Hedge Fund Managers Give Congress an Earful

Date: Friday, November 14, 2008
Author: HFN Daily Report

Some of the hedge fund industries most successful managers told Congress Thursday to quit blaming the asset class and focus on subprime loans, financial institutions and rating agencies as the basis of the financial crisis.

The House Committee on Oversight and Government Reform, chaired by Henry Waxman (D.-Calif.), held hearings to examine systemic risks to the financial markets posed by hedge funds and proposals for regulatory and tax reforms.

Hedge fund manager stars who were asked to appear and testify about their industry included John Paulson, Paulson & Co.; George Soros, Soros Fund Management; James Simons, Renaissance Technologies; Philip Falcone, Harbinger Capital Partners; and Kenneth Griffin, Citadel Investment Group.

The one thing those managers had in common was that they each made, on average, more than $1 billion last year.

Everything from lack of mortgage underwriting standards to Treasury's conduct of the $700 billion bailout was cited by the managers as being the real cause of the country's fiscal woes.

Paulson, who was one of the first to short subprime last year, told the Committee, "There was a complete mispricing of mortgage securities. We found Moody's and S&P were rating some of these triple-AAA that we thought were worthless."

Simons agreed that ratings agencies were a big aspect of the problem. He proposed that big bond investors, like Pimco or the California Public Employees' Retirement System, sponsor a new nonprofit agency that would focus on complex instruments.

Although the managers agreed that greater transparency was warranted to determine if there might be systemic risk from hedge fund activity, they also said it should be provided only on a confidential basis to a government regulator.

Griffin said the economic crisis did not call for greater government regulation of hedge funds.

"Failure stress points have been in the regulated institutions, whether AIG, Fannie and Freddie, the banking system," Griffin said. "We haven't seen hedge funds caught in the current economic tsunami."

Also high on the list of continuing problems in the financial crisis was the way the Treasury Department handled its $700 billion bailout program.

Simons pointedly told the Committee, "in all the trillions of government support that has been handed out globally, not one dollar yet has been used to support a hedge fund. The problem has been with investment banks and other financial institutions."

Falcone said he was in favor of the government's Troubled Asset Relief Program (TARP), "but I don't think it should be used for random purchasing of assets because of lack of clarity of what institutions will do and what benefits it will give for individual institutions."

Soros, who has been vocal in his opposition to the administration of President George W. Bush, said he was on record as being critical of the TARP proposal. He said he also believed that the equity injection directly into banks "was not adequate or acceptable."

"If it were properly done, $700 billion would be more than sufficient to replenish the gaping hole in the banking system and encourage the banks to start lending," he said.

Naturally, elected representatives, doing the kind of grandstanding that is common in Congressional hearings, also wanted to score points against what they view as the unfair tax advantages they believe private investment managers enjoy.

Last year, Congress failed to pass a bill to tax so-called carried interest as ordinary income, instead of the capital gains tax rate that it currently enjoys.

Griffin, who said that most of his income last year was subject to ordinary income tax rates, said the issue was how the tax laws approach the issue of capital gains for all taxpayers.

"What we should seek to have is consistency in how we treat long-term capital gains whether it is hedge fund, private equity, or investors in a business," Griffin said.