Reuters
Hedge fund directors George Soros (L-R), chairman of Soros Fund Management LLC, James Simons, director of Renaissance Technologies LLC, John Alfred Paulson, president of Paulson & Co Inc, Philip Falcone, senior managing director of Harbinger Capital Partners, and Kenneth Griffin, CEO and managing director of the Citadel Investment Group, are sworn in to testify before a US House Oversight and Government Reform Committee hearing on the regulation of hedge funds, on Capitol Hill in Washington November 13, 2008.
A hedge fund manager recently quipped in our presence, “regulating hedge funds is like protecting millionaires from billionaires.”
And yet, this cadre of financial elites can be quite populist when they want to — particularly when they can share the U.S. taxpayers’ frustrations against the appointed scapegoats of the crisis: investment banks and ratings firms. Both the banks and the ratings agencies have been rivals and obstructions to the greater glory of hedge funds, and we have sensed the hedge funds’ need for revenge.
So, as five prominent hedge fund managers testify today in front of the House Oversight and Government Reform Committee — you can see our introduction to the proceedings and some of the statements here — Deal Journal tuned in, expecting to hear a lot of hedge funds prove how they share many of the same interests as average taxpayers. We weren’t disappointed, as Congress quickly identified the hedge-fund managers as governmental allies against the investment banks. We’re live-blogging it.
12:25: Phil Falcone of Harbinger Capital Partners gives his opening remarks. He looks like a besuited John Lennon, with round glasses and artfully shaggy hair. He wants Congress to know this: Compensation in the hedge fund world is performance based, and that works. Short-selling is a long-standing and valuable feature of our markets.
12:27: We were so right about the populism. Falcone points out he grew up working class, and his mother worked in the local shirt factory. It includes details of the square footage of the house he grew up in. “Not everyone who runs a hedge fund was born on Fifth Avenue. That is the beauty of America and the beauty of our industry.” Very Horatio Alger, and it shows the savvy Falcone knows his audience. Congress eats this up as a great support to Main Street. Our president was just elected on a similar platform, after all.
12:28: Harbinger is doing well, and that’s fine. But it’s bad for management of companies to take compensation when the company is failing, Falcone says.
12:29: Hedge funds encourage “outside the box” thinking. Isn’t that part of the problem? Or rather, that no one can see the box, or know what’s in it?
12:30: Falcone says, “While I was growing up, my family may have lacked money, but we didn’t lack integrity in what we did and how we did it….I love this country and am grateful for the opportunity I’ve been provided.” He wants people to see the hedge fund industry as “part of the solution for the economic turmoil.” Cue the Star-Spangled Banner.
12:32: Ken Griffin of Citadel is up next. “We call financial risk-taking research and development.” Good line.
12:34: “The concept of ‘too interconnected to fail’ has replaced ‘too big to fail,” Griffin says. Another good line. The Committee appears to be silently sizing up his speechwriting ability.
12:36: Questions begin. “Witnesses will not be required to answer questions unrelated to the topic of today’s hearing,” Waxman warns. Later, this turns out to be unfounded, as the Committee is all too eager to talk about the topic of today’s hearing. At length.
12:37: Waxman begins at the beginning: with systemic risk. Long-Term Capital Management, which was leveraged about 33 times and nearly collapsed, requiring a government-brokered bailout. Seriously, everyone in the entire hedge fund industry could devote the rest of their lives to digging wells for poor villagers in Africa, and they will still never be absolved from the LTCM debacle.
12:38: George Soros starts, in his euphonious accent. The power of hedge funds does justify greater financial regulation, he says. Just like that! We’re surprised, since the industry fought regulation for years. But then, he didn’t make his money by being on the wrong side of a trade, even a political one. Most of the others agree.
12:41: John Paulson says that hedge funds do not need as much control over their use of leverage as banks and financial institutions. “The problems at LTCM were minuscule compared to the $150 billion at AIG, the $700 billion in the TARP program, or even the capital advanced to GE.”
12:43: Falcone: “With $1 trillion outstanding…the industry is not nearly as levered as some of the banking institutions we did business with over the past few years.”
12:44: Griffin advertises Citadel’s joint effort to create a derivatives clearinghouse with the CME. This is sort of like product placement in movies, but with complicated financial systems. He advocates private-market solutions like that. Griffin is the first to say he believes that the hedge fund industry does not need more regulation. Waxman breaks in to note that some of the private-market solutions were brokered by the Fed. Griffin shoots back, “If we look at the stress points, they have been in the regulated institutions like AIG.” Oh, snap. Hedge funds have not been part of the carnage, he notes. Well, that’s not exactly true — plenty have gone out of business — but it is true that the failures of regulated institutions were much, much larger.
12:45: All of the hedge fund managers say they are willing to disclose their positions, but not to the public — only if the government keeps them confidential. Because the U.S. government is soooo great at keeping secrets, we presume. Griffin dramatically states that asking hedge funds to disclose their positions would be like asking Coca-Cola to disclose the recipe for Coke. Oh, boy. He invoked Coke. Next we expect to hear about the sanctity of the recipes for motherhood and apple pie.
12:52: Paulson: “It doesn’t make sense to me that the government puts in capital, the banks take the capital, and then that capital comes out the other door in the form of dividends.” He wants restrictions on cash compensation, and any bonuses should be paid in common stock (meaning, not in stock options or restricted stock.) This will protect taxpayers and restore badly needed capital to these institutions.
12:53: Simons reminisces about how he suggested to former Treasury official Bob Steel that the government set up a two-sided auction process, matching buyers of troubled assets with sellers of those assets. Great idea, sure, but the problem all along was that there were no buyers. Simons explains that the assets would be significantly marked down.
12:55: Soros says that if the asset purchases were done properly, $700 billion would have been enough to fix the “gaping hole” in the markets. He believed TARP should only have underwritten the securities, not acquired them, and underwritten them on terms that would be beneficial for taxpayers.
12:58: The next questioner points out why these hearings are so mild: every single manager up there has made a ton of money this year. These calm, gathered billionaires are hardly poster children for failure, thus their mild, helpful, even jolly demeanors. The Congressman only cares about one thing, though: How did they do so well?
12:59: Griffin answers first, and much to his credit he confesses that Citadel had a tough eight weeks. He also says that no risk management system would have identified what happened over the past eight weeks. True, true.
1:00: Falcone attributes his firm’s ability to “weather the storm” to their “diligence.” It took him eight to 12 months of analysis before he invested in the mortgage market. Subtext: Hedge funds are thoughtful, and not trigger happy like the banks. Bad, bad banks.
1:08: Soros: “Markets that allow short-selling tend to be more stable than those prohibiting them.”
1:13: Griffin blames the lack of a central clearinghouse for derivatives for pushing “thousands of high-paying jobs abroad.”
1:15: After an incredibly long-winded question that wanders everywhere from George Soros’s recent book to the state of the financial system, Rep. Carolyn Maloney retreads all the answers that the managers have already given: Yes, they would agree to disclosure and transparency.
1:17: Maloney is officially incapable of asking a question in less than 200 words. She yields with respect. Congress is being so much nicer to hedge fund managers than they were to bankers, who received the grilling of their lives in a TARP hearing earlier today.
1:23: Rep. Shays asks questions about whether hedge fund managers should have their money in all of their funds. Griffin notes that the fund he has his money in has lost more money than his firm’s other funds. Soros answers that to avoid precisely that conflict of interest, he has only one fund, and that all his money is in it. Shays asks how that fund’s performance compares to Soros’s other funds. His other funds of…one fund, he means? Shays then turns to Simons, who he accuses of mumbling and cuts off. The remaining two managers race through their answers. Watching Shays work is like watching a drive-by.
1:25 Rep. Cummings says the five managers are “richer than God,” and promises not to disclose their individual compensation, but each of them made $1 billion last year on average, he says. He notes that they are not taxed like normal citizens because they are taxed at lower capital-gains rates. As the managers start to reply, Cummings orders, “I want you to keep your voices up for my questions.”
1:28: Paulson replies, somewhat condescendingly, “I appreciate your concern for the tax code,” or something to that effect. Falcone says that hedge funds should not be treated differently than other investors, and notes that 98% of his income last year should have been taxed as ordinary income. Paulson argues that there’s no problem with taxing short-term capital gains at the short-term rate, and long-term gains at the long-term rates. Griffin compares the tax treatment to being a chef and co-founder at a restaurant; he works every day (slaving over hot convertibles and plating steaming credit-default swaps) and when the restaurant is sold, he pays long-term capital gains. It’s not a complicated concept.
1:33: Rep. Tierney shows himself confused at the difference between management fees –taxed as ordinary income — and carried interest. He also is confusing the basic difference between “goods” and “services,” as he claims that hedge fund managers are not expending effort that requires remuneration when they are investing other people’s money. He basically believes management fees shouldn’t exist. So hedge fund managers should work for free? Great business model. If it applied everywhere, then Congressmen would not get salaries for representing their constituents, right? Then he accuses Griffin of using the restaurant analogy to confuse people.
1:34: Rep. Tierney decides that John Paulson should be in charge of TARP, instead of Hank Paulson. The veering from attacking Griffin to loving Paulson makes us dizzy.
1:38: Rep. Yarmuth launches into a long reminiscences of the hearings that included Angelo Mozilo earlier this year. Keep in mind, the representatives only have five minutes total, including questions and answers. We notice they’re spending much of that time talking, and then cutting off the hedge fund managers later.
1:41: Griffin says corporate leaders need to take risk in order to push innovation.
1:43: Rep. Cooper — apparently moonlighting as a newspaper editor — says grandly that the “headline of this hearing is Paulson v. Paulson: John Paulson accuses Hank Paulson of botching the bailout.” We didn’t hear that.
1:44: Paulson immediately points out that he, um, never criticized Hank Paulson or accused him of botching the bailout. Instead, he believes Hank Paulson has reoriented the bailout in the right way. Sure, but does he expect Congress to let facts get in the way of a good sound bite?
1:46: Rep. Cooper asks how much volatility in the markets is enough. “2,000?” We’d be surprised if he gets an answer. He doesn’t.
1:48: Soros points out that the obsession with risk has left out the importance of volatility and uncertainty. It’s a good point.
1:49: Rep. Cooper accuses Citadel of having a conflict of interest in launching a clearinghouse with the CME. Griffin says there is no conflict because Citadel will contribute intellectual capital, while CME will actually run the clearinghouse. Cooper is not happy with having to rely on a Chinese wall, rather than a real separation.
1:50: Rep. Van Hollen asks, in a two-and-a-half-minute long question, something about hedge fund regulation that takes multiple byways. The question appears to be about regulation, and whether regulators should have greater powers, including setting leverage ratios.
1:52: Soros notes that useful old laws on leverage ratios and other things have fallen out of use and should be reinstated. All the other hedge fund managers agree. Griffin turns the question back to clearinghouses and points out the difference between the “TCC” solution, open only the buyside, and the “Citadel solution,” which would open the clearinghouse for everybody, and it’s in the “interest of our nation and the entire world’s financial system.” Griffin is lobbying like a champ. Call it market efficiency: Why spend time testifying in front of Congress if you don’t also pitch your product?
1:55: Rep. Van Hollen makes an excellent point: the hedge fund industry fought regulation tooth and nail a few years ago. It gives the lie to the current professed willingness to disclose positions and accept stricter regulators.
1:58: Soros points out to Rep. Issa that regulators should understand the instruments they’re regulating, and should not allow the use of instruments they don’t understand. Sensible.
1:58: Rep. Issa throws a softball to Paulson, who he congratulates for earning a 1% return, and asks how Paulson manages leverage. This goes nowhere. We’ll spare you.
2:02: Issa asks why hedge funds should be treated differently than mutual funds when it comes to capital gains. Paulson says perhaps hedge funds should have time horizons of more than one year, and then they would be closer in profile.
2:02: Waxman closes the session with big smooches to the hedge fund managers, the combined billionaire superwattage of which has left the Committee presumably blinded by the fund raising possibilities. Here is what Waxman says: “Congress usually has trade associations here, and they speak in their self-interest. That’s why we wanted to have you here, to get an unfiltered response.” Oh, boy. If Waxman believed the managers were not speaking in their own self-interest, it just highlights how much more Washington needs to understand how Wall Street communicates. Besides, these managers succeeded in the credit crisis, so they have nothing to be defensive about.
2:05: The session ends.
source: wsj deal journal
Directors of a number of products linked to the AllWeather fund, the flagship fund of hedge funds overseen by Pioneer Alternative Investments, have established separate portions of their vehicles to isolate their exposures to Bernard Madoff. The funds’ directors have also frozen subscriptions to their portfolios, according to a filing with the Irish Stock Exchange.
September 15
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