Winning Ugly

Big Money in Short Sales

Quote of the Day:"Capitalism isn't pretty" but "So what?"

"It's clear somebody has to win and somebody has to lose. It's not pretty at all because people say, 'Oh my God. Look how much money these guys are making while people are losing their homes and are complaining about the cost of eggs and sugar.' But so what? We don't live in a society that is pretty all the time. That's why it's capitalism."

~ So sayeth Daniel Strachman, a former hedge fund consultant and author

Over the past 2 days, all of the news is about hedge fund manager John Paulson and the obscene amount of money he made personally last year--3.7 BILLION~ "by betting subprime mortgage securities would sour...
[...]

"He wasn't the only one with Titanic-size profits. Two other fund managers, George Soros and James Simons, who are notoriously secretive about their investments, earned $2.9 billion and $2.8 billion, respectively, according to Alpha Magazine's annual list of top hedge fund earners.

"The numbers left jaws agape across Wall Street and Washington. With his windfall from last year alone, Paulson could have bought troubled Wall Street giant Bear Stearns three times over. Or he could have matched the price Delta agreed this week to pay to merge with Northwest Airlines and still have $600 million left over.

"A few years ago, individual income reaching into the billions of dollars was unfathomable. In 2002, the first year the magazine tracked hedge fund compensation, the top 25 managers earned $2.8 billion combined.

"Paulson's feat was even more astonishing because he started 2007 managing $6 billion, not a massive pool of money by hedge fund standards. Over the course of the year, one of his funds earned a whopping 590 percent return, and another soared 353 percent, according to Alpha. By the end of December, his funds' assets were worth $28 billion.

"He amassed his winnings by 'shorting' securities linked to subprime mortgages. In a short sale, the investor borrows securities -- in this case, subprime mortgages that were widely held by banks, brokerages and other investors -- and sells them to another buyer. Later, the investor must buy those securities back and return them to the original lender. As the subprime market collapsed, the value of the securities fell, and Paulson was able to pocket the difference. The lenders were stuck with the losses.

"Several hedge fund managers, including Philip Falcone, who has been challenging the board of the New York Times Co., also profited from the mortgage crisis by betting that subprime debt securities would plunge in price. Falcone earned $1.7 billion last year. Others made fortunes by betting that the prices of commodities such as oil, sugar and corn would rise.

"Hedge funds are pools of private money, largely generated from wealthy individuals, pension funds and endowments, used for a wide range of investments. Usually 80 percent of any gains are given to such investors, while fund managers take 20 percent, plus an annual fee for their services. Alpha's list tracks the income that managers receive after paying their staff members and other expenses.

"Some Wall Street analysts who follow the industry said the gigantic compensation figures may prompt Congress to consider raising taxes on the business. Last year, several lawmakers introduced bills aimed at raising the tax rate, usually 15 percent, that fund managers pay on their gains. None of these efforts became law. "

Mr. Strachman and others claim raising taxes on hedge funds really isn't fair ~ the Captains of Churning Wall Street Markets gambled that borrowed stock, and won that money, fair and square!

http://www.washingtonpost.com/wp-dyn/content/article/2008/04/16/AR2008041602027.html

The New York Times observed yesterday that "the..unprecedented and growing affluence underscores the gaping inequality between the millions of Americans facing stagnating wages and rising home foreclosures and an agile financial elite that seems to thrive in good times and bad. Such profits may also prompt more calls for regulation of the industry.

"Even on Wall Street, where money is the ultimate measure of success, the size of the winnings makes some uneasy. 'There is nothing wrong with it — it’s not illegal,' said William H. Gross, the chief investment officer of the bond fund Pimco. 'But it’s ugly.'”

http://www.nytimes.com/2008/04/16/business/16wall.html

Your Demon can't help but note that the last time we saw such extremes in the economy it was the good old Roaring '20's ~ except that it inevitably led to a crash, and suicides as the cannibal captains of Wall Street watched their fortunes melt away, and, rather than face the world without money, leapt out of Wall Street windows to their deaths. The Great Depression followed. But that can't happen now, can it? Banks are supposed to be regulated (except if they're investment banks like Bear Stearns) ~ but no matter ~ you, the taxpayer, are indemnifying them from all their bad and risky decisions. You pay more taxes (they get more favorable rates than you), and you pay the increased costs of everything due to the tanked dollar and a moribund economy ~

If you really want an-eye-opening treat regarding the historic paralells and danger signs, over at that heretic liberal progressive website TPM Cafe there's a very lively book review and discussion going on about the ghosts of the Roaring '20's and what they might teach a new crowd of progressives about the empty activity generated by churning money markets (or nothing of very great practical use being produced, except profits of "thin noney, aka money "out of thin air"~) that led to the Crash.

For instance, an interesting comment:

"Now, the next key question is: what does that 'thin air' money get used for? If it is used to purchase physical goods and services, and to invest in the future expansion of output then things pretty much stay in balance and everyone's happy.

"Everyone, that is, except the usurers and speculators, who would rather use the 'thin air' money to create even more 'thin air' money. When you allow this to happen, the end result is always, always bad. This is the problem we have run into today. There is a fundamental mismatch: the financial system can create an unlimited amount of debt. The real economy cannot do the same for physical wealth. (see "The roots of the subprime crisis" at http://www.eurotrib.com/?op=displaystory;sid=2008/3/11/122016/316

"So, when you have a financial meltdown, it's usually because the ability to create money out of thin air was being used for private speculative gain, rather than for the public good. The solution, therefore, is relatively straightforward: you use the sovereign power of government to cancel or negate all useless 'thin air' money - in our case today, some $500 trillion of derivatives - and you use the 'full faith and credit' of the government to either reorganize that 'thin air' money or create new 'thin air' money while making sure that it is directed only into useful and productive activities. No speculation, no usury.

"Of course, it does not work out all that simple, largely because of the massive political crises that are created as the faction of usurers and speculators attempt to maintain their prerogatives. That's basically the story of the creation of the conservative movement: a bunch of rich twits who were unhappy with the New Deal restraints on their ability to get rich quick kiting 'thin air' money decided to create a movement to demand 'free trade' and 'free markets.' That's really what it all boils down to.

"The usurers and speculators will do anything to prevent this, including attacking, deprecating, and sabotaging the'full faith and credit' of the economy. The last time it got this bad, Franklin Roosevelt stuck to his guns, a bunch of usurers and speculators (including George Bush's grandfather) ended up asking retired Marine General Smedley Butler to stage a military coup and impose essentially a banker's fascist dictatorship. I am NOT making this up! See http://en.wikipedia.org/wiki/Business_Plot Fortunately, General Butler listened to the bankers very politely, then turned right around and screamed "foul" as loud as he could. Unfortunately, all the coup plotters got off without even a scolding - we would probably be better off today if at least a few of them had been shot for treason.

"So, the technical side of what to do to stop and get out of a meltdown is relatively simple. It's the politics that presents the real messy problems."

http://tpmcafe.talkingpointsmemo.com/2008/04/16/the_perils_of_deregulation/