starters, the conflation of Wall Street and hedge funds isn’t entirely crazy — they do a lot of business with each other — but it misses the mark. If the prototypical Wall Street firm is an investment bank such as Goldman Sachs, the prototypical hedge fund … doesn’t really exist.
It’s a diverse, global industry. There are about 10,000 hedge funds that manage about $3 trillion dollars in assets, a respectable sum but far off the roughly $16 trillion that Americans alone have in mutual funds.
What are we really talking about?
Hedge funds pursue wildly varying strategies that constantly confound those who would categorize them. Some stay far off the public radar, trading corporate debt or energy-related securities. Others swagger into the limelight by buying chunks of prominent companies and demanding changes. Plenty build strategies around broad macroeconomic trends. Not a few specialize in stocks or bonds. Saying you work for “a hedge fund” tells the listener about your legal structure, but precious little about what you actually do.
“The term ‘hedge fund guys’ is kind of an empty vessel. I just sort of take that as ‘generic rich guy from New York,’ which is what I think its meaning is, really,” said Ryan Ellis, tax policy director at Americans for Tax Reform told the Huffington Post.
And by the way, if you wanted to identify a single geographic location for hedge funds, synonymous with the industry, you’d probably choose Greenwich, Connecticut, where many have concentrated their operations.
Much of the incoming fire directed at hedge funds from presidential candidates involves less who they are than what they do. And the critique goes something like this: Hedge funds are vultures who pick on helpless companies or even countries and profit from the misery of others.
Clinton took this tack in discussing Puerto Rico’s debt crisis, where some holders of the island’s debts are hedge funds. “We need to tell the hedge funds and the other creditors, who are just trying to make a profit off the misery of the Puerto Rican people, to go to the back of the line and stop blocking us from making a fair resolution of this crisis,” she said in April.
Bernie Sanders, the Vermont Senator who’s given Clinton a good run for her money, has offered much the same line.
It’s not even worth looking at whether all hedge funds do something like this. They don’t. Remember, it’s a diverse industry. The question is rather, do some of them do something akin to what Clinton and Sanders are saying.
So they want to make money. Shocking.
The first part is undoubtedly correct: hedge funds are trying to make a profit. By investing in Puerto Rican debt, the funds were buying what are known in the financial services business as distressed assets. These are securities or other obligations whose value has plunged as other investors doubted their value and dumped them. Hedge funds snap up the securities for low prices, giving liquidity to investors who may otherwise struggle to find a buyer, and then seek to squeeze out of the investments what they can. This is what a number of hedge funds have done with regard to Puerto Rico. On one level, the funds are doing what anyone would in any business: buying low in hopes of selling high. They are as American as apple pie.
Are they also ruthless exploiters of Puerto Rico? Well, there’s a lot more than meets the eye there.
The charge obscures an important point: at times, hedge funds have been the good friends of Puerto Rico’s government, lending the island money when few others would. By the end of 2014, a clutch of funds were providing financing, advice and political support to a very willing Puerto Rican government.
Now, with the island out of options and needing to restructure its debts, Congress is considering plans that would let it do so under the eye of a federal supervisory board. And hedge funds are jockeying for a favorable position — something that any creditor, hedge fund or otherwise, would do.
So much for what hedge funds do. But there’s another issue: what they don’t do, according to Clinton, Sanders and the presumptive Republican nominee, Donald Trump. They don’t pay enough taxes.
The “the hedge fund guys” are “getting away with murder” by “paying nothing” in taxes, Trump groused during an early primary campaign rally. Clinton and Sanders have made similar arguments, usually by comparing tax rates of hedge fund managers to butchers, bakers and candlestick makers.
Hedge funds can be our friends, too.
It’s worth noting that none of the criticism of hedge fund managers from Trump and Clinton — the likely antagonists in November — gets in the way of other relationships. Trump’s new national finance chair, that is, his chief fundraiser, is Steve Mnuchin, the chairman and chief of Dune Capital Management. Yes, a hedge fund manager.
Clinton’s son-in-law is Marc Mezvinsky, founder of Eaglevale Partners, a New York-based hedge fund. To boot, one investor in the fund is Lloyd Blankfein, the CEO of Goldman Sachs, a true Wall Street badboy in the view of today’s Democratic Party.
The question of whether they pay less in taxes than more prosaic professions, as the Annenberg Public Policy Center has documented, is influenced mightily by exactly what profession we’re talking about, where the person lives and how the person files a tax return. “There are plenty of firefighters, police officers, nurses and truck drivers who should not be fooled into thinking they pay higher rates than the wealthy hedge fund managers,” the center’s Lori Robertson wrote in a report.
Presidential candidates have also latched onto one particular tax provision – opaquely known as carried interest – that they want to abolish. The punchline in all this rhetoric is – or should be – that Trump, Clinton and Sanders are determined to kill something that really doesn’t matter much to hedge funds.
Would you believe they want to minimize their taxes?
Carried interest describes the investment gains that fund managers – whether private equity, hedge or venture capital – harvest as their payoff, usually in addition to a management fee. The tax code treats this income like a profitable investment, and applies the capital gains tax, not the higher income tax. It’s a bit dicey because fund managers don’t usually risk their own money, so it looks more like income than capital gains.
Be that as it may, it’s largely irrelevant for hedge fund managers. Tax rules specify that the investment be held for longer than a year, a period during which hedge funds might buy and sell hundreds of securities. Carried interest is another matter entirely for private equity funds, whose stock in trade is to take control of a company and restructure it. They’d lose if the carried interest rule changed.
That’s not to say hedge fund managers don’t make great efforts to limit their tax liability. They do. Corporate cutouts in the Cayman Islands and other tax havens, complex reinsurance schemes and well-paid lawyers are part of the game plan. But carried interest? Not really.
Okay, but hedge funds are lightly regulated, a threat to the financial system, and that’s bad. We need more rules!
Is it possible there are better things to worry about than hedge funds?
During and after the 2008 financial crisis, governments concerned themselves with banks – the institutions that round up the savings of individuals and businesses and loan it out for productive uses. They are essential to an economy, so governments in Europe and the United States spent a lot of taxpayer money to rescue banks. They spent even more cushioning the blow of the resulting recession. And then they imposed all sorts of new rules on banks.
Hedge funds largely escaped new rules under the 2010 Dodd-Frank law, which overhauled financial regulation in the United States. The U.S. Congress imposed some light reporting requirements, which did little more than create a public record of the broad outlines of the hedge fund industry. One change that Clinton is proposing – that banks be prevented from investing in hedge funds – speaks more to the problems of banking than hedge funds.
Why the light touch?
Back in the late 1990s, the Federal Reserve gave its implicit blessing, but no actual money, to a rescue of Long Term Capital Management, a hedge fund gone awry at the time of broader financial turbulence. Nearly 10 years later, shortly before the financial crisis, a large hedge fund, called Amaranth, went belly up with no lasting consequences. In short, during the crisis that nearly felled the western financial system, hedge funds mostly stayed out of trouble.
It took the 2016 presidential campaign for them to really feel the heat.