Sunday, November 16, 2008

Being John Bogle III

Here is Mr. Bogle on hedge fund managers, namely Henry Paulson, in chapter one of Enough. True Measures of Money, Business, and Life.

According to the New York Times, the highest - paid hedge fund manager for 2007 was John Paulson, who took down a cool $ 3.7 billion. It is said that his firm, Paulson & Company, made more than $ 20 billion for his clients by betting against certain mortgage - backed securities (more fully described later). Who's to begrudge Mr. Paulson a large share of the rewards that his firm earned for its clients by such a remarkably successful speculation?*

Not I! My problem with the incredible compensation earned by hedge fund managers is its asymmetry — its lack of fundamental equity. Managers on the winning side of speculation win big; but the losers don't lose big. For example, if the Paulson firm indeed won its gamble by betting that mortgage - backed securities or collateralized debt obligations would tumble (or being on the right side of the rank speculations known as credit default swaps), some other firm lost its gamble, betting that those debt obligations (or those swaps) would rise. The other side, it follows, would have lost $20 billion. But those managers, as far as anyone knows, didn't give $ 20 billion back to their clients. So the huge cost of our financial system rose, benefiting insiders even as their clients were impoverished (relatively speaking).

∗ I do begrudge hedge fund managers the maximum 15 percent tax rate that the federal government applies to so - called carried interest, an obfuscatory phrase referring to the share of profits paid to hedge fund managers. Such a low rate is an insult to those hardworking citizens whose far smaller earned incomes are often subject to standard federal tax rates that are twice as high or more. I also understand that clever tax planning enables this income to be deferred, free of any taxes and earning a return until drawn down later. Unsurprisingly, attempts at tax reform by Congress have been overwhelmed by the well - funded lobbyists hired by hedge fund managers.

Is having Mr. Paulson over the $750 billion dollar bailout like having the fox in the hen house?

Another question, who has benefitted most over these past years, the hedge fund managers or the middle class?

Mr. Buffett's fair statment that his secretary should not be paying more taxes than him is very relevant here.

We can't continue like this. What should be done?

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