The Preposterous Reality: 25 Hedge Fund Managers Are Worth 680,000 Teachers (Who Teach 13 Million Students)

"It’s going to take a lot of political will — over a long period of time — to reorder our most basic economic values."

April 10, 2010 |

What work do we value most?

In 2009, the worst economic year for working people since the Great Depression, the top 25 hedge fund managers walked off with an average of $1 billion each. With the money those 25 people “earned,” we could have hired 658,000 entry level teachers. (They make about $38,000 a year, including benefits.) Those educators could have brought along over 13 million young people, assuming a class size of 20. That’s some value.

Apparently the 25 hedge managers did something that is even more valued in our society. But how valuable was it, really? To assess that, we need to answer a few basic questions:

1. What do hedge managers do?
They run funds into which very rich people put money to make even more money. Hedge fund managers move the money around in very risky ways to get the most enormous yields possible. (Wealthy investors believe they are entitled to double digit and even triple digit returns.)

Because hedge funds are considered playthings for the rich, who presumably are fully aware of all the risks, they are exempt from most financial regulations. (We’ll soon see if the financial reform bill now moving through the Senate changes this in any substantial way.)

The wealthy will have placed an estimated $2 trillion into hedge funds by the end of this year. (That’s about $6,500 for every man, woman and child in the U.S.)

2. Where does all that hedge fund money come from?
It’s mostly excess cash the super-rich have in hand now that their tax rates have dramatically declined. In the 1970s the marginal rate on those with incomes above $3 million (in today’s dollars) was 70 percent. Today, the effective rate on the 400 richest Americans is 16 percent, according to the most recent IRS data.

The wonderful thing about putting your money in a hedge fund (or managing one) is that the income you get from it is not taxed as income (say, officially at the rate of 35 percent). Instead, it is treated as a business investment, something that’s good for the economy and that we need to encourage through a low tax — a “capital gain.” The tax rate on capital gains is 15 percent. This is one reason that Warren Buffett can say that he pays a smaller percentage in taxes than his secretary.

3. How do hedge funds make money?
Some hedge fund managers use computerized modeling to decide where to invest or to make investments automatically. Other managers claim they just make good judgment calls. They also make enormous bets using lots of leverage and deploy an arsenal of derivatives.

It’s a dicey business, but it’s not supposed to put the larger system at risk… until it does. In the late 1990s, the hedge fund known as Long Term Capital Management, run by the brightest bulbs in the financial universe (including a couple of Nobel laureates), found itself with over $100 billion in assets but only $4 billion in capital. When that upside down pyramid began to crumble, the effect was systemic. So systemic that the Federal Reserve, fearing a major meltdown of the financial markets, forced Wall Street banks and investment houses to bail out the fund’s investors. Some economists argue that risky gambling by hedge funds did not cause the current crisis. But no one has conducted an impartial investigation into that question.

The $1 billion each those 25 hedge fund managers netted (for themselves) was impressive — but doing it in the year 2009 was also slap in the face of struggling Americans. That’s because hedge funds would have earned little or no money at all in 2009 had the government not bailed out the financial sector with trillions in loans, asset guarantees and other forms of financial assistance. It was, in effect, a generous gift from we the taxpayers. Much of that money was “earned” by betting that the government would not let the financial sector collapse. Smart bet.

In principle hedge funds would do little harm if they were not implicitly backstopped by the taxpayer in this way. Here’s how one sage financial expert put it to me recently:

Personally, I do not care whether hedge funds and other pools of unregulated funds gamble in opaque derivatives rated by incompetent ratings agencies. But I do want them to fail when their bets go bad. Nor do I want them to be rescued in the event of a run to liquidity. If they are leveraged and cannot come up with cash, they should fail. It will be painful for their creditors. So be it, the more pain, the better. That is the downside to private property. Greed is good, but must be balanced by the fear of failure. Without failure there is no fear.

Les Leopold is the executive director of the Labor Institute and Public Health Institute in New York, and author of The Looting of America: How Wall Street's Game of Fantasy Finance Destroyed Our Jobs, Pensions, and Prosperity—and What We Can Do About It (Chelsea Green, 2009).